1

UNIVERSITA' COMMERCIALE LUIGI BOCCONI

Bachelor in Economics and Finance (CLEF)

Are Private Equity funds successful ways to growth?

Empirical Evidences based on Italian market.

Tutor:
Prof. Stefano Gatti

Final Dissertation:
Antonio Mercurio ID 1239284

Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . .
3

I.

The theoretical framework

. . . . . . . . . . . . . . .
5 5 5 5 8 10 10

Chapter 1. Private Equity and Venture Capital: a general overview . . . . . . . . . . . . . . . . . . . . . . . 1.1. Private Equity and Venture Capital definition . . 1.2. Private Equity and Venture Capital role . . . . . 1.3. Trend Analysis before financial crisis . . . . . . 1.4. The disinvestment process . . . . . . . . . . . .

Chapter 2. The Financial crisis impact . . . . . . . . . . . . 2.1. The fall of Private Equity . . . . . . . . . . . . . . .

II.

The Analysis
. . . . . . . . . . . . sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14 14 15 16 18 21 22 22 25 27 28 30 32 33 35

Chapter 3. Analysis background . . . 3.1. Review of the main literature 3.2. Research hypotheses . . . . . 3.3. Variables description and data 3.4. Sample description. . . . . . 3.5. Methodology . . . . . . . . . Chapter 4. The analysis result 4.1. The Profitability . . . 4.2. Financial Solidity . . . 4.3. Managerial Efficiency . 4.4. Corporate Development . 4.5. Underpricing . . . . . . 4.6. Empirical Analysis Gaps Bibliography . . . . . . . . . . . . . . . . . . . . .

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Introduction
The aim of this work is to show the contribute of private equity funds to societies' decision to go public in the Italian market: how the private equity funds are successful to create value in the subsidiary companies through the functions of certication, monitoring and control; besides, their contribute to the reduction of underpricing in the securities placing . The work consists of two parts, the rst one is about the Private Equity industry environment, in which the analysis developed in the second part is engaged. The rst chapter introduces the above industry by highlighting the increasing role played in the economy in recent years, not only in Anglo-Saxon world, but also in continental Europe and emerging markets. In this chapter there are described the trends that have recently characterized the industry, highlighting the characteristics of operators, the markets in which they operate and the nature of their investments. The chapter ends with a brief description about the important phase of disinvestment. The second chapter continues analyzing the Private Equity environment, explaining how it reacted to the nancial crisis of past years and especially focusing on the Italian market events. The third chapter introduces the empirical analysis with a brief review of the literature and the description of the statistical samples and the methodology used. The literature emphasizes the role played by Private Equity rms in mitigating agency problems and in supporting growth and economic development through innovation activity of R&D. Mitigating agency conicts between shareholders and managers when the company is still private and between the original shareholders and new investors in the IPO, Private equity performs screening, monitoring and certication for investments held in the portfolio. The fourth chapter goes deep into the empirical analysis showing its results. Consistent with the literature, the analysis should conrm the hypothesis that VentureBacked issuers were characterized by better operating performance and lower underpricing in the stake placement.

Part I
The theoretical framework

Chapter 1
Private Equity and Venture Capital: a general overview

1.1. Private Equity and Venture Capital denition

The terms Private Equity and Venture Capital (PEVC) denote an entrepreneurial activity that, starting in the 80s from the Anglo-Saxon world, has conquered a global relevance by now. With PEVC, it is pointed out the institutional investment activity in the risk capital of rms in a long-medium term perspective. This activity has the aim to create value and to realize a capital gain from the sale of its stake. In the Anglo-Saxon meaning, Venture Capital is a subset of the wider Private Equity activity, while in Europe the two activities are usually separated; Practically there isn't any dierence except for the investment typology, that dened the Venture Capital as the nancing activity of rm life specic phases such as Seed, Start-up and Early Stage. The characteristic element of Private Equity activity is the equity investment, that consists in a medium-long term nancing for a generally non listed target rm.

1.2. Private Equity and Venture Capital role

The investment activity in the risk capital of institutional investors helps to develop the industrial system and the whole economy, supporting with capital the most deserving entrepreneurial initiatives. The capital can be used to develop new products, technologies or markets, to nance the working capital or capital expenditure expansion, to solve corporate governance problems, to nance corporate nance operations and nancial structure re balancing. Nevertheless, the PEVC contribution is not limited to satisfy the capital needs, but also to contribute in terms of certication and network eects. The institutional investor has a remarkable experience and professionalism in the advisory, mentoring and consulting activities as well as solid relationships with the nancial, political and industrial sectors. There is evidence that the greatest contribution of Private Equity operators is the lobbying activity that they are capable to conducting thanks to their strong networks.

1.3. Trend Analysis before nancial crisis

The data provided by the private equity principal operators, underlined that , between 1998 and 2007, a high growth of the industry, both in terms of nancial resources collected (CAGR=14,70%) and in terms of resources employed by investments (CAGR=17,44%). In other words, the PEVC has quadrupled its turnover in a decade, with global investments in 2007 amounted to 297 billion U.S. dollars, or 0,55% of world GDP.

Chapter 1. Private Equity and Venture Capital: a general overview

6
(1998 2007)

Figure

1.1. Investments

and

funds

raised

global

trends

Sources: The PricewaterhouseCoopers; Venture Economics; National Venture Capital Association; Thomson Financial; CVCA Annual Statistical Review

Fundraising reached a record US$459 billion globally for 2007, rising 5% to exceed even the US$437 billion total for 2006. In this framework there is a dierent contribution depending on the region: The United States are the rst country for both funds raising and investment destination. In fact, in the United States there is more than half of the global funds raising, where a signicant part of the funds collected are allocated to foreign investments.

Table 1.1. Private Equity volumes - comparison between 2004 and 2007 (US$ bil.)

Sources: The PricewaterhouseCoopers; Venture Economics; National Venture Capital Association; Thomson Financial; CVCA Annual Statistical Review

As shown in table 1.1, Private Equity industry is much more developed in Anglo-Saxon countries: in these countries, the private equity industry is more ecient due to a bigger average size of the operators, which can manage a lot of operations every year. Moreover, the greater ease of raising capital and the possibility of easily nding a way out for the investment, makes possible to realize bigger investments for Anglo-Saxon operators. The most striking nding from the table is the continued rise of the emerging markets as investment destinations. In addition to India and China's rises as investment destinations, the following countries stand out: Malaysia , Singapore, South Africa and Hong Kong.

Chapter 1. Private Equity and Venture Capital: a general overview

The amounts invested in individual countries were small by the standards of those huge transactions, but they undeniably show a signicant shift in investment. Once again, investments made exceeded locally raised funds, showing that capital has been transferred from North America and Europe (Overhang).

