| dc.description.abstract | It is often recommended that the issue price of an IPO be equal to the fundamental
value because this is the optimum price for all the parties involved in the IPO process
including the underwriters and investors. However, this rarely happens in practice
because in determining issue prices, certain subjective considerations are made that
have nothing to do with the perceived fundamentals of the company. It is this
relationship between the fundamental value at the time of an IPO and the issue price
selected that is the focus of this research project. In determining whether a particular
IPO has been undervalued or overvalued, most studies take the initial day closing
price as a substitute for the fundamental value and compare it with the issue price.
However studies such as those carried out by Purnanandam and Swaminatham (2004)
demonstrate the need for a more realistic approach in determining fundamental values
for the purpose of establishing under pricing/under valuation. In this particular study a
retrogressive discounted cash flow approach was used to determine the fundamental
values at the time of the IPOs by using the post-IPO financial performance of the
companies to determine the free cash flows to the firm. These free cash flows along
with a terminal value were then discounted back to the IPO date. A sample of 5 IPOs
that were carried out between the year 2006 and 2010 was selected for this study. The
results that were obtained after a detailed analysis were mixed, with 60% of the
sampled companies showing that they were significantly overvalued at the time they
went public by an average of 128.7%. It is important to note at this point that 2 of the
companies that registered the largest valuation premiums namely, Eveready East
Africa Ltd and Safaricom Ltd experienced sharp price reversals a few months after
going public. 40% of the IPOs were found to be under valued with discounts
averaging 43.5%. A mean computation of the entire sample revealed an overall
average premium of 59.9% for the entire sample, this in line with the results of
Purnanandam and Swaminatham (2004) that found that on average IPOs in India that
were described as being under priced, were in fact over valued by an average of 50%. | en |
