IPO Valuation Model (25:44)
In this tutorial, you’ll learn what an “IPO valuation” really means, how to model an initial public offering (IPO) transaction, and what an IPO model tells you about the company and its possible valuation multiples before and after going public.
For Aspiring Investment Bankers Only:
Nearly there: please tell us where to send your...
Free DCF Video Tutorial Series
Master Financial Modeling, As It Is Performed In Real Life.
We get a lot of questions about “IPO valuation” or “IPO modeling,” but the truth is that it’s really simple because you don’t, in fact, “value” a company in an IPO.
Instead, you simply value a company and then decide how its valuation might be different in an IPO (e.g., no private company discount).
Step 1: Assumptions & Setup
You almost always start an IPO model with an idea of how much in funding the company wants to raise, and the multiples it may be valued at (based on public comps).
The multiples used vary by industry, but 1-year forward P / E multiples are very common (e.g., go to the next full fiscal year and assume a multiple for that projected full-year figure).
Here, we’d pick forward multiples from similar, profitable social networking / mobile messaging companies (not covered in this tutorial in the interest of time).
Amount of Capital to Raise: Very discretionary and it comes down to the company’s plans, how many existing shareholders want to sell, whether it’s PE or VC-backed, etc.
This is often set to 20-40% of a company’s value; common to sell ~1/4 or ~1/3 of the company in a public offering, though that also varies.
Step 2: Trading vs. Pricing and the Pricing Discount
You apply the assumed multiple to the company’s relevant metric, so Forward Net Income in this case, which gets you the “Post-Money Equity Value @ Trading.”
This is what the company’s market cap should be after it has raised the capital and is trading on the stock market.
So we can then calculate the Post-Money Equity Value at Trading (the market rate) vs. Pricing (the discounted rate that institutional investors get).
And then calculate the Implied Offering Price per Share based on this – take this value, subtract the funds raised, and divide by the company’s current share count.
Step 3: Determining the Primary vs. Secondary Shares and the “Greenshoe” (Overallotment) Provision
“Primary Shares” are newly created shares that represent actual capital being raised in the deal – this capital then goes to the company in the form of cash.
“Secondary Shares” represent existing investors selling their stakes to new investors (usually large institutions like Fidelity). No capital is raised here.
Formulas: Always determine the Primary Shares first, based on the Post-Money Equity Value @ Pricing and/or the amount of capital raised… and then figure out the Secondary Shares in relation to that.
Have to also figure out split between “Base Offering” and “Greenshoe” – “Greenshoe” is an option to issue even more shares if demand is strong enough. Used for cases where the company wants to keep the same offering price, but simply raise more capital if more investors are interested.
Very commonly set to ~15% in offerings in developed markets.
Step 4: Net Proceeds to Issuer
Look at Total Offering Size first (Primary + Secondary + Overallotment) and then subtract out fees.
Underwriting Discount: Banks used to, and sometimes still do, buy a portion of the company’s stock as “insurance” in case the company can’t sell it to anyone else… so this is supposed to compensate them for the risk of holding the stock temporarily, in case it can’t find any buyers.
Bigger deal = lower fee % in most cases.
% Company Sold: Based on Primary Proceeds and Post-Money Equity Value @ Pricing – how much the company sold of itself just before it started trading publicly.
Step 5: Valuation Multiples
We move from Equity Value to Enterprise Value as we normally do… but we must factor in the cash raised in the IPO now!
Equity Value implicitly reflects this cash, so it must be subtracted when calculating the new Enterprise Value.
Would have to compare these multiples to those of the public comps to decide whether or not they look reasonable.