Table

1.2. Private

Equity

and

Venture

Capital

Operators

(2007)

Source: Data processed from previous sources

Table 1.2 provides an overview of the dominant players in the industry of PEVC in dierent geographic areas, highlighting dierences related to the specic legal, scal and cultural frameworks. In the U.S. , institutional investment in venture capital is mainly conducted through VC funds, in the legal form of the Limited Partnership: in addition to one or more general partners (GPs), there are one or more limited partners (LPs). The GPs are, in all major respects, in the same legal position as partners in a conventional rm, i.e. they have management control, share the right to use partnership property, share the prots of the rm in predened proportions, and have joint and several liability for the debts of the partnership.Like shareholders in a corporation, LPs have limited liability, meaning they are only liable on debts incurred by the rm to the extent of their registered investment and have no management authority. The GPs pay the LPs a return on their investment (similar to a dividend), the nature and extent of which is usually dened in the partnership agreement. A favorable tax regime has pushed the diusion of this vehicle, that is a system of scal transparency that avoids double taxation if the company realizes capital gains on investments held in the portfolio for more than ten years. The limited liabilities partnerships, that apply the funds of funds (FofF) scheme, are also widespread, where some of the general partners are limited partnerships companies. Finally, the small business investment companies (SBIC), with the equity divided equally between public and private, are also relevant. Even in Britain the major industry players are Limited Partnerships, but a signicant role is also played by VC trusts, which oer a high exibility of use thanks to the complete legal segregation between the investors and the trustee. Contrary to the Anglo-Saxon model, the PEVC activity in Europe is strictly regulated because it is considered a nancial service. For this reason, the favorite vehicle in continental Europe is the close-end fund. An exception is represented by Germany, where the most common vehicle is KG that applies a very similar scheme to that of Anglo-Saxon partnerships: a KG has one general partner and one or several limited partners. in the majority of cases, the general partner of a german kg is a limited company. The limited partners may be participating in the KG directly or via a trustee.

Chapter 1. Private Equity and Venture Capital: a general overview

8
(2004-2007)

Figure

1.2. Distribution

of

investments

by

stage

Source: Data processed from previous sources

Figure 1.2 shows what are the clusters, where the PEVC investments are concentrated, in dierent geographic areas and what is the market trend in the ve years before the nancial crisis. It is clear that most of the resources are employed to nance the acquisition of target companies, which is very expensive. For this reason, it is very common the use of Leverage Buy-Out (LBO), where the funds for the tender oers come predominantly from debt. This activity was growing in US and Europe, contrary to Asia, where the characteristic stages of Venture Capital activity, such as Seed, Start-up and Early Stage are more common. On these investments Europe is very late, especially in countries such as Italy, where there aren't activities of seed nancing. This situation testify the incapacity of the country to sustain the new entrepreneurial activities, even if they would deserve a lot of attention because they are localized in very innovative elds such as bio technologies, renewable energies and information & communication. Finally, also the replacement and vulture nancing activities hold little importance in Europe, especially when they are focused on the restructuring of operations in crisis.

1.4. The disinvestment process

The disinvestment phase consist in selling of the PEVC operator stake.This phase is very critical, because it can impact on the value created by the investment, i.e., words on its Internal Rate of Return (IRR). The disinvestment is characterized by two fundamental choices: the most appropriate moment for divesting (timing) and the most appropriate channel for disposing (way out). The principal investment way outs can be summarized as follow: 1. 2. 3. 4. 5.

Initial Public Oering: the sale of the shares on the market. Trade Sale: the sale of the stake to an industrial partner. Replacement, Secondary buy-out: the sale of the stake to another priBuy-back: The repurchase of participation by original member's Write-o : The reduction in the value of an asset or earnings by the amount
of an expense or loss. It is not related to a sale but rather to a liquidation or to a bankruptcy. vate equity operator.

Even though the choice of the investment way out is partially dened at the time of the negotiation, it results from a number of factors related to the type of the target (size, sector, organizational characteristics etc.), the results achieved through collaboration between investor and entrepreneur, economic factors, including the specic wishes and preferences of all shareholders. In fact, none of the above ways is actually programmed with a degree of absolute certainty: everything depends on the quality of Private Equity operator work and success.

Chapter 1. Private Equity and Venture Capital: a general overview

The listing of subsidiary securities on a regulated market is, in most cases, the most coveted way of participation disposal. Stock market otation should correspond with a genuine wish to make the company more dynamic over the long term and to prot from the growth possibilities oered by a stock market. Therefore, the equity share placed on the market (the oat) must be suciently large to ensure liquidity  the reward for appealing to the market. A otation is not an end in itself but the beginning of a long process of development.
Figure in 1.3. Disinvestment Europe trend of divested ve at largest historical economies cost.

amount

Source:

The PricewaterhouseCoopers; Venture Economics; National Venture

Capital Association; Thomson Financial; CVCA Annual Statistical Review

In reaction to the growing number of operators, the disinvestment through the sale of the stake to other private equity operators have increased consistently. Countries with a mature market, such as Great Britain, are characterized by a framework where is represented the full range of way out solutions. Other countries with less experience, such as Italy and Spain, show a focus on certain channels, while others are almost totally absent. For example, in Spain, where the stock market is poorly developed, the public oer of participation is a channel of disinvestment little practiced, while it is important exit through sale to management (MBO). In Italy, the disposal on regulated markets is common, as well as trade sale and the sale to another institutional investor. Buy-back and management buy-out are marginal solutions. In short, the trade sale is the preferred mode of disposal, regardless of the geographical area. Some of the way outs are strongly aected by nancial markets trend. For this reason Initial Public Oering, Secondary Buy out and Replacement are reduced during the downturn and they growth during the upturn.

Chapter 2
The Financial crisis impact

2.1. The fall of Private Equity

The years before the nancial crisis have been a golden age for Private equity, characterized by record peaks in raising capital, investments and disinvestment. Several factors have supported this incredible period:  favorably low interest rates, that have allowed a high leverage use  strong investor demand, supported by an abundant availability of capital (mainly from Asia)  strict requirements for diversication of operators (especially pension funds), that have encouraged LBO operations  regulatory changes, especially in the European pension funds, which have increased access to alternative investments. These positive trends, however, were abruptly interrupted by credit crunch. The large availability of credit that had marked the years before the crisis had strongly encouraged the funds' investments into best performing companies. There were many companies showing prot margins capable of capturing the interest of private equity funds, and the former favorable conditions I wrote about, triggered the typical LBO mechanism: consequence of the good market. Up to the point the market was characterized by the balance between supply and demand there were no problems. However, when the credit crunch became suocating because of the crisis, PEVC operators experienced a rapid decrease in the performance of their investments and remained with considerable quantities of landlocked capital. The activities of the companies did not drive investments anymore and, once the most dramatic moment of the credit crunch was over, the demand for protable companies by PEVC operators exceeded supply: in essence, the stagnation of the market. In 2008, global private equity investments were halved over the previous year, driven downward by the imbalance between quality companies demand and supply; the most aected were the buy outs that in addition to not nding suitable target companies, could not rely on debt levels used in previous years, consequently reaching equality in comparison to the equity in 2008. leverage was the the natural

Chapter 2. The Financial crisis impact

11
by operation type (2007-2008).

Figure

2.1. Global

investments

Source: IFSL

In Europe, the decline in investments was mainly generated in the fourth quarter, in line with what happened in the nancial markets. The same way, also the exit activities signicantly fell , while write-downs increased. In terms of fund raising, the overall level dropped far less than investments, but this is largely due to those funds that have had to delay or anticipate the closing collections. In addition, the so-called denominator eect portfolios has considerably aggravated the impairment. On the other hand 2008 was double-faced for Italy: very negative fund raising (depressed by the low interest of banks and funds of funds) and exits trend (write-o accounted only for 20% of total), while investments surprisingly reached their peak (especially in the expansion segment), due to the fact that the real economy crisis arrived in Italy later than the rest of European countries, which experienced signicant decreases in the activity of investment. This trend was conrmed in 2009, a year particularly negative for Italian private equity both in terms of fund raising and investments, and with massive write-downs on the front of the exits (more than

for limited partners

1 bi ).

