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Tencent Holdings Limited: an IPO Case Study

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Tencent Holdings Limited: an IPO Case Study UNIVERSITY OF CAPE TOWN Department of Finance and Tax Tencent Holdings Limited: An IPO Case Study DARIO DE WET Prepared under the supervision of Doctor Ryan Kruger and Doctor Francois Toerien and presented to the School of Management Studies in fulfillment of the requirements of the degree of MASTER OF BUSINESS SCIENCE April 2015 Abstract The purpose of this case study is to empirically investigate the phenomenon of initial public offerings (IPOs) by applying it to Tencent Holdings Limited (Tencent). Tencent is a Chinese internet and telecommunications value-added service provider that launched its IPO on 16 June 2004. Tencent is China‟s largest internet firm and Asia‟s most valuable brand, boasting a current market capitalization of HK$1.224 trillion (US$157.9 billion). The origins of Tencent‟s success story trace back to its IPO decision, an important topic in the field of finance. The aim of this study is to investigate the structure of Tencent‟s IPO, its listing decision and determining an intrinsic value of its IPO shares on its listing date. It was found that Tencent‟s IPO extensively relates to academic literature surrounding IPO underpricing and valuing unlisted companies. The results reveal that Tencent left money on the table by underpricing its offer shares and exercised its over-allotment option as a form of price stabilization. It was further found that Tencent‟s underpricing was not influenced by competitor IPOs but rather by stringent IPO allotment policies and other signals of firm quality. It was also discovered that there may have been bias in the allocation of Tencent‟s shares. An investigation into Tencent‟s listing on the Hong Kong Stock Exchange (HKEx) revealed that while its competitors listed on the NASDAQ Stock Market, there was a clear correlation between Tencent‟s operations and corporate structure to the HKEx listing and regulatory requirements. The decisive factors included domiciling in the British Virgin Island and Cayman Islands, the cost of listing on the HKEx Main Board versus the NASDAQ National Market as well as the effects of US GAAP and the Sarbanes-Oxley Act of 2002. i The study was concluded with the application of a relative valuation and discounted cash flow (DCF) valuation. The relative valuation estimated a price range of HK$14.40 - HK$18.72 for Tencent‟s IPO shares, while the DCF estimated the intrinsic value of the shares to be HK$18.68. The analysis was comprehensive and in-depth and suggests that Tencent‟s IPO shares were five times undervalued and were offered to shareholders at a deep discount. ii Declaration of Authorship I, Dario de Wet, declare that this thesis titled, `Tencent Holdings Limited: An IPO Case Study‟ and the work presented in it are my own (except where acknowledgements indicate otherwise). I confirm that: This thesis was submitted in fulfillment of the degree of Master of Business Science at the University of Cape Town. Neither the whole work nor any part of this thesis has been, is being, or is to be submitted for another degree or any other qualification at this University or any other institution. Where I have consulted the published work of others, this is always clearly attributed. Where I have quoted from the work of others, the source is always given. With the exception of such quotations, this thesis is entirely my own work. Signed: 28 April 2015 iii Acknowledgements This thesis would not have been possible if it were not for the guidance of Dr Kruger and Dr Toerien. Their input has been invaluable throughout this process. Their willingness to consult and abilities to solve problems has always been remarkable. I offer my sincere gratitude to both of them for their time. I dedicate this thesis to my dear parents Leon and Lilia de Wet. You have always placed utmost confidence in everything that I do and have encouraged me to give of my best no matter how difficult the circumstances. If it were not for your support, guidance and caring nature I would not have been where I am today. I am truly grateful for everything you have done for me throughout my life thus far. iv Contents Abstract ............................................................................................................................................ i Declaration of Authorship ............................................................................................................. iii Acknowledgements ....................................................................................................................... iv Contents ..........................................................................................................................................v List of Tables .............................................................................................................................. xiv List of Figures .............................................................................................................................. xvi Definitions .................................................................................................................................. xvii Glossary ...................................................................................................................................... xxi Preamble ................................................................................................................................... xxix Chapter 1: Introduction ........................................................................................................... 1:1 1.1 Tencent Holdings Limited ................................................................................................... 1:2 1.2 Structure ........................................................................................................................... 1:3 1.2.1 Research Methodology ................................................................................................ 1:4 1.2.2 A Critique of Academic Literature - IPO Underpricing Theory and Valuing Unlisted Companies ............................................................................................................................ 1:4 1.2.3 The Case Background.................................................................................................. 1:5 1.2.4 The IPO Listing Decision ............................................................................................ 1:5 1.2.5 A Complex Valuation of Tencent Holdings Limited .................................................. 1:6 1.2.6 Underpricing the Offer Shares and Post-IPO Subsequent Events ............................... 1:6 Chapter 2: Research Methodology .......................................................................................... 2:1 2.1 Case Study Research in Finance ..................................................................................... 2:1 2.2 Assessing and Applying Case Study Research Methodology ....................................... 2:2 2.2.1 Assessing the Suitability of the Case Study Research Method ................................... 2:2 2.2.1.1 Description, Explanation, Prediction and Control .............................................. 2:4 2.2.2 A Precautionary Methodological Measure .................................................................. 2:5 2.3 Value of Adopting the Case Study Research Method ................................................... 2:6 v 2.3.1 Practicality and Skills Development ........................................................................... 2:6 2.3.2 Simplicity and Effectiveness ....................................................................................... 2:7 2.3.3 Insight .......................................................................................................................... 2:8 2.4 Pitfalls of Case Study Research ....................................................................................... 2:9 2.4.1 Theory.......................................................................................................................... 2:9 2.4.2 Reliability .................................................................................................................. 2:10 2.4.3 Validity ...................................................................................................................... 2:10 2.5 Conclusion ....................................................................................................................... 2:11 Chapter 3: A Critique of Academic Literature - IPO Underpricing Theory and Valuing Unlisted Companies ................................................................................................................... 3:1 3.1 IPO Underpricing Theory ............................................................................................... 3:1 3.1.1 IPO Underpricing in the Hong Kong Equity Market .................................................. 3:1 3.1.2 Asymmetric Information Theory: The Winner‟s Curse .............................................. 3:2 3.1.3 Asymmetric Information Theory: Underpricing as a Signal of Firm Quality ............. 3:4 3.1.4 Institutional Theory: Price Support ............................................................................. 3:5 3.1.5 Ownership & Control Theories of IPO Underpricing ................................................. 3:7 3.1.5.1 Underpricing as a Means to Retain Control ....................................................... 3:7 3.1.5.2 Underpricing as a Means to Reduce Agency
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