1. EXECUTIVESUMMARYThis reportanalyses the IPO case study on Ctrip. The first section provides an overview ofthis company, including its business structure, strategies, businessenvironment and its stock market conditions, etc. Ctrip is an online travelagency and went public on December 9th, 2003, expecting to sell 4,200,000ADS atbetween $16 and $18 per ADS.
In the secondsection, the discussion is based on the reason and timing that a firm goespublic, and why IPO usually is underpriced, linking with Ctrip’s situation. Irealised that the most common reason to go public it to raise funds. Timingdepends on the overall market condition. Underpricing can be explained byasymmetric information.In the thirdsection, I evaluate Rashtchy, S. and Avilio, J.’s analysis report (2004). Ifirst analyse the overall report.
Then, I picked two forecasts to have a moredetailed evaluation: revenue contribution and profits. Finally, I review theseforecasts with my own opinion. 2. OVERVIEWCtrip is aChina-based online travel agency (OTA), which was founded in 1999 andheadquartered in Shanghai. Its core business is to provide its members withhotel reservations, flight ticketing, packaged tours, corporate travelmanagement and so on. The targeted customers are business and leisuretravellers who travel alone.
As other travel agencies focus on grouptravelling, Ctrip has its opportunity and advantage by offering individualsinformation of hotels and air-tickets and access to considerable discounts.Ctrip also provides convenient and reliable 24-hours online and offlineservices. Free memberships and its upgrade system are parts of its successfulmarketing strategy. It also has the largest call-centre in Chinese travelbusiness with progressive customer’s relation management system (CRM) andself-developed app. Ctrip remains as aleader of a consolidator of hotel accommodations and airline tickets in Chinaamong the past 15 years with superb market shares. With its power over themarket and its cooperation with hotels and airlines, it has a considerableinfluence on hotel pricing and flight ticket supplying.
The revenue structureof Ctrip is quite simple: as playing an agent between hotels and customers, itreceives brokerage by recommending customers and hotels to each other.Meanwhile, it established platforms for advertising and other services, whichare parts of its revenue contribution. For the past tenyears internet sector has been growing and became indispensable for dailyactivity, Ctrip, an online service company, is beneficial for the technologygrowth. At the same time, China has been experienced high-speed economic growthand boosted GDP, thus, provides Ctrip with a comfortable business environment.On December 9th,2003, the company went public on NASDAQ. The company expected to sell 4,200,000American Depositary Shares (ADS), which was 8,400,000 ordinary shares, in andoutside the United States at an expected public offering price between $16.
00and $18.00 per ADS with an underwriting discount of $1.26 per ADS.
3. LITERATUREREVIEW 3.1 whyand when do firms go public?3.1.1Why?According to Brauand Fawcett (2006), the survey shows that facilitating mergers and acquisitions(M) is the most common motivation for going public. IPO can help thecompany to create public shares for use in such activities in the future.
Intheir survey, it shows that IPO companies are more often an acquirer ratherthan a target. They also state that IPO company would need a market price asthe starting point of acquisition progresses. Scott (1976) indicates thatconducting a public offering is a method to reduce the cost of capital. ButBrau and Fawcett’s (2006) study shows that reducing the cost of capital isranked quite low as a reason to go public by CFOs.Zingales (1995)stands for an idea that IPO would help insiders to sell their company and thuschange the proportion of their cash flow and control rights. He argues thatgoing public is not only a stage of corporation growth but also a channel tosimulate venture capitalist activities.
In his opinion, IPO is used by initialowners to build the optimal structure of their ownership. Going public has highcosts, yet, it is a relatively cheaper way to raise funds without increasingleverage. According toPagano, Panetta, and Zingales’s study (1998), the control turnover after an IPOis twice the normal turnover.
Moreover, market-to-book ratio affects theprofitability of IPO. There is a positive relationship between market-to-bookratio and the probability of a firming going public. Meanwhile, their studyalso shows that the larger the size of a firm is, the higher the likelihood toconduct an IPO. A firm with high growth and profit also tends to be involved inIPO. In Ctrip’s prospectus, it shows that Ctrip’s revenues had increased fromRMB6.9 million in 2000 to RMB105.3 million (US$12.
