Valuing and pricing IPOs

Abstract

a b s t r a c tThis paper investigates how underwriters set the IPO firm's fair value, an ex-ante estimate of the market value, using a unique dataset of 228 reports from French underwriters. These reports are issued before the IPO shares start trading on the stock market and detail how underwriters determined fair value. We document that underwriters often employ multiples valuation, dividend discount models and discounted cash flow (DCF) analysis to determine fair value but that all of these valuation methods suffer from a positive bias with respect to equilibrium market value. We also analyze how this fair value estimate is subsequently used as a basis for IPO pricing. We report that underwriters deliberately discount the fair value estimate when setting the preliminary offer price. Part of the intentional price discount can be recovered by higher price updates. We find that, controlling for other factors such as investor demand, part of underpricing stems from this intentional price discount.

How Do Underwriters Select Peers When Valuing IPOs?

“…The price‐to‐earnings ratio (P/E) is the most frequently adopted multiple, used to value 272 IPOs in the sample (75.3%). The central role of P/E as a valuation multiple in European IPOs is also confirmed by Deloof et al () and Roosenboom (), who report that underwriters use a P/E ratio in 93% and 84% of their samples of IPOs, respectively. The EV/Sales and enterprise value‐to‐EBITDA (EV/EBITDA) multiples are used to value 194 (54%) and 177 (49%) companies, respectively.…”

“…Price revision is defined as (offer price – POP)/POP and underpricing as (first day closing price – offer price)/offer price. A negative price revision is in contrast with Hanley and Hoberg (), who report an average price revision of 5% in the US, and Roosenboom (), who finds an average 4.6% on French second‐tier markets. However, our evidence is affected by some IPOs experiencing highly negative price revisions in 2001 and in 2007–2008 due to conditions related to the technology bubble burst and to the financial crisis, respectively.…”

Valuation and Underpricing of Turkish Ipos

“…In the European markets, recent regulations allowed several studies to investigate IPO valuation directly from the information disclosed in prospectuses. Roosenboom (2007Roosenboom ( , 2012 explain the valuation methodology employed by French underwriters. Deloof et al (2009) investigate valuation models used by Belgian investment banks.…”

“…The valuation reports include percentage underwriter discounts, a key element of the underpricing theories of Rock (1986) and Benveniste and Spindt (1989), enabling a direct test of the relationship between discounts and initial returns. Roosenboom (2012) argues that underwriters inflate the value of the firm to advertise larger deliberate discounts as a strategy to attract investors, where discounting serves to underprice the issue. If discounts are offered on the basis of providing positive initial returns to investors, and percentage discounts advertised in the valuation reports are taken at the face value, the discounts and underpricing should be proportional.…”

Ipo Underpricing and Financial Analysts’ Forecast Accuracy in Poland

“…One modification had to be done -instead of current stock prices (which were obviously not known for IPO related analyses), issuing prices were examined. Two pricing methods were evaluated: discounted cash flows (DCF) and multiples, as suggested by Ritter and Kim [1999: 409-437] and Roosenboom [2012Roosenboom [ : 1653Roosenboom [ -1664. Whereas the DCF method in the examined reports always resulted in a single price, multiples valuation frequently provided for a range of prices.…”