DRs add value and liquidity, study shows

Study finds that depository receipt programmes on average add over 10% of shareholder value in the first year. The improvement is higher for Chinese companies which add 40% of value.

Company managers who are concerned about their share price performance may want to take a closer look at a recent study, which has found that Asian companies with established depositary receipts programmes can gain significant value and liquidity advantages compared with companies without DRs.

The study, which has been conducted by independent research firm Oxford Metrica in association with Bank of New York Mellon, also shows that companies with DRs have shown more resilience during the current financial crisis than those without DRs, suggesting that it is worthwhile for a company to consider DRs as a means to both attract and retain investors. The benefits apply both to listed and unlisted DR programmes, but are slightly more pronounced for the former.

"Set against a backdrop of extraordinary volatility in financial markets in the last few months, the results from our analysis provided compelling evidence for the benefits of establishing a DR programme," says Christopher Kearns, head of depositary receipts for Asia-Pacific at Bank of New York Mellon, one of the big four depositary banks.

After stripping out market-wide factors that affect all stocks in a specific sector or in the market as a whole, such as interest rate movements, core economic trends and key industry-wide events, and risk-adjusting each individual share price movement using the stock's beta, the study shows that DR programmes on average add over 10% of shareholder value in the first year. Chinese companies show the most dramatic improvement, adding approximately 40% of value from listed programmes and over 30% of value from over-the-counter programmes, but strong value was also realised by Indian and Japanese firms.

Or, looked at in a different way: an investment of $1,000 in the Shanghai Composite Index in October 2003 would have grown to $1,680 five years' later. The same investment in a portfolio of Chinese DRs would be worth $2,640 as the share prices would have both grown more initially and fallen less during the market downturn that began in October 2007.

The key reason for the benefits, says Rory Knight, chairman of Oxford Metrica, is that a DR programme tends to increase a company's visibility and result in more analyst coverage. The market also welcomes the voluntary increase in financial disclosure and reporting standards.

These arguments are supported by the fact that companies which have chosen to delist their DRs and have them trade OTC instead, have on averaged destroyed about 25% of their value.

"As a portfolio investment one would have done significantly better, both in terms of risk and return, by being in a portfolio of DRs rather than being in a broadly diversified portfolio represented by the index," Knight says."They (both portfolios) are going to be affected by movements in the individual markets, but it turns out that when you do a more in-depth analysis, you'll see that that additional value is retained even when you take out that market effect." 

The study has analysed all 596 DR programmes set up by Asian companies between 1980 and September 2008, of which 279 are listed and 317 trade over-the-counter. It includes both American depositary receipts, which are trade in the US and tend to be targeted primarily at US investors who cannot or chose not to invest in shares that are listed in a foreign stockmarket, and global depositary receipts. The latter trade in various overseas markets -- typically London or Luxembourg, although Singapore and Dubai have attracted a few GDRs by Indian companies over the past couple of years.

"A myth that has been around for at least 20 years is that establishing a DR programme negatively impacts local liquidity (i.e. the trading volume in the company's home market). We have always felt instinctively that this really wasn't accurate and we had lots of anecdotal evidence that supported this fact. Now, for the first time we have absolute empirical evidence that not only is local liquidity not impacted negatively, but in fact it is impacted very beneficially," he says.

According to the study, listed DRs resulted in a doubling of the liquidity in the company's shares in its home market, while unlisted DRs improved liquidity in the home market by an average 31%.

The study comes as a Securities and Exchange Commission (SEC) rule change in early October has made it easier for foreign companies to set up sponsored Level 1 ADR programmes in the US market. Level 1s trade in the OTC market and are not registered with the SEC, meaning they are not required to comply with Sarbanes-Oxley or to report earnings according to US GAAP. It has also made it easier for the DR banks to set up unsponsored DR programmes, which refer to programmes that are set up by a depositary bank without the participation of the company itself, amid a belief that that there is sufficient interest among investors to trade the stock. Together, the four DR banks have set up more than 1,000 unsponsored DR programmes over the past three months, supposedly in the hope that they will eventually be turned into sponsored programmes.

By comparison, only four Asian companies -- all Chinese -- listed in the US market through DRs in 2008 as the market environment pushed valuations to multi-year lows and made investors extremely nervous about participating in initial public offerings.

"This study finds that if you are looking to improve valuation and you have an open mind between listing and OTC, then absolutely you should go listing. But many companies, at least initially, discard the listed route. What this study now tells them is that there is great value to go the OTC route. They may not get the 20% value reaction in the first year, but you will get 10%."

¬ Haymarket Media Limited. All rights reserved.
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