Figure 2.2. Italian PEVC market by fund raising and investments (2005-2009).

Source: Price Waterhouse Coopers

because of the diminished value of a limited partner's public equity holdings (at-

tributable in many cases to a necessary mark to market valuation), the percentage of its holdings attributable to private equity has, in many instances, exceeded that limited partner's targeted allocation for that asset class.

Chapter 2. The Financial crisis impact

12

Despite the nancial crisis, PEVC activity has shown one of its main strengths: exibility. In fact, the small-size operations, especially nanced with equity, have taken the place of big size operations of the previous years. In other words, even though global buy outs fell even lower in 2009 (the realized deals were worth only $ 81 bi , while in 2007 their value were about $ 600 bi ) , if we analyze the quarterly data of 2009 it is possible to see a recovery. In particular buy outs steadily grown both at global level and at European level: 8% volumes increase in Europe in the second quarter, after the rst one followed the 2008 negative trend; in the third quarter, despite the number of investments, which were lower (-10%), the volumes increased by 10%. Concurrently globally, the investments rose by 35% in the 2nd quarter (from $8 to $ 11 bi) and more than doubled in the 3rd quarter (arriving to $ 25 bi.) In the last phase of the year, the worldwide increase was of 44% (up to $36 bil.) and even by 110% in Europe (from $2 of 3rd quarter to $5,5 bil. ).
Figure 2.3. Global and European buy outs trends.

Source: EVCA, Prequin, Thomson & Reuters

At this point, if we consider the whole framework, characterized by the great LBO depression, the changing in the operations size and the fact that the nancial crisis reached its climax between the end of 2008 and the beginning of 2009, we can assert that the PEVC activity reacted to those extremely down times, turning its attention to smaller operations with more equity to support. In particular, the rising trend observed since last year are about investing in distressed companies, in nancial institutions, PIPE transactions, diversication into new target areas (especially infrastructures) and developing countries.

Part II
The Analysis

Chapter 3
Analysis background

3.1. Review of the main literature

In the last decades an increasing number of studies concerning the PEVC market, in parallel to its development, has always been more central and considered from researchers and academicians. The innumerable works produced are mainly focused on two themes: 1. 2. the role of PEVC operators to mitigate the agency problem between shareholders and managers. the contribution of PEVC to nance the economic growth and development through innovation and R&D activities. The study conducted by Megginson and Weiss (1991) belongs to the rst current. It is based upon a sample of 640 IPO, taken among more than 2000 IPO occurred in the USA between the 1983rd and 1987th, and veries the eect of certication of PEVC operators. It appears that the PEVC operators participation to the capital can be complementary or substitutive to the certication provided by investment banks and prestigious auditors. The role of the third-party certication has value whenever an informative asymmetry problem exists between the seller and the buyer in the market. This is the case of an IPO, when the issuer is interested to place its securities with external investors. In this context, if the information gap between insider and external investors does not ll, it will create the premises for market failure. In fact, the PEVC operators act constantly on the market, participating in dierent rms capital. For this reason, the incentive to provide manipulated information,penalizing the subsequent IPOs, is low. The work of Black and Gilson (1998) remarks the second condition. They documents that the return of PEVC operators is correlated to the age and the reputation growth, because they act in a very narrow and exclusive market, where the performance is constantly monitored and evaluated. Numerous contributions highlight how dicult and expensive is for the issuer to use the support of PEVC operators, who are only interested in very high annual returns (from 27% to 49%, depending on the belonging cluster of the participated rms) and impose pressing contractual clauses. As described by Kaplan and Stromberg (2003) , the venture capitalists arrange agreements in order to be part of and vote in the directors board. Furthermore, they grant deferred nancing which is conditioned by the objective achievement and underwrite convertible and privileged securities. From the foregoing lines, we presume that only rms with high and specic requisites can use venture capitalists services. The conspicuous literature about this subject is also interested in disinvestment ways of PEVC operators and particularly in the disinvestments through initial public oerings. We trace an important contribution to this area back to Lerner (1994), who documented a lower underpricing in the venture-backed IPO, justifying the lower discount on the stock issue with the certication eect. The venture capitalists capacity to identify the best opportunities of the market would be greater in the case of mature and expert operators. This is explained by their higher degree of exibility, due to their non-pressure to build a good track record. In fact, according to Gompers (1996) exists an incentive for young venture capitalists to adopt conducts that would show their ability. The young venture capitalists would be inclined to hold less participation for less

Chapter 3. Analysis background

15

time than the more experienced operators, to complete as many operations as possible. But for this reason, their IPOs result more discounted. This represents a sacrice justied only by the need to capitalize the investments in the portfolio and to undertake new investments to improve their history and reputation. On the other side, mature operators would be inclined to hold the participation longer, even after the quotation. In this way they could be able to realize higher returns both during the placing, thanks to the less underpricing, and on the secondary market. A minor stream of studies investigate the change in operating performance of rms involved in the transition from private to public ownership. The rst contribution about this theme is by Degeorge and Zeckhauster (1993), who examine the operating performance of a particular type of issuers, the reverse leveraged buyout. They verify that the information asymmetry problem faced by the rms when they turn to public markets for equity, as well as behavioral and debt overhang eects, produce a pattern in which superior performance should be expected before an oering , with a subsequently disappointing performance . Moreover, the study of Loughran and Ritter (1995) provide evidence regarding post-IPO investment performance: analyzing a sample of 4652 operating companies going public in the United States during 1969 to 1989 and listed within the next three years on CRSP daily tapes, showed that listed rms exhibit a decline in post-issue operating performance, taking into consideration a period extended to ve years after the public oering. However, the authors show that this deterioration is reduced where there is equity retention by the original entrepreneurs, a conclusion coherent both with agency theory (Jensen M., Meckling W., [1976] ) and with signals theory (Hayne E. Leland and David H. Pyle, [1977] ). There are a number of potential explanations for the decline in post-issue operating performance of IPO rms. One explanation is related to the potential of increased agency costs when a rm makes the transition from private to public ownership. The reduction in management ownership that occurs when a rm goes public, is likely to lead to an agency problem as described in Jensen and Meckling (1976). As a result of the heightened conict of interest between initial owners and shareholders, the performance of the rm could suer as managers have incentives to increase perquisite consumption. A second reason could be that managers attempt to window-dress their accounting numbers prior to going public. This will lead to overstate pre-IPO performances and to understate post-IPO performances. A third explanation for the decline in operating performance is that entrepreneurs time their issues to coincide with periods of unusually good performance levels, which they know cannot be sustained in the future. In a subsequent contribute Jain and Kini (1995) test the hypothesis of the worsening of post-issue operating performance in a sample of VentureBacked IPO rms, recognized that these subject, for the reasons set out above, have less incentive to behave opportunistically. The study , conducted on a sample of 301 IPOs collected in the period 1975-89, conrms the general trend of decline in post-issue operating performance, but it also nds that venture capitalist-backed IPO rms exhibit relatively superior post-issue operating performance compared to non-venture capital-backed IPO rms.

