1 valuing ipos moonchul kim,jay r. ritter presenter ：蕭靜雯姜佳瑗汪欣如林惠琴...

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Valuing IPOsValuing IPOsMoonchul Kim ,Jay R. RitterMoonchul Kim ,Jay R. Ritter

Presenter ：蕭靜雯姜佳瑗汪欣如林惠琴陳玉綾

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Abstract

This paper finds that the comparable firms approach with P/E ratios , M/B ratios and price-to-sales multiples have only modest predictive ability without further adjustment.

33

Abstract (Cont.)

This paper further indicates that the accuracy would be improved if we used forecasted earnings rather than used historical earnings data.

44

1. Introduction

The incentive of this paper:

The comparable firms approach is widely recommended , especially in the IPO firms, but there has been no systematic study of the usefulness of this approach.

55

1. Introduction (Cont.)

• The comparable firms approach results in weak predictive power when we use historical accounting data without further adjustment.

• When forecasted earnings are used for calculating P/E ratios , the accuracy will improve

substantially.

66


• This is because among publicly-traded firms in the same industry, P/E ratios display wide variation that just about any price can be justified.

77


• Two sets of sample firms:

(1) Recent IPOs in the same industry

(determined by four-digital SIC codes)

(2) Comparable firms chosen by a

“ research boutique ”

( Renaissance Capital ) .

88


• The result indicates that the sample firms chosen by the research boutique ( Renaissance Capital ) has better predictive power than the sample firms chosen by recent IPOs in the same industry.

• Multiples using forecasted earnings work better than those using historical earnings.

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• Other multiples :

M/B ratios , price-to-sales, enterprise value-to-sales , enterprise value-to-operating cash flow ratios.

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These ratios are somewhat more accurate than the use of historical accounting data , especially when we make adjustment to reflect the differences between the profitability and growth rates of the IPO firms and comparable firms.


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There is a presumption that many IPO firms have valuable growth options whose value is difficult to capture using one-year-ahead earnings forecasts.

Splitting the sample firms into young and old firms → The valuation errors of the comparable firms multiples are apparently smaller for the older firms than for the younger firms, especially using earnings data.


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Valuation Methods :

(1) Comparable firms approach .

(2) Discounted cash flow approach (DCF) .

(3) Asset-based approach .

2.Related literature-Alternative valuation frameworks

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Comparable firms approach:

It can use several market multiples

such as P/E ratios , M/B ratios , P/S ratios ,

price-operating earnings ,

enterprise value-to-sales,

enterprise value-to-operating earnings ratios.

2.1 Alternative valuation frameworks

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The estimated market price of the IPO firm

= EPS of the IPO firm × the average or median P/E ratios of comparable firms

2.1 Alternative valuation frameworks( Cont. )

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The comparable firms approach works bestwhen a highly comparable group is available,because it can reduce the probability of misvaluing a firm relative to others.

Disadvantage:It provides no safeguard against an entire sectorBeing undervalued or overvalued.


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Boatsman and Baskin (1981) compare the

accuracy of two different samples of P/E models.

Absolute prediction error

= log (predicted price) － log (actual price)


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Two different sample firms :

(1) Random firms from the same industry； (2) The firms from the same industry with

the most similar ten-year average

growth rate of earnings → better.


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Alord (1992) examines the accuracy of the P/E ratios valuation method when compar

able firms are selected on the basis of industry, firm size, and the earnings growth .

→The median absolute prediction error is smaller for selecting comparable firms by industr

y (defined by three-digital SIC codes) than selecting comparable firms by non-industry factors.


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The effect of adjusting earnings for

cross-sectional difference in leverage :

→ Adjusting earnings for differences in leverage

decreases accuracy, and adding