7 million) in 2002. For thenine months ended September 30, 2003, $13.4 million revenue and US$3.5 millionnet income were generated even though SARS had a strong negative effect on theeconomy during the second quarter of 2003. 3.1.
2When?Lucas and McDonald(1990) assert that the timing of IPO would depend on the overall marketcondition such as a bull market, which is called Market-timing theory. In abear market, the firms feel that they are undervalued; thus they will delaytheir IPO timing. Meanwhile, Ritter (1991) argues in a long-term perspectivethat high volume period of IPO usually are involved with poor long-runperformance, which indicates that by taking advantage of “windows ofopportunity” issuers can time IPO successfully. Figure 1. monthly data on aggregate U.S.IPOs per monthLowry and Schwert(2002) state that statistical tests show a weak negative relationship betweenIPO volume and future initial returns and a significant positive relationshipbetween initial returns and future IPO volume. This means that firms have agreater incentive to go public if they realise that IPOs are significantlyunderpriced.
They argue that during the registration period, information keepsbeing released, which will raise the expected valuation and thus the initialreturns. In this case, more companies are willing to go public after realisingthe opportunity. 3.2 whyis IPO underpriced?IPO is underpriced if thefirst day ends with a higher stock price than the initial offering price, thusgenerating a return.
The underpricing can attract the investors and offset therisk they are taking. However, Ritter and Welch (2002) suggest thatasset-pricing risk premia cannot explain the situation as the second-dayinvestors do not seem to require risk premium while the risk cannot be resolvedby one dayOne of the reason can beused to explain underpricing is based on asymmetric information. As the sellersalways have better information than the buyers, investors feel unsafe andafraid to buy a “lemon”. The lemon problem is that products are soldonly if the quality is pool.
In this case, the investors fear that the issuerssell their shares and rights due to some inside problem. Ritter and Welch(2002) assert that the high-quality issuers set a lower-than-market price tostop lower-quality issuers from mimicking their behaviour while low-qualityissuers sell shares at normal price. If investors have better information thanissuers, then issuers have problems to set a price that the market accepts.
Onthe contrast, if issuers are less informed than investors, they may underpricetheir shares as they do not know the preference of investors. Asymmetricinformation between the informed underwriter and uninformed issuers also leadsto underpricing as underwriters can receive higher compensation from informedinvestors. Ritter and Welch (2002) state that as long as the asymmetricinformation uncertainty eliminates, underpricing would disappear. Brau and Fawcett (2006)argue that underpricing can serve a marketing function.
Demers and Lewellen(2001) state that IPO price, same as product price, affects the demand ofquantities. Lower price can attract investors to buy the new shares. Thus,underpricing increases the trading volume and issuers can be beneficial.Meanwhile, underpricing can reduce marketing cost.Another reason ofunderpricing is related to “Bookbuilding”. In Hanley’s study (1993),she finds that underwriters do not adjust share price upward along with thehigh demand unless the underpricing is higher.
Underwriters use bookbuilding togather information from informed investors. They set a preliminary offer pricerange to estimate demand by recording “indications of interest from prospectiveinvestors.” As potential investors reveal a willingness to pay a higherprice, underwriters need to offer underpricing or more IPO allocations tocompensate these investors.Hughes and Thakor (1992)assert that under symmetric information, underpricing is due to legal liabilityreduction. A lower price has a lower possibility to be sued. However, Ritterand Welch (2002) argue that this is not the primary reason of underpricing inthis situation.Another explanation forunderpricing is given by Boehmer and Fisher (2001) that as evidence shows thattrading volume in the aftermarket and underpricing, underwriters can gainadditional trading revenue in a Nasdaq-listed IPO. Nevertheless, there is no aclear clue that issuers can benefit from this underpricing explanation.
4. EVALUATION 4.1 Summary of KeyPointsTheincreasing Chinese urban population and the move towards technologicallyefficient services is one evidentiary aspect which qualifies for the investmentin China’s internet and technology-based companies.
With an increasing growthin internet usage in the world and in China, it is envisioned that the consumeracceptability and use of e-commerce will significantly increase and the samecan be said for online travel. Additionally, Rashtchy and Avilio (2004) statethat the growth of Chinese economy has brought with it various changes not onlyfor the economy but also to consumer social life in which consumers in Chinahave shifted to individual travel. The rise of this group of independenttravellers has drawn remarkable attention from travel agencies with Ctrip atthe forefront to gain a share in the market as a result of consumers lookingfor web convenience services. Lookingat China’s travel market, then there is a reason to believe it is fragmented.
