Key terms first
- Enterprise value (EV): the value of the operating business, regardless of how it is financed.
- Equity value: EV minus net debt and debt-like items (such as pensions or certain provisions), plus non-operating assets.
- Pre-money valuation: equity value before the new money from the IPO.
- Post-money valuation: pre-money value plus primary proceeds.
- Market capitalisation at the offer price: offer price times all shares outstanding after the offering.
Confusing these is a common cause of misunderstandings between owners, management and banks. The offer structure calculator shows them side by side.
Valuation methods
Trading comparables (peer multiples)
The anchor for almost every IPO. Banks select listed peers with similar business models, growth and margins, and apply their multiples to the company's figures.
- Common multiples: EV/revenue for high-growth or early-profit companies, EV/EBITDA and EV/EBIT for established businesses, price/earnings for financials and mature companies.
- Forward multiples (on next year's forecasts) usually matter more than historical ones.
- The company's growth, margins, risk and size are compared to the peer group to justify a premium or discount.
Peer selection is a negotiation: a peer group with higher multiples supports a higher valuation, but investors will challenge peers that are not truly comparable.
Discounted cash flow (DCF)
A DCF values the company on its projected free cash flows, discounted at the cost of capital. It helps test whether the valuation is supported by fundamentals, and is useful for companies with few listed peers. Results are very sensitive to the terminal value, long-term growth and discount rate assumptions.
Other methods
- Sum of the parts for groups with distinct businesses.
- Precedent transactions for context, keeping in mind that M&A prices include control premiums that IPO investors do not pay.
- Dividend discount models for high-payout, stable businesses.
The IPO discount
Banks typically set the offer price below their view of fair value after listing. Reasons:
- Investors take a risk on a company with no trading history.
- A discount compensates for information asymmetry between insiders and new investors.
- A positive aftermarket supports the company's reputation, future capital raises and employee morale.
The size of the discount depends on market conditions, demand, the sector and the quality of the company. Too large a discount leaves money on the table for the company and selling shareholders. Too small a discount risks a weak debut.
From valuation to price range
- Analyst research values the company using the methods above and gives a range.
- Investor education feedback shows which valuation investors find credible.
- Price range is set, often a moderate spread between the low and high end, and published with the prospectus.
- Bookbuilding reveals demand at each price level.
Setting the final price
At the end of the bookbuilding, the global coordinators and the company look at:
- Coverage: how many times the offer is oversubscribed, at each price.
- Quality: share of long-term institutional investors versus short-term or hedge fund demand; anchor orders; price sensitivity of orders.
- Price limits: the distribution of limit prices in the book.
- Aftermarket: the price at which the book should support stable trading.
The final price balances proceeds today against aftermarket performance tomorrow. A well-covered book with high-quality demand can justify pricing at or near the top of the range, or in strong markets an upward revision. A thin book may force pricing at the bottom, a cut to the offer size, a lower range or postponement.
Fixed price and auction alternatives
- Fixed price offerings set the price before subscription. Common for some retail-oriented offerings.
- Auction or modified auction methods let demand set the price more directly. Used rarely in practice.
- Direct listings let the opening auction set the price without an underwritten offering.
After pricing
Use the first-day return calculator to measure the first-day move and the money left on the table, and read IPO performance research for what history says about IPO pricing patterns.