An analysis of underpricing and aftermarket performance of initial public offerings on the Alternative Exchange (AltX)

This paper reviews the international evidence of underpricing of Initial Public Offerings and analyses IPO underpricing by companies listing on the South African Alternative Exchange (AltX). Underpricing is indicated by measuring the percentage difference between the initial offer price and the closing market price on the first day of trading. Underpricing is costly to the pre-issue shareholders. However, studies have reported significant long run underperformance of investing in IPO listings. The objective of this study is to test whether new listings on the AltX are subject to underpricing and measure the level of such underpricing as well to measure the aftermarket performance of investing in new listings on the AltX.During the period October 2003 to September 2007, 42 firms listed on the AltX. The findings of this study indicate that underpricing was evident on the AltX during the period under review with the average first-day return recorded at 29%. The level of underpricing compares with other South African studies which indicated an average underpricing of between 27% and 32.7% for companies listing on the JSE Securities Exchange. The results of this study are consistent with the level of underpricing indicated in prior studies. However, the level of underpricing indicated by a prior study of the Development Capital Market (DCM) was significantly higher than the underpricing indicated by this study for new listings on the AltX. This may be due to the focus on high quality listings by the AltX, increased listing and corporate governance requirements as compared to the DCM as well as due to the continuing role of the Designated Advisor to companies listing on the AltX.Levels of underpricing have not increased on the AltX in the last six months of the study and there is no evidence to indicate that the level of underpricing is related to firm size, the level of proceeds or the age of the firm.Limited analysis of aftermarket performance of the new listings on the AltX indicates that investors would have earned a non-risk adjusted cumulative return of 44% higher than the market benchmark (ALSI), based on the opening issue price. If the first day return is excluded then investors would have earned a non-risk adjusted cumulative return of only 6% higher than the market benchmark. The performance of AltX companies, excluding the first-day return, has been similar to the Small Cap Index of the JSE. The study did not find that high initial returns for AltX companies were followed by long-run under-performance, yet the very low incremental return relative to the ALSI market index, once the first-day return is omitted is surprising relative to the higher risks involved of investing in the small listed entities of the AltX.