This is due to its poor booking, reservation, and fulfilment infrastructure.Moreover, the 9,000 hotels in China with the top three hotels only accountingfor 2% of the market share having that most of the hotels are privately ownedand managed and as such lack a central reservation system similar to Europe orthe United States of America. The travel market in China has about 12,000travel agencies and a majority of this agencies have a local focus putting mostinterest on business and packaged tour travellers. This is what brings aboutthe observation in which no single chain has greater than 2% market share. Accordingto the analyst report, there is noteworthy barriers to the entry of in theChinese travel market. There are many licenses which are required in China foran online agency to start its operation. The report lists air ticketing permitas one of the requirements for every city as there is no national air ticketingpermit with Ctrip being the only organisation having a countrywide booking andfulfilment in China (Rashtchy and Avilio, 2004).
Additionally, there is thetravel agency license which is obligatory for both local and internationalbusinesses. Within this framework, a foreign agency is only allowed to operatein four cities in China. Similarly, the report includes the requirement ofadvertisement license and internet for online businesses. Away from thebarriers to entry in the Chinese travel market, the report also points onChinas travel market with respect to the global travel economy which stands at1.3 trillion dollars. According to the report, the market share of China isexpected to be at $33 billion representing 2.5% of the world’s travel marketrevenue having an expected a continuous growth of around 10%.
Thefactor contributing to the growth of the Chinese travel market has beeneffectively elaborated as one of the key points in the report. The report lists four factors which areinstrumental to the growth of the travel market is China as; China’s overallGDP growth at about 7-10%, increasing middle-class consumers in the economy, acontinuous increase in business travel, and the increasing demand for leisuretravel. A major hurdle for the Chinese online companies is the low usage ofonline payment methods, however, Ctrip has 30% online usage and imploring onlow tech methods of paid which are efficient. The report sequentially comparesthe U.S online travel booking to China’s online travel booking, Ctrip has aplatform to compete in revenue generation with other U.S travel agencies giventhat the China market grows at the same rate as that of United States. Thereport examines the growth strategy implored by Ctrip which inculcates four keyelements; grow the user base and transaction volume, grow average commissionrate, enter merchant model, and finally implore accretive and strategicacquisitions.
Rashtchy and Avilio (2004) list many risk factors such ascompetition, and potential margin or commission contraction. Competition isbrought about by the fact that the e-commerce and travel are blossoming inChina and even though Ctrip has established a leadership position, there arenew competitors establishing their brands in China. 4.
2 Evaluation of TwoForecast by AnalystsThis section ofthe appraisal will critically evaluate two forecasts by analysts usingqualitative and quantitative information to substantiate the evaluation. Oneforecast made by Rashtchy and Avilio (2004) predicts the revenue contributionfrom each product line of Ctrip. The report provided by Rashtchy and Avilio(2004) provides the following forecast for revenue contribution from eachproduct line; Table 1 : revenue contribution from Ctrip productlines Source:Rashtchy and Avilio (2004)For the fourthquarter of the year 2003, the company realises a contributory revenue fromhotel reservation of about 84% which successively brings out an average of87.25%.
For the year 2004, Rashtchy and Avilio (2004) forecast a that thecontribution on total revenue earned from hotel reservation will be 84% for the1st quarter, 83% for the second quarter, 82% for the third quarter and 83% forthe fourth quarter. This translates to a total revenue contribution for Ctripcompany of about 83%. Analysis on the contribution from the air-ticketingproduct line to the total revenue accrued by the company shows that for 2002,the contribution stands at around 5.
25%, 11.25% for the year 2003 and 14% forthe year 2004. Rashtchy and Avilio (2004), also forecast on the revenuecontribution from packaged tour product line of the company, with anexpectation of 2.
