IPO VALUATION                  Wali MemonW ALI MEMON                    1
MOTIVATION          The second half of the 1990s witnessed          several significant innovations in technology         ...
MOTIVATION          “Early profitability is not the key to value in a          company like this (Inktomi).”              ...
MOTIVATION          Were traditional value-relevant variables such          as income, sales and book value of equity     ...
DISCOUNTED CASHFLOW VALUATION                                        t = n CF                                 Value = ∑   ...
RESEARCH QUESTIONS       Were the following variables valued differently by       investment bankers and first-day investo...
PRIORS / EXPECTATIONS       Based on anecdotes, we expect that income would be valued less in the       boom period relati...
MODEL SPECIFICATION                                                         Dependent variable choices              Price-...
MODEL SPECIFICATION                                           Dependent variable choices              Offer value in milli...
MODEL SPECIFICATION                                           Independent variables (expected signs)              Prior-Ye...
MODEL SPECIFICATION          Boom     = 1 if the offer date is during 1/1997-3/2000,                     and 0 otherwise. ...
Table 1                     Summary statistics of 1,855 US IPOs during 1986-1990 and 1997-2001                            ...
Panel C: Frequencies              Year   % of loss firms      % of Technology   % of Internet IPOs                        ...
Table 2                Relation between IPO values and time period dummies, accounting variables,                      gro...
Table 3, Appendix Table 1           Inter-temporal differences and inter-industry differences in IPO valuation of accounti...
RESULTS          Controlling for IPO fundamentals and allowing for different valuation          of these fundamentals acro...
RESULTS          Controlling for IPO fundamentals and allowing for          different valuation of these fundamentals acro...
RESULTS          Controlling for IPO fundamentals and allowing for          different valuation of these fundamentals acro...
RESULTS          Contrary to anecdotes in the financial press, income of          IPO firms is weighted more and sales is ...
IMPACT OF OWNERSHIP STRUCTURE ON IPO  VALUATION  We substitute aggregate insider retention with ownership levels of four  ...
Table 5                Relation between IPO values and time period dummies, accounting variables, growth                  ...
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IPO Valuation

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IPO Valuation

  1. 1. IPO VALUATION Wali MemonW ALI MEMON 1
  2. 2. MOTIVATION The second half of the 1990s witnessed several significant innovations in technology and the rise of the internet sector. This has been labeled as the new economy period. In the new economy period (or boom period), equity values in the U.S., especially those of initial public offering (IPO) firms, reached unprecedented heights.W ALI MEMON 2
  3. 3. MOTIVATION “Early profitability is not the key to value in a company like this (Inktomi).” Jerry Kennelly, Chief Financial Officer of Inktomi Inc (1999). “But valuations are just as often based on gut feel. As one entrepreneur told me, “Its as if everybody just settles on a number that they are comfortable with.” Gove (2000) in Red Herring.W ALI MEMON 3
  4. 4. MOTIVATION Were traditional value-relevant variables such as income, sales and book value of equity valued differently in the boom period relative to an earlier time period for IPO firms? Also, beginning from March 2000, the U.S. stock market took a dive (crash period). So the other question is “How did these variables fare in the crash period?”W ALI MEMON 4
  5. 5. DISCOUNTED CASHFLOW VALUATION t = n CF Value = ∑ t t t =1 (1 + r) where, n = Life of the asset CFt = Cashflow in period t r = Discount rate reflecting the riskiness of the estimated cashflowsW ALI MEMON 5
  6. 6. RESEARCH QUESTIONS Were the following variables valued differently by investment bankers and first-day investors in the boom and crash periods relative to the second half of the 1980s? Income Book value of equity Sales R&D Industry price-to-sales ratios Insider retention Investment banker prestige Were the valuation of these variables different for tech firms, internet firms, and loss firms?W ALI MEMON 6