3.2. Research hypotheses .

The analysis will be developed in line with the contributions of the literature cited above. These considerations lead to our testable hypothesis:

H1 H2

Venture backed rms exhibit superior operating performance compared to non-venture backed rms. Venture-backed IPOs are characterized by a less underpricing respect to non-venture backed IPOs

Chapter 3. Analysis background

16

3.3. Variables description and data sources

In the way of the rst hypothesis I have selected for the analysis a set of dierent nancial ratios. They are usually utilized , according to the literature and the current practice of rm evaluation, to evaluate the rm management. In particular, I will utilize nancial ratios referable to four study areas:

PROFITABILITY
a class of nancial metrics that are used to assess a business's ability to generate earnings as compared to its expense and other relevant costs incurred during a specic period of time

indicator (ratios) ROE = Net Income after Tax / Shareholder Equity

description

sources

RETURN ON EQUITY measures the rate of return on the ownership interest of the common stock owners. It measures a rm's eciency at generating prots from every unit of shareholders' equity. ROE shows how well a company uses investment funds to generate earnings growth. RETURN ON INVESTED CAPITAL is the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested. The amount of money gained or lost may be referred to as interest, prot/loss, gain/loss, or net income/loss. The money invested may be referred to as the asset, capital, principal, or the cost basis of the investment. RETURN ON SALES A ratio widely used to evaluate a company's operational eciency. A method of valuation that measure roughly the company capacity to produce cash ows

    

database AIDA database Datastream CONSOB website Italian Stock Exchange website Issuers website

ROIC

ROS = Net Income (before interests and taxes) / Sales EBITDA / Capital employed

DEBT
measure the rm's ability to repay medium/long-term debt.

indicator (ratios)

description

sources

Chapter 3. Analysis background

17

EBIT/(Interest expense)

INTEREST COVERAGE A ratio used to determine how easily a company can pay interest on outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the company's interest expense of the same period DEBT/EQUITY A measure of a company's nancial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to nance its assets.

database AIDA CONSOB website  Italian Stock Exchange website  Issuers website  database Datastream
 

Tot.Liab/Equity

MANAGERIAL EFFICIENCY
indicator (ratios) Reve. / Tot.Ass description sources

ASSET TURNOVER Asset turnover is a nancial ratio that measures the eciency of a company's use of its assets in generating sales revenue or sales income to the company.

database AIDA CONSOB website  Italian Stock Exchange website  Issuer website  database Datastream
 

CORPORATE DEVELOPMENT
indicator (ratios) revenue growth rate description sources

competitive eciency measurement

database AIDA CONSOB website  Italian Stock Exchange website  Issuer website  database Datastream
 

Chapter 3. Analysis background

18

employment growth rate

organizational dimension measurement

Each ratio will be tested with a statistical test to reveal eventual signicant dierences between the venture backed rms and non-venture backed rms. According to the second hypothesis, I will conduct an analysis of issue price , as a way to conrm the conclusions deducted from the analysis of nancial ratios (source database DATASTREAM).

3.4. Sample description.

The analyzed sample is composed of 85 IPO that were completed between 2000 and 2006 in the markets operated by Borsa Italiana s.p.a. . To compose the sample, I excluded some companies from the sample for the subsequent reasons: Financial issuers were excluded because of PEVC operators in Italy and Europe are in general "legal vehicle" that often consist of banks and insurance companies, so it wouldn't make sense to evaluate the impact of private equity on this segment of the IPO. Companies have suered a delisting as a result of takeover bids aimed at mergers or acquisitions over the period

T , t+3 .

Finally, I excluded companies that have started a liquidation process in the three years following the quotation and the companies for which nancial information was missing for the years between

t 3

t+3

mainly because they

were created within the two years preceding the listing. The sample of 85 IPOs is divided into two subgroups, 50 non-venture backed companies and 35 venture-backed companies, identied according to the presence of PEVC operators participation for at least 2% of the capital at the time of the initial public oering. PEVC operators were identied crossing the information in the prospectuses of issuers with those obtained by the Zephyr database.
Figure 3.1. IPO number between 2000-2006 and sample composition.

Source: IPO.it, Zephyr

As shown in the gure 3.1, the sample is principally composed by companies listed in two spans, the 2000-2001 period characterized by the Internet bubble and the period of economic growth in 2005-2006. The extracted sample reveals three very interesting aspects: There is a clear correlation between the evolution of the economic cycle and the number of IPOs, such that the propensity of companies to go public is growing in the years of economic expansion and decline during recessions. Another important aspect to highlight is the strong contribution of PEVC to

Chapter 3. Analysis background

19

the development of the nancial market since, at least one out of three initial public oering was promoted by VB issuers. Finally, it is interesting to note the number of venture-backed IPOs compared to the number of non-venture backed companies in the years 2003-2004, i.e. in the years preceding the economic recovery. This observation is well known in the literature, where it is recognized to PEVC operators the ability to capture early signs of economic recovery. The analysis on the variable  issuer age , computed as the dierence between the year of listing and the year of incorporation, certies that there aren't signicant contributions to youth companies by PEVC operators in Italy. This conclusion is consistent with the observations already shown in Figure 1.2 : in Europe, compared to Anglo-Saxon model, the contribution on start-up and early growth companies is lower, with a preference to participation almost exclusively in consolidated businesses. In 2000-2006, the majority of listed companies were between thirteen and fteen years old, in other words, they were characterized by a proven operating track record.

Figure

3.2. Sectoral

distribution

of

the

statistical

sample.

Figure 3.2 shows the distribution by economic sectors of the sample. The sectors that contributed the most to the IPO market and which represent about half of the sample are the traditional industry, the production of plant and machinery, utilities, textiles and fashion; It is also signicant the contribution of technology companies and software, which have exploited the boom in nancial markets between 2000 and 2001. Regarding institutional investors' investment decisions , it is noted that the technology, distribution and production of plant and equipment are the most exploited areas. On the other hand, there is an absence of venture-backed IPOs belonging to the real estate, oil, utility and telecommunications services. In other words, in those areas directly and indirectly aected by the state. Figure 3.3 shows the dierent choices adopted by the issuers to go public.

Chapter 3. Analysis background

20
of Public oering techniques .

