Does Strict Due Diligence Guarantee A Successful IPO?

This article appeared on Business Times Weekend edition on 12 Jan 2008 which i thought may an a good article to share on my blog in case you have missed it. Personally i like the IPOs from HL Bank and Sterling Coleman.

Does strict due diligence guarantee a successful IPO?
By TEH HOOI LING SENIOR CORRESPONDENT

THE Singapore Exchange believes that investment banks which have very strict due diligence processes will tend to bring in better quality companies to the market. This is why it is going to be very selective in qualifying the full sponsors - those responsible for bringing companies for listing on its new board, Catalist. So which of the investment banks have had the best record in the last three years?

Before we go into the detailed results, let's set the stage with some big picture numbers. Just under 150 companies were admitted to the main board of the SGX between 2005 and 2007. For Sesdaq, it was 36. More than half these companies - 56 per cent for the main board and 58 per cent for Sesdaq - underperformed the SES All Shares Index from the time they were listed to Jan 9, 2008.

Now on to the records of the various investment banks. Surprisingly, all the local banks' corporate finance outfits did not have a very good history of bringing better performing companies to the market.

For example for DBS, of the five companies it brought to the main board in 2005, only one - Asia Enterprise Holdings - managed to outperform the broad market. The rest - Longcheer, Genting International, Electrotech and CDW - had all fared worse than the market. These are IPOs where DBS was the sole issue manager. The average annualised returns of the five IPOs is 14 percentage points worse than the SES All Shares Index. The median is -10 per cent.

In that year, OCBC brought three companies to the main board. All three - Ban Leong Technologies, Karin Technology and Union Steel - under-performed the market. Meanwhile, UOB Asia had four main board IPOs in 2005. Only one - C&O Pharmaceutical just about edged ahead of the general market by 1.3 per cent. The rest, Sarin Tech, Advanced Integrated Manufacturing and Pacific Healthcare chalked up returns of 10 to 36 percentage points lower than the market. All its three Sesdaq companies in that year also fell significantly behind the market - in excess of 30 percentage points - in terms of share price performance.

Their general record in 2006 also left much to be desired, although OCBC did hit the jackpot with Jiutian. Between its IPO and Wednesday this week, the stock has outperformed the market by a whopping 160 percentage points. Last year was not much better.

Arguably, the investment bank which has the best performance in the past three years is HL Bank. There are more hits than misses when it comes to the companies it helped go public. In 2005, it managed the IPO of China Sky Chemical and Sinopipe Holdings. The former outpaced the market by 45 percentage points, while the latter performed in line with the market. Three out of its five IPOs outpaced the market. There, is however, no escaping the duds. In that year, Fabchem had turned out to be one, and so did Sun East. Last year, it was responsible for bringing China Oilfield to Singapore. And up till this week, that counter is ahead of the market by 48 percentage points. Even for Sesdaq listing, HL Bank has brought more winners and losers to investors.

Hong Leong Finance had a very good record in 2005. It hit the bull's eye in all three deals that it did - Fragrance Group, BH Global Marine and China Wheel. Each has outperformed the market by 92, 52 and 11 percentage points respectively. However, the outfit did not have any deals in the last two years.

Another two investment banks which had brought more winners than losers to the market are Westcomb and Stirling Coleman. Ironically, they are two of the firms which have been censured before by the exchange for supposedly not being stringent enough in their due diligence work.

Westcomb brought eight companies to the main board and nine to Sesdaq in 2005. Out of that, five from each board have beaten the general market returns. It did only one deal in 2006, and that was Swiber. The stock has turned out to be a multi-bagger for investors. It has risen by eight times compared with its IPO price. One of two of its Sesdaq deals in 2006 also turned out to be a super performer. Sitra Holdings has returned 344 per cent since its debut on the second board in November 2006. Westcomb's record in 2007 also stands out. Out of the four deals it did - three for main board and one for Sesdaq - three outperformed the market by a big margin.
As for Stirling Coleman, it has its hits and misses. But the hits more than make up for the misses.

My study also found that when the market got heated in 2006 and 2007, investment banks tended to stay conservative in pricing their IPOs. As a result, there were huge gains on the first day of trading. The average was 33 per cent gain on debut in 2006 and 50 per cent in 2007. This compared with just 2.9 per cent in 2005.

However big foreign issue managers like UBS and Credit Suisse were rather aggressive in pricing their IPOs. This resulted in issues which didn't leave much on the table for IPO investors, or worse, issues which fell underwater on the first day of trading.

UBS's Babcock and Brown dropped below its IPO price by 4.7 per cent on its first day of listing on Dec 20, 2006. The Swiss bank's two other issues - MacarthurCook Industrial REIT and Parkway Life REIT - last year also ended below their offer prices by 3.3 per cent and 7 per cent res respectively.

The average first-day performance for Credit Suisse's two IPOs in 2006, meanwhile, was a mere 4.6 per cent and its lone IPO in 2007 chalked up a first-day gain of 8.7 per cent. Again, these are issues where the banks are the sole managers.

So, as seen from the study, having a strict due diligence process at the IPO stage does not necessarily guarantee a market-beating issue.