5% for the year 2003 and 5.5% for the year 2004. Examiningresearch journal authored by Wang, Chiang and Hsieh (2015), they use data fromCtrip Company’s provided in the table below; Table 2: revenuecontribution from Ctrip product lines Source Wang et al. (2015)The data provided by Wang et al. (2015, 166) will beused in this section to evaluate the analyst’s report. The table below comparesthe two forecast by Rashtchy and Avilio (2004) and data provided by Wang et al.(2015). Table 3: comparisonbetween the two reports Another forecastwhich will be evaluated presented by Rashtchy and Avilio (2004) is the grossprofit expectation for the year 2002 to 2004.
The table below represents theanalysts forecast on the gross profit for Ctrip Company for the year 2003 and2004. Profit in $Million dollars assuming 8.3RMB/USSD 2002 2003E 2004E Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4E Q1 Q2 Q3 Q4 Gross Profit 1.8 2.4 3 3.2 3.
4 1.8 5.9 6.1 5.8 7.3 8 8.1 Total 10.
4 17.2 29.2 Table4: Gross profit forecast for Ctrip Source: Rashtchy and Avilio(2004)For the year 2002the average gross profit for Ctrip Company is at $10.4 million, while theforecast for the year 2003 stands at an average of $17.2 million and for theyear 2004, the analysts forecast predicts an average gross profit of $29.2million. To effectively evaluate the analysts forecast adopted by Rashtchy andAvilio, their forecast will be compared to Ctrip’s report.
The table belowrepresents data for gross profit for the company; Profit in Milliondollars assuming 8.3RMB/USSD Table5: Gross Profit for Ctrip for the year 2002-2004 Source: Ctrip report Through examiningthe analysts’ forecast on the Gross profit realised for the year 2002, 2003 and2004, I find that there is almost a match between the forecast and thecompany’s annual report. However, the forecast for the year 2004 by Rashtchyand Avilio (2004), predicts a gross profit of around $29.2 million, yet thecompany’s annual report postulates on a $34.37 million gross profitrealisation.
4.3 Revision of ForecastsHaving evaluatedthe forecasts in the previous section of this paper, I will revise theforecasts and successively propose new forecasts. For the forecast on thepercentage of revenue generated by each product line, it is more succinct toharmonise the forecast made by the analysts. In so doing, the percentage ofrevenue generated by each product line offered by the company will be less thanthe projected proportion. For the year 2003, the new forecast will reduce thefraction of revenue generated by hotel reservation to about 85% given thecompany’s increase in offering other services and development of new products.Similarly, for the year 2003 the air-ticket and packaged-tour products willremain as they are and a column for other product lines and services will becreated to account for the reduced hotel reservation percentage contribution.For the year 2004, hotel reservation and air-ticket percentage will be slightlylower than the forecast provided by the analysts and similar to the year 2003 acolumn for other company product line or services is created to take care ofthe company’s product development programs. For the forecast on the gross profitappreciated in the company for the year 2003 and 2002 will not change in thenew forecast as they get in line with the company’s annual report with aminimal difference being witnessed between the forecast and the company’sreport.
However, the forecast for the year 2004 will be more in the newforecast when compared to the analyst forecast. For the gross profit for theyear 2004, the new forecast will have an increased gross profit expectation incomparison to the analysts’ expectation of $29.2 million.
This will ensure thatthe new forecast is almost in line with the company’s annual report. 4.4 Conclusion of the caseAs established inthe analysts’ report by Rashtchy and Avilio (2004), China’s leading travellingagency is Ctrip with a product line in hotel reservation, air-ticket andpackaged tour.
The travel market in China is fragmented as discussed in thereport this is due to its poor booking, reservation, and fulfilmentinfrastructure. Additionally, Rashtchy and Avilio (2004) give four factorswhich are instrumental to the increase such as China’s overall GDP growth atabout 7-10%, increasing middle-class consumers in the economy, a continuousincrease in business travel, and the increasing demand for leisure travel. Evenwith such prospected growth in the travel market share of China, there are somebarriers which make it difficult for the entry in the Chinese travel market.
The analyst’s report lists a number of license requirements which are necessaryfor an agency to establish an online business and successively penetrate theChinese travel market. Apart from the prospected growth and barriers to entryin the travel market, the analysts’ report discusses some of the risk factorssuch as competition, supplier risk, government intervention, and technologicalissues. Having looked at the key insights about the company and the travelmarket at large, I am concise to say that the price movement after the IPO iseffectively justified even though commendable changes are necessitated toensure a perfect justification.