Figure

3.3. Percentage

use

The oering techniques are three: the Secondary oering (SO), the Primary Oering (PO) and the Splitted Oering (SPO). The SO is used to oer to the market the shares held by shareholders, so there will not be any eect on the company, but only the composition of the owners will be aected. In other words it represents only a wayout for old shareholders for realizing the capital gain. The PO aims to the placement of new shares on the market, thus it aects both the company and the property . Moreover it will be rewarded by the market due to its fundrising function. and secondary oerings. The SPO and PO oering are the most exploited techniques for both VentureBacked and Non-VentureBacked subgroups. The comparison between the two samples is very interesting , because while SPO percentage is higher in the VentureBacked sample, the OPV percentage is higher in the Non-VentureBacked sample. This observation can suggest a greater sensitivity of Private Equity operators to the signalling theory problems: the SO will be penalized by the market that recognizes the selling Shareholder moral hazard. For these reasons, the most suitable way for devesting is SPO. The descriptive analysis is concluded by the summary measures, mean and median, relating to shares held by private equity rms in the capital of the issuing companies. The sample certies that the investment of venture capitalists represents approximately 29,38% of the equity shares on average and that after the listing it is reduced to about 13.06% due to both the dilutive eect of the capital often related to the IPO and the sale of shares in the placement. The values shown take into account only the shares sold directly in the placement process. It is possible to assume that the Private Equity operators' participation to deteriorate further as a result of the exercise of Greenshoe option and then also for sales carried out on the market at the end of the lock-up period. The Venture Capitalists consistently reduce their investment after the SO (pre SO mean = 27,34% and post SO mean = 4,23%) , since they are only interested in realizing the Capital Gain. In the other two operations, the participation reduction is denitely lower (considering the mean, from 28,72% to 14,04% for the SPO and from 34,56% to 29,71% for the PO), because SPO and PO are characterized by a greater interest in nding new resources for the corporate development. The median analysis, through lower shifting between the pre- and post-IPO values, conrms more weakly the previous results. Finally, the SPO is a combination of primary

Figure

3.4. Retention

of

Private

Equity

operators

participation.

Chapter 3. Analysis background

21

3.5. Methodology
For each issuer I will analyze the nancial statements between the periods t3 and

t+3 ,

or rather in a span of seven years, where

is the year of listing. Based

on the nancial statements, I will compute the nancial ratios under analysis and build a database characterized by a number of worksheets equal to the number of companies of the sample. Then I generate a new database containing a number of variables equal to the product of the performance measures times the number of years considered. This sample will include both the subset of Once generated the venture backed issuers and non-venture backed issuers.

nal worksheet, I will create for each variable a Boxplot, to identify and exclude the outliers, which could distort the measures of central tendency. Statistical signicance testing will be conducted using the software SPSSStatistics. As method of statistical inference I will use the p-value, which is the probability of obtaining a test statistic at least as extreme as the observed one, assuming that the null hypothesis is true. We reject the null hypothesis if the p-value is smaller than or equal to the signicance level

corresponding respectively to

the probability of rejecting the null hypothesis when it is true. Popular levels of signicance are 5% (0.05), 1% (0.01) and 0.1% (0.001). For this reason, it is clear that the refusal of the null hypothesis is much stronger when the the pvalue associated with the test is small, because the probability of error is less. The assumptions set out in the analysis is used to verify if the participation of PEVC operators is neutral with respect to the operating performances and the issue price by venture backed rms compared to non-venture backed rms. In practice this means testing for equality of the statistics of the venture backed and non-venture backed sample. The signicance of the two conclusions is assessed with two tests for independent samples: Student's t-test and WilcoxonMannWhitney test. The Student's t-test , as parametrical statistic test, assumes data come from a type of probability distribution (a Student's t distribution if the null hypothesis is supported) and makes inferences about the parameters of the distribution. Let

X1 , X2
bution

denote two independent random variables, respectively representing the

sample of venture backed and non venture backed companies with normal distri-

N (1 ; 1 ) and N (2 ; 2 ), unknown means 1 , 2 and unknown variances 2 2 1 , 2 . I will test the null hypothesis that the population means are equal H0 : 1 = 2 for each indicator of the analysis.
To ensure greater robustness to the analysis, I will conduct the Wilcoxon  Mann  Whitney test, the equivalent nonparametric test of Student's t. A nonparametric statistical test makes no assumptions about population parameters and for this reason it is very useful in some circumstances, such as when it isn't certain the shape of the distribution or when there are many outliers and also when the sample is not large enough. So, let

X1 , X2

denote two

independent random variables respectively representing the sample of venture backed and non venture backed companies with the same unknown functional form equal

1 (x)

the two medians

2 (x) and possibly dierent only for a translation that moves 1 and 2 . I will test the null hypothesis that the medians are H0 : = (1 2 ) = 0 for each indicator of the analysis.
and

Chapter 4
The analysis result

4.1. The Protability

ROE (return on equity) is the best summary indicator of the performance of management, which measures the prot or loss, net of nance charges and taxes, for the return on capital contributed by shareholders. It is expressed as a percentage and calculated as

N et Income Shareholder s Equity ; it is a ratio that reects all the business decisions and market factors for each management area. The numerator
is aected by the operational, nancing, tax and investment management and the denominator reects in particular the choices of leverage and dividend policy. ROE, expressing the book yield for the period of risk of capital, is also an

important indicator for estimating the fundamental value of a company from the equity side. In fact, multiplying the ROE for the book value per share, you can get the earnings per share (EP S ), used to calculate a signicant market multiple, the PricetoEarnings (

P E ).
on Equity statistical analysis

Figure

4.1. Return

Figure 4.1 shows the results of the analysis conducted on the ROE. Consistent with previous studies, the analysis shows a trend of increasing protability for shareholders in the three years preceding the listing and a decreasing trend during the following period. The post-listing decline in ROE is obviously inuenced by the increase in equity resulting from capital increases that often follow an IPO; but the decline in ROE is not only due to this reason, but also to a lower earnings growth than the denominator growth of the quotient. The data collected shows a decline from levels on average above 10% to an average ROE of about 3%. Focusing on the median the levels of ROE above 10% in the pre-quote for the VB sample can be conrmed, while in the following years the median is about 3%; the NVB sample does not show signicant changes in the median value thanks to the transition to regulated markets.

Chapter 4. The analysis result

23

The most important aspect revealed by the analysis are about p-values corresponding to signicance tests that demonstrate the absence of statistically signicant dierences between the means and medians of the samples, although in the pre-listing period the VB sample medians are signicantly higher than those of the NVB sample. So, the analysis shows only a sharp decline of ROE post-listing performance, regardless of the origin sample of the issuer. For a better understanding of shareholders protability, the index can be

D E (1 d) (1 t). As shown by the formula, ROE depends on the operating protability (ROIC), D from the cost of debt (c), from leverage ( ) that reects the rm nancial E structure, from non-operational management (d) and the incidence of taxes (t)
decomposed as follows:

ROE = ROIC + (ROIC c)

. This breakdown shows the multiplicative eect of the debt, which can enhance the protability for shareholders as well as depress, depending on whether the operational management is able or not to remunerate the capital above a level higher than the cost of debt. The ROIC (return on invested capital) is a measure of the ability to produce income with operational management. To calculate ROIC, the operating income (OI) is divided by the cost of the investment (Net Invested Capital); the result is expressed as a percentage or a ratio. In this way, the ROIC expresses the protability of the invested capital, regardless of the sources used. This ratio, after making appropriate changes can be used to compute an important indicator, the EVA (economic value added), which is an estimate of a rm's economic prot, being the value created in excess of the required return of the company's shareholders.
Figure 4.2. Return on Invested Capital statistical analysis

The analysis presented in Figure 4.2 shows that Return on Investments as Return on Equity presents a growing trend in the three years prior to listing and a deterioration in the aftermath; this is conrmed by both the trend of the mean and the median, regardless of subgroup considered. The ROIC decline is due to the corporate assets increase, which is the denominator of the ratio, generally on the rise after the capital contributions associated with the IPO. Since management is not always able to eciently manage the resources acquired, operating income is not growing at the rate of investment. Noticeable are the results of statistical tests that prove a VentureBacked sample performance signicantly higher than that of the NVB sample, both in terms of mean and median. In four out of seven years under study, condence levels are above 90% for the mean and twice for the median. we note that in period In particular,

T3 T ,

i.e. the period in which PEVC operators, as

Chapter 4. The analysis result

24

shareholders, exercise more markedly the activity of monitoring and control, the VentureBacked companies over-performance is clearly visible. In fact, the VentureBacked sample in the rst period has a ROIC of about 8-9%, compared to about 4-5% which characterizes the Non-VentureBacked companies. However, with respect to post-IPO period, the dierences between the samples are reduced and the ROIC levels decline, reaching 4-5% for the VentureBacked sample and 3-4% for the Non-VentureBacked sample.