  7. 7. PRIORS / EXPECTATIONS Based on anecdotes, we expect that income would be valued less in the boom period relative to the 1980s. Based on anecdotes, we expect that sales would be valued more in the boom period relative to the 1980s. Given the above two priors, we expect insider retention and IB prestige to be valued more in the boom period relative to the 1980s. We had no priors on how things would change in the crash period, and so we let the data speak. For technology and internet firms, we expect income and sales to be less valuable and insider retention and IB prestige to be more valuable. For loss firms, we expect income to be valued less, and insider retention and IB prestige to be valued more.W ALI MEMON 7
  8. 8. MODEL SPECIFICATION Dependent variable choices Price-to-earnings ratios Problem: Leads to elimination of IPOs with negative earnings from the sample. 63% of IPOs during 1997-2001 have negative earnings. Price-to-sales ratios Problem: Some IPOs during 1997-2001 have zero or extremely small values for sales. Price per share Problem: Investment bankers estimate total offer value first and then partition it somewhat arbitrarily into price per share and shares outstanding. Modal offer price in our sample of IPOs is $12: Pre- IPO income for these firms ranged from -$66 million to $71 million.W ALI MEMON 8
  9. 9. MODEL SPECIFICATION Dependent variable choices Offer value in millions of dollars. Problem: non-normality. Logarithm of Offer value. Logarithm of first-day Market value.W ALI MEMON 9
  10. 10. MODEL SPECIFICATION Independent variables (expected signs) Prior-Year Income (+) Prior-Year Book value of equity (+) Prior-Year Sales (+) Prior-Year R&D (+) Pre-IPO Industry median price-to-sales ratio (+) Post-IPO insider retention (+) Investment banker prestige (+)W ALI MEMON 10
  11. 11. MODEL SPECIFICATION Boom = 1 if the offer date is during 1/1997-3/2000, and 0 otherwise. Crash = 1 if the offer date is during 4/2000- 12/2001, and 0 otherwise. Loss = 1 if income before extraordinary items is negative, and 0 otherwise. Tech = 1 if a firm belongs a technology industry, and 0 otherwise. Internet = 1 if a firm belongs to an internet industry, and 0 otherwise.W ALI MEMON 11
  12. 12. Table 1 Summary statistics of 1,855 US IPOs during 1986-1990 and 1997-2001 Book Industr value y Investm Numb Offer Mark of Price- Insider ent Year er value et Sales Inco equit R&D to- retentio banker of Valu me y sales n prestige IPOs e multipl e Panel B: Medians 1986 230 49.0 51.3 27.7 1.1 4.0 0.0 2.5 0.70 8.1 1987 179 58.0 62.1 26.1 1.2 3.7 0.0 2.7 0.72 8.8 1988 70 61.5 72.6 29.3 1.4 3.3 0.0 1.7 0.75 8.8 1989 77 67.5 76.3 33.6 1.9 5.7 0.0 2.7 0.72 8.8 1990 77 77.6 84.0 30.0 1.4 4.9 0.2 3.0 0.71 8.8 1997 330 99.2 106.6 24.2 0.7 4.4 0.0 3.2 0.70 8.1 1998 197 147.5 166.0 22.2 -0.1 2.4 0.0 3.9 0.73 8.1 1999 359 291.7 425.1 8.2 -5.6 -0.2 1.6 31.7 0.81 9.1 2000 285 377.9 473.4 8.6 -8.9 -0.2 3.7 39.2 0.82 9.1 2001 51 321.5 356.4 68.0 -3.7 -2.2 0.0 3.0 0.76 9.1W ALI MEMON 12
  13. 13. Panel C: Frequencies Year % of loss firms % of Technology % of Internet IPOs IPOs 1986 21.7 20.4 -- 1987 19.6 25.1 -- 1988 21.4 30.0 -- 1989 22.1 33.8 -- 1990 20.8 31.2 -- 1997 42.7 35.8 3.3 1998 53.3 43.7 17.3 1999 80.5 64.9 59.1 2000 84.9 58.2 38.2 2001 68.6 35.3 5.9W ALI MEMON 13
  14. 14. Table 2 Relation between IPO values and time period dummies, accounting variables, growth proxies, investment banker prestige, and insider retention Sample of 1,655 US IPOs completed in 1986-1990 and 1997-2001. Independent L(Offer Value) L(Total Market L(Offer L(Total Market Variables Value) Value) Value) Intercept 4.18 4.25 -0.77 -1.31 (106.1) (106.8) (-6.2) (-8.6) Boom 1.03 1.27 0.79 0.92 (19.7) (21.9) (22.1) (22.7) Crash 1.70 1.87 0.95 0.90 (25.4) (24.4) (17.5) (13.7) L(Income) -0.07 -0.09 -- -- (-5.7) (-6.0) L(BV) 0.01 0.01 -- -- (1.4) (.9) L(Sales) 0.15 0.14 -- -- (10.4) (8.3) L(R&D) 0.07 0.11 -- -- (3.1) (3.8) L(Price-to-sales 0.07 0.10 -- -- Comparable) (5.5) (6.4) Investment 0.24 0.25 -- -- banker prestige (23.9) (21.0) Insider 3.58 4.31 -- -- Retention (19.3) (19.3) Adjusted R2 0.267 0.261 0.743 0.710W ALI MEMON 14
