An initial public offering (IPO) typically presents a snapshot of a business as it prepares to list. There is usually a 'proforma' profit and loss and balance sheet, which means that the accounts are not what actually existed just prior to IPO.
Post IPO the 'proforma' business, as it was presented, no longer has the ability to choose how and what to include in its accounts. Investors will own a share of a business that will progressively reveal how well it can deliver on its IPO investment outlook and how well its management, products and structure can cope with positive and negative surprises.
This paper examines a database of almost 1,900 IPOs that have taken place since the year 2000. We attempt to answer the question as to whether there is a degree of financial alchemy in the IPO process that causes underperformance as a business reveals its level of profitability and sustainable return on capital.
"In the end, alchemy, whether it is metallurgical or financial, fails. A base business cannot be transformed into a golden business by tricks of accounting or capital structure." Warren Buffett, 1989 Annual Report Berkshire Hathaway
These issues have been around forever
In 1720, while discussing the significant volatility surrounding South Sea shares, Sir Isaac Newton, who at the time was Master of the Mint, remarked that, "I can calculate the motions of the heavenly bodies but not the madness of people."
For this reason, it is necessary to examine the performance of IPOs over a reasonable period of time to remove the impact of positive and negative short-term speculation and trading noise. We are interested in examining returns over a sufficient period for the business to report multiple interim and final results and to hold multiple annual general meetings. That way investors will be able to access value not just based on the snapshot presented at IPO but on multiple sets of accounts and presentations.
During the era of Sir Isaac Newton's tenure as Master of the Mint there were all sorts of interesting capital raisings including those to create a wheel of perpetual motion and many to profit from trading with the newly discovered Terra Australis. What could possibly go wrong?