Sales OI Sales N et Invested Capital , we can highlight the components of protability: the ROS (return on sales), the rst factor that expresses
Decomposing ROIC as the protability of sales and the second factor, the asset turnover, which expresses how many times the capital invested in a year is made turn from sales.

Figure

4.3. Return

on

Sales

T-Student

and

WilcoxonMannWhitney

tests

The ROS trend in Figure 4.3 shows no signicant dierences between the VentureBacked and the Non-VentureBacked sample. A dynamic analysis conrms, in line with the analysis on the other indicators of protability, a steady improvement in the pre-listing years and an equally steady decline in the years ahead. There may be a lot of causes for this trend, such as a squeeze in operating margins due to increased competition, or higher depreciation of new xed investment, which lowers EBIT. However, as demonstrated by sales growth below, the main explanation for the decline reported by ROS can be connected to less than proportional growth in operating income compared to very high growth rates of sales during

T T+3 .

EBIT DA Capital employed ratio. This indicator can be used to roughly measure the ability to generate cash ows.
Finally the study on protability examines the EBITDA is an indicator of a company's nancial performance which is calculated as the dierence between net revenues and operating costs and it does not include non-monetary costs such as depreciation and amortization, nancial charges or taxes. EBITDA is used as a basis for estimating the free cash ow to rm, a measure that also considers the amount of investment in xed assets and working capital, as well as the tax eect. The importance of this analysis stems from the fact that the Free Cash Flow to Firm is an essential measure for analysts for estimating the intrinsic value of a company and a fundamental value which represents a control parameter for those seeking to assign a fair value to shares in a company that is to be listed on regulated markets.

Chapter 4. The analysis result

25
T-Student and WilcoxonMannWhitney tests

Figure

EBIT DA 4.4. Capital employed

The indicator shows an improvement for both samples in the period before the IPO, both in terms of mean and of median, however, with the exception of the year in which the IPO is executed, there is no registration of a signicant decline in post-listing period as well as the ROIC case. This gure may actually suggest that the decline in ROIC after the listing is to be attributed in part to the impact of depreciation of new investments on operating income. With a condence level above 90%, the statistical tests conducted highlight VentureBacked companies' better performance only in the pre-IPO period. The ndings of the analysis suggest more evaluation of the VentureBacked companies than Non-VentureBacked companies in the IPO, due to a higher ability to generate cash ows. Obviously, to better estimate the value of a company, there would need to be a computation of the cost of capital, expression of the risk prole related to companies cash ow. Summing up all these facts, Private Equity operators contribution is only evident in pre-IPO period, while it seems that all the operating performances worsen after the Initial Public Oering. This phenomenon is certainly due to the increase of capital used by the issuer after the IPO, which leads the ratios denominator to increase and consequently the multiples to decline. In addition to the previous technical reason, the phenomenon can be also explained as the consequence of the agency problem increasing that characterizes post-IPO period. In fact after the listing, the risk is partially transferred outside and the willingness to control and to monitor the management is lower. This left the management free to invest in representative operations that can result very low productive. The Window-Dressing techniques belong to the same stream of agency problems. In fact the corporate management tends to decide to go public at the business success peak and can use accounting decisions that show high performance before the listing. Finally, the market is able to more accurately control the listed companies aecting the corporate performance indicators.

4.2. Financial Solidity

To evaluate the company nancial solidity can be used the debt ratio ( which expresses the ratio between total liabilities and equity.

D E ), The debt can

increase protability for shareholders, oering also the advantage of the tax shield compared to equity, a benet known as tax-shield that helps to create

Chapter 4. The analysis result

26

value for shareholders. the index over time.

However, a high debt may also lead to high nancial

risks by increasing the risk of default, so it is necessary monitoring the level of

Figure

4.5. Leverage

T-Student

and

WilcoxonMannWhitney

tests

D E ratio. In period T3 T , debt is on average at levels between three and four times the equity, ratio that is reduced
Figure 4.5 shows the evolution of to two considering the median. After the listing, the nancial structure bounce back to the equilibrium level and the debt is reduced drastically, returning to almost one and a half the equity value. The signicance analysis doesn't show signicant dierences between means and medians of the two samples, with the exception of two years. In

T1

the VentureBacked sample mean is lower than that of the Non -

VentureBacked sample with a condence level above 90%. The data is consistent with the superior ability of VentureBacked companies to generate earnings and cash ows, which will be used to repay debt and go on the market with a more balanced nancial structure. Looking at the median analysis, it is visible that the VentureBacked companies adopt a more aggressive nancial structure than Non - VentureBacked companies, but nevertheless they are able to present a lower debt to equity ratio at listing time. Instead the

T+3

data is much more surprising, since there is a higher level

of debt for VentureBacked companies in both the statistical tests conducted, conrmed by condence levels exceeding 95%. The signicant increase in debt in the VentureBacked sample reects the sharp post-listing decline in the profitability already shown by all the analyzed measures above. The reason for this phenomenon could be attributed to the VentureBacked companies' needs to nance new investments. Those needs would be anticipated before the listing for not aecting the protability levels. If this conclusion is correct, it suggests that the Initial Public Oering represents for VentureBacked companies an investment way-out more than an opportunity for nancing the business growth. To assess the nancial solidity of a company is also useful to use the interest

EBIT Interest Expenses ), which measure company's ability to repay the debt on time, in other words to reward and repay creditors through cash ows
coverage ratio ( generated by operations. The above ability is the more favorable the higher the ratio, since an high ratio is representative of a healthy nancial structure. However, the optimal level of the ratio, as well as the composition and the sector of the company.

D E , depends on the assets

Chapter 4. The analysis result

27

Figure 4.6. Interest Coverage ratio T-Student and WilcoxonMannWhitney tests

The interest coverage levels are higher for VentureBacked companies. Both the means and the medians conrm the observation with a condence level above 90%, particularly in the period preceding the listing. The data conrms the Private Equity operators contribution in terms of performance monitoring. The VentureBacked coverage ratio is greater than that of Non-VentureBacked, as well as the lower debt ratio in the year preceding the IPO. These features demonstrate the Private equity operators attention to the nancial structure equilibrium, in order to obtain a positive response from the market after the initial public oering.

