Pricing Ipo

Pricing an IPO

By Dr. Therese E. Pactwa

From “Finance 101,” the valuation of any asset is the present value of its cash flows. There are two types of cash flows: lump sum and payment (annuity). PV, FV, PVA, FVA. Growth can be constant or non-constant. Plus, the payments could be different in different periods (not just level payments).

Pricing an IPO

Market comparables approach plays an important role in the pricing of IPOs.

Due to the variety of comparables and valuation ratios typically used, lead underwriter determines an initial estimate of a range of values for the issuer’s shares, not a single offering price.

After setting initial price range, underwriters go through book-building process. Collects information from potential institutional investors related to their interest in purchasing shares at various prices within the initial valuation range. Nonbinding expressions of interest.

At the final pricing meeting on the eve of the IPO, the investment banker and company executives meet to narrow down the range of prices to a single price. Result of judgment of company executives and the following considerations:

An updated valuation based on that day’s pricing information for comparable companies and recent IPO transactions in combination with the most up-to-date measures of company performance (i.e., EBITDA, Revenues, P/Es).

An analysis of the level of interest in the new offering that is determined in the book-building process. High interest will encourage the firm to move the offering price toward the upper end of the initial pricing range, and vice versa.

Underwriters like to price the IPO at a discount, typically 10% to 25%, to the price the shares are likely to trade on the market. Argue that this helps generate good after-market support for the offering.

Types of Valuation

Two ways to look at valuation:

What is the value of this company based on the value of similar publicly traded companies?

Should give rough idea on the value of similar publicly traded companies.

Peer group or relative valuation takes various investment ratios from comparable companies to determine a likely trading value of the potential issuer.

What is the company’s intrinsic value?

Gives the value a purchaser of 100% of the shares might place on the business.

Discounted cash flow analysis accomplished by forecasting the firm’s free cash flows and discounting them at the firm’s cost of capital to arrive at a present value.

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