  15. 15. Table 3, Appendix Table 1 Inter-temporal differences and inter-industry differences in IPO valuation of accounting variables, growth proxies, investment banker prestige, and insider retention Sample of 1,655 US IPOs completed in 1986-1990 and 1997-2001. 1980s Boom period Crash period Tech firms Internet firms Loss firms Offer Market Offer Market Offer Market Offer Market Offer Market Offer Market value value value value value value value value value value value value Intercept 0.31 0.47 0.32 -0.13 0.60 0.57 -0.86 -1.07 -0.03 -0.46 -0.10 -0.24 (1.5) (2.0) (1.2) (-0.5) (1.3) (1.0) (-3.8) (-3.7) (-0.1) (-0.9) (-0.4) (-0.8) L(Income) 0.21 0.21 0.07 0.06 0.08 0.08 0.05 0.07 0.02 0.05 -0.49 -0.48 (5.2) (4.6) (2.0) (1.5) (2.0) (1.7) (2.3) (2.7) (.9) (1.3) (-11.3) (-9.1) L(Sales) 0.22 0.22 -0.13 -0.12 -0.19 -0.20 -0.03 -0.05 -0.09 -0.08 - - (8.3) (7.5) (-3.9) (-3.5) (-5.3) (-4.7) (-1.1) (-1.7) (-2.3) (-2.0) L(BV) -0.003 -0.003 -0.004 -0.007 0.05 0.05 -0.02 -0.02 0.03 0.04 - - (-0.2) (-0.2) (-0.2) (-0.3) (1.9) (1.9) (-1.3) (-1.2) (1.6) (1.9) L(R&D) 0.13 0.11 -0.15 -0.14 -0.06 -0.03 -0.07 -0.02 0.07 0.14 - - (3.4) (2.5) (-3.4) (-2.8) (-1.1) (-.3) (-2.0) (-.4) (1.6) (2.2) L(Price-to-sales 0.07 0.07 0.02 0.07 -0.10 -0.10 0.01 0.02 -0.06 -0.10 - - comparable) (2.7) (2.6) (0.6) (1.7) (-2.6) (-2.1) (-0.6) (0.7) (-2.2) (-2.6) Investment 0.15 0.13 0.10 0.13 0.18 0.23 1.40 -0.01 -0.08 -0.09 -0.003 -0.001 banker prestige (11.2) (8.9) (6.4) (7.4) (5.7) (5.4) (4.1) (-0.5) (-2.7) (-2.2) (-0.2) (-0.01) Insider retention 2.12 2.17 -0.06 0.27 -0.51 -0.96 1.40 1.71 1.50 2.45 0.60 0.76 (6.6) (6.0) (-0.1) (0.6) (-0.9) (-1.4) (4.1) (4.0) (2.7) (3.3) (1.6) (1.7)W ALI MEMON 15
  16. 16. RESULTS Controlling for IPO fundamentals and allowing for different valuation of these fundamentals across different time-periods, Average IPO valuations in the late 90s were not statistically different than those of the late 80s. Naïve interpretation of above result: IPO valuations in the late 90s were not excessive compared to the late 80s. We would caution against such an interpretation, since we find that fundamentals, especially income and sales, were valued quite differently in the late 90s. Above results hold after controlling for endogeneity of insider retention and investment banker prestige. (Appendix Table 2) Above results hold in robust regressions. (Appendix Table 3)W ALI MEMON 16
  17. 17. RESULTS Controlling for IPO fundamentals and allowing for different valuation of these fundamentals across different industries, Tech IPOs are valued less than non-tech IPOs. Income and insider retention are valued more for tech firms.W ALI MEMON 17
  18. 18. RESULTS Controlling for IPO fundamentals and allowing for different valuation of these fundamentals across different industries, Internet IPO valuations were not statistically different than non- internet IPOs. For internet firms, insider retention is valued more, but investment banker prestige, surprisingly, is valued less.W ALI MEMON 18
  19. 19. RESULTS Contrary to anecdotes in the financial press, income of IPO firms is weighted more and sales is weighted less when valuing IPOs in the late 90s, compared to the late 80s.W ALI MEMON 19
  20. 20. IMPACT OF OWNERSHIP STRUCTURE ON IPO VALUATION We substitute aggregate insider retention with ownership levels of four categories of owners. CEO Officers & Directors Venture Capitalists Other 5% Blockholders We also examine the impact of changes in percentage ownership of above four categories of owners around the IPO. Result: Greater the post-IPO ownership, and smaller the sales by each of these four categories of owners – greater the IPO valuation.W ALI MEMON 20
  21. 21. Table 5 Relation between IPO values and time period dummies, accounting variables, growth proxies, investment banker prestige, and detailed ownership variables Sample of 1,655 US IPOs completed in 1986-1990 and 1997-2001. Independent Variables L(Offer Value) L(Total Market Value) Intercept 1.64 1.57 (14.7) (12.2) Boom .80 .94 (21.0) (21.7) Crash .98 .95 (17.5) (14.1) L(Income) -.08 -.10 (-5.7) (-5.9) L(Sales) .15 .15 (10.3) (8.4) L(BV) .02 .01 (1.8) (4.6) L(R&D) .11 .15 (4.1) (4.6) L(Price-to-sales comparable) .08 .12 (6.0) (6.7) Investment banker prestige .26 .27 (23.1) (20.8) CEO% Change -2.33 -2.52 (-7.5) (-6.9) OffDir% Change -2.00 -2.38 (-5.4) (-5.58) VC% Change -3.45 -4.73 (-7.4) (-7.8) Block% Change -1.50 -1.96 (-5.2) (-6.0) CEO% After .76 .80 (4.2) (3.7) OffDir% After .66 .84 (3.5) (3.7) VC% After 1.26 1.76 (5.7) (6.3) Block% After .89 .99 (5.7) (5.3) 2 Adjusted R 0.709 0.676W ALI MEMON 21

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