4.3. Managerial Eciency

The eciency is dened as the company's ability to maximize the outcome when there is a limited amount of resources. This area is analyzed using a ratio that measures the turnover of assets, which represents the number of times the management is able to let the total investments rotate through sales.
Figure 4.7. Asset turnover T-Student and WilcoxonMannWhitney tests

Chapter 4. The analysis result

28

The rst interesting point identiable in the gure is the steady decline of the ratio over the years, although it is not a very marked decline. The reasons for this trend can be attributed to new investments made with capital raised in the new stake placement, investments that determine higher assets growth rates than the turnover. Another obvious fact is the continued over-performance of VentureBacked companies, which have systematically higher levels of assets turnover respect to Non-VentureBacked companies. This is conrmed by the Wilcoxon-Mann-Whitney test, which shows for four years out of seven, a signicant dierence of the medians of the samples with condence levels above 90%. So, VentureBacked companies' management is more ecient, because is able to generate more turnover with the same quantity of assets employed. viously carried out. on ROS trend. This observation conrms the conclusions on the operating income breakdown preIn fact, it reveals that the VentureBacked sample best performance in terms of ROIC only depend on the asset turnover trend and not

4.4. Corporate Development

The size of the company's growth has been analyzed from two perspectives: the competitive growth and organizational growth. Company's competitive eectiveness is summarized by revenues growth that express the consistency between corporate supply and company products and services demand. The revenue growth is expressed both by the increase in the volume of products sold, and as result of the increase in prices or rates charged by the company. The increase in sales is an important value operator, especially when it comes from a market share expansion, and it is sustainable over time, only if the company conducts a balanced management of working capital. The company's turnover as well as being correlated with market trend, it is also aected by the specic dynamics characterizing the competitive environment. Sales are conditioned by the specic sector and products life cycle, as well as the life cycle of the company. Generally company life cycle is explained through the OLC ( Organizational life cycle) model, that proposes that businesses, over time, progress through a fairly predictable sequence of developmental stages: start-up, growth, maturity, and decline, with diversication sometimes considered to be an additional stage coming between maturity and decline. To evaluate the competitive development dimension is used the cumulative growth rate in sales using as:

T3 as the base year .

The above indicator is computed

Salesn SalesT z SalesT z

The denominator of the above indicator always has a constant value, thus it is possible to assess the contribution of each year to revenue growth. It is important to underline that the ratio is calculated on sales denominated in nominal terms because the ination is not considered particularly inuent on the quality of the analysis.

Chapter 4. The analysis result

29
T-Student and WilcoxonMannWhitney tests

Figure

4.8. Change

in

turnover

Figure 4.8 shows the strong revenues growth that characterizes both samples of rms. Within seven years the turnover of the Non-VentureBacked companies have grown on average more than three and a half times. Over the same period, the VentureBacked companies have grown on average about one and a half time, less than half of Non-VentureBacked companies. Looking at the medians analysis the previous observations are conrmed, although the margin between the samples is reduced: Non-VentureBacked companies have a growth of 2.18 compared with 1, 27 of VentureBacked companies. The signicance tests strongly indicate that the Non-VentureBacked sample is characterized by a larger revenues growth compared to that of the VentureBacked companies; P-values from t-Student and Wilcoxon-Mann-Whitney test provide condence levels sometimes exceeding 99%. Since the two samples do not show signicant dierences in age and in the sectoral composition of rms, we can not assume a relevant dierence in the stages of the life cycle or in the sectors for the companies of the two samples. So, it is necessary to evaluate possible alternatives to the analysis results. The result could be due to a greater focus on the commercial dynamics of the Non-VentureBacked companies, which consider the sales growth as a fundamental driver of value creation. An other explanation more consistent with previous results could be that VentureBacked companies opt for a more gradual and organic process of growth, focusing on maintaining high levels of protability and eciency in the use of corporate resources. Even the smaller investments characterize VentureBacked companies activity may be a cause of the lower rate of revenue growth. In order to assess the development prospect, the size of the corporate structure, indicated as corporate personnel growth, has been analyzed. To evaluate this dimension is used an indicator similar to that of turnover variation: the cumulative growth rate in corporate personnel using

T3

as the base year

P ersonnel #n P ersonnel #T z P ersonnel #T z

Talking about employment levels, the literature argues that Private Equity contribute to the creation of new jobs. Numerous empirical studies have demonstrated a greater ability of VentureBacked companies to support employment levels, but most of these contributions focus on English and American markets, where PEVC operators are very active in start-up and early growth nancing.

Chapter 4. The analysis result

30
T-Student and WilcoxonMannWhitney tests

Figure

4.9. Change

in

personnel

The Non-VentureBacked sample shows a superior performance, as in the turnover growth case. Non-VentureBacked companies increase the number of employees on average of 3,63 compared to 1,38 registered by VentureBacked companies. These dierences were signicant even at levels above 99%. However, the medians analysis does not result statistically signicant, even though conrms the previous results with dierences between samples that are reduced and the growth rates of employees respectively of 0.85 and 0.32 for the Non-VentureBacked sample and the VentureBacked sample. So, the result of the analysis contradicts the past studies produced by the Anglo-Saxon literature. The data can be interpreted as the consequence of a strong expansionary policy adopted by Non-VentureBacked companies that exploit the management discontinuity produced by the listing to give a strong impetus to business growth, both on the external front, expanding the turnover, and on the internal front,investing in human capital. However, this result may also suggest an alternative interpretation, according to which VentureBacked companies can better manage the listing process, anticipating the organizational adjustments required to be a public company. The listing creates new costs related to the introduction of corporate governance systems best suited to managing relationships with nancial markets. In this acception, the result can be interpreted as the consequence of the careful planning of the listing process performed by the VentureBacked companies.

4.5. Underpricing
Going public marks an important watershed in the life of a company. It provides access to public equity capital, and so it may lower the cost of funding the company's operations and investments. It also provides a venue for trading the company's shares, enabling its existing shareholders to diversify their investments and to crystallize their capital gains from backing the company  an important consideration for venture capitalists. This important process is manifested in the disinvestment phase, characterized by the selling of the Private Equity operator stake. The disinvestment consists of two fundamental choices: the most appropriate moment for disinvesting (timing) and the most appropriate channel for disposing (way out). Many factors inuence the disinvestment decision and for this reason, it is almost impossible to forecast the way out from the beginning. This is because

Chapter 4. The analysis result

31

the inuencing factors are not only endogenous, such as contractual agreements, but also exogenous, such as the market and the sector trends. Most companies that go public do so via an initial public oering of shares to investors. IPOs have interested nancial economists for many decades. Early writers, notably Logue (1973) and Ibbotson (1975), documented that when companies go public, the shares they sell tend to be underpriced, in that the share price jumps substantially on the rst day of trading. This `underpricing discount' can be seen as the dierence between the price at which shares are traded on the market and the IPO price, a dierence that represents the discount at which the shares which were oered, consequently `underpriced' compared to fair value indicated by the market. The placement at a discount is a form of compensation for the risk borne by investors and underwriters, a risk whose genesis has been the subject of many studies. First, underpricing is explained in the literature as a consequence of asymmetric information between issuers and investors, in other words, determined by the demand side due to the higher perceived risk. Another line of study gives the supply side the cause of the phenomenon: according to Ritter and Welch (2002) behavioral biases in general, and Prospect Theory in particular, may explain underpricing. They conjecture that shareholders are willing to suer underpricing if their prior ``reference point'' is low enough to make them perceive the selling price as satisfactory. The ``reference point'' can be determined in part by the shareholders' risk aversion and portfolio diversication. Numerous studies ( Carter R. B and S. Manaster [1990]; Allen F. and G.R. Faulhaber [1989]; Booth J. R. and R. L. Smith [1986] ) suggest that the underpricing may serve as a substitute for the technical promotion and marketing of the title. Another view of the phenomenon is proposed by Brennan and Franks (1995) that dene underpricing as a positive function of the level of oversubscription: they examine change in ownership from the IPO to seven years later and conclude that insiders reduce ownership slowly over time. They interpret this behavior as consistent with an attempt to retain control after the IPO. In conclusion, the expected liquidity and the risk of illiquidity would be some of the most important determinants for underpricing, since they aect the premium for the risk borne by the subscribers. In literature there are dierent procedures used to calculate underpricing as well as the computed timeframe with which the underpricing is calculated. In my work I used two dierent meanings of underpricing:

U nderpricing =

Pclosing PIP O PIP O

However, since this formula reects the eect of market on the closing price of the stock, the analysis was also carried out by adopting a formula adjusted for the eciency of the market, modifying the previous equation as follows:

M odif iedU nderpricing =

Pclosing PIP O S &P M IBt S &P M IB t1 PIP O S &P M IB t1

where the previous equations terms indicate:

Pclosing =closing price of the rst day of trading in the security market. PIP O =the issue price of the IPO. S &P M IBt =S&PMIB index closing level on the day of listing. S &P M IBt1 =S&PMIB index closing level on the day before the listing.

Chapter 4. The analysis result

32
and Modied Underpricing statistical analysis

Figure

4.10. Underpricing

Figure 4.10 shows the data related to underpricing detected in the sample. The analysis conrms that the IPO price is lower on average by 5% to the price given by the market in the rst trading day, so the underpricing hypothesis is conrmed by the study sample. The survey also conrms the hypothesis that the incidence of this phenomenon is lower in the VentureBacked sample, which in fact shows a modied underpricing of 0.83% against 6.34% recorded in the Non-VentureBacked sample. The result is supported by a level of statistical signicance over 99% and it is reinforced by the medians analysis, which conducts to the same conclusions.

4.6. Empirical Analysis Gaps

Assessing the contribution of the Private Equity operators can not be exclusively delegated to the nancial ratios, since an accurate estimate of the value of the company would require the use of other assessment techniques such as market multiples and DCF Analysis. The nancial ratios have the strong limit to represent the business reality on a historical basis, since they summarize economic events that have already had an impact on the company. Moreover, they are distinguished by additional defects. First, ratios can be easily manipulated by corporate managers through windowdressing techniques that aim to alter the nancial statement items in order to improve to improve the appearance of the performance before presenting it shareholders. Ratios also reect gaps in the application of accounting principles: the balance sheet items considered during the seven years of analysis does not always adhere to the same accounting rules, as it happens in the analysis from 2005, when consolidated nancial statements are prepared in accordance to the application of the International Accounting Standards that have a signicant impact on some balance sheet such as goodwill and xed assets. An other analysis constraint is due to the breadth and composition of the statistical sample. The Italian market was the research object, thus the analysis is not supported by a very large sample. For this reason, sometimes the statistical signicance of the analysis is conditioned by the paucity of data collections.

Conclusions
The analysis carried out on public companies from 2000 to 2006 in Italy, in a span of seven years, including three years preceding and following the listing, has provided some conrmation of the conclusions reached by other work conducted on dierent markets from the Italian one Descriptive statistics conrmed the correlation between the number of IPOs and the economy and nancial markets conditions, so that favorable market conditions increase the number of IPOs. In particular, we highlight the strong contribution of private equity in the development of nancial markets, since one IPO out of three in Italy is performed by a VentureBacked company. The analysis also shows a PEVC operators feature already known from literature, the ability to anticipate the recover of the economic cycle. The issuer type characterizing the Italian market has been identied looking at the age of the companies included in the two samples: it has an average operating history of fteen years , without substantial dierences based on belonging to the VentureBacked sample rather than to the Non-VentureBacked. So, it was conrmed that it is very limited in Italy the PEVC contribution to the young business growth. The inferential statistical analysis conducted on the sample showed highly signicant results for nancial ratios. First, there been detected a trend of increasing protability ratios in the period before listing, and a progressive deterioration thereafter. This phenomenon is certainly due to the increase in invetsed capital operated by the issuer after the IPO, resulting in an increase in the denominator of the ratios and hence their decline. Besides this technical reason, the post-IPO decline in protability can be interpreted as the consequence of the management use of the obtained resources in activities that create little value. After the listing, in fact, the agency problem worsens because because the shareholder-entrepreneur incentive controlling and monitoring the management is reduced, since the risk is transferred out, having reduced its stake. In this context, the VentureBacked companies show a superior operating performance compared to Non-VentureBacked issuers, amplifying the upward trend in the pre-IPO years and its further decline thereafter. In particular, companies owned by private equity rms show a higher operations protability, but this doesn't correspond to higher levels of protability also for shareholders. Talking about nancial equilibrium, VentureBacked companies are very capable to manage and monitor debt. For this reason, despite the nancial structure is sometimes more aggressive during the seven years analyzed, the VentureBacked sample has higher levels of interest coverage ratio than Non-VentureBacked companies and less debt in the year preceding the IPO. It is possible that the PEVC operators participation represents an additional guarantee for nancial institutions that allows to VentureBacked companies accessing at more favorable conditions to credit. Also in eciency terms, VentureBacked companies record higher levels of invested capital turnover, which explains the reason for better performance in terms of protability. With regard to the business development size, the reported results are in contrast with previous literature, showing a greater cumulative growth in turnover and number of employees in Non-VentureBacked companies. The data, particularly signicant according to statistical tests, can be interpreted as the signal for a greater propensity of NVB rms to focus on the competitive levers and structural growth , unlike VB companies that opt for a more gradual and organic process of growth.

Conclusions

34

In short, the nancial statement analysis conrms the Private Equity contribution to participated companies, particularly in the period preceding the listing, where these investors still have a strong commitment towards the investment. This contribution would be appreciated by the market, rewarding VB companies placements with less underpricing. In other words, the gap between the oer price and the price traded on the market is less, because the contribution of Private Equity operators quality is recognized. In conclusion, it seems appropriate to highlight some concerns such as revenue growth, signicantly higher in the NVB companies, the signicant increase in the debt of the VB companies in year limits. Interpreting the preceding results in an alternative perspective, it is possible to assume that the protability ratios , as well as the asset turnover ratio, are higher for VB companies than NVB companies because private equity operators would tend to reduce Investment in working capital and xed assets, nancing less future growth in turnover. In this light, the Private Equity operators, using their professional skills, carefully plan the exit process through IPO, only to maximize their performances. Their interest in optimizing the public oer appreciation and protably exiting from the investment would be pursued at the expense of the investee company, which would be sacriced the future growth prospects. This dierent interpretation, however, seems less likely, as PEVC operators, frequently working on the IPO market, are monitored and any opportunistic behavior is subsequently punished by the market. For these reasons, the argument that private equity makes a signicant contribution to the companies that initiate a process of listing, both in improving operating performance, and lowering the depreciation of the securities in the placement, seems more likely.

t+3

and the nancial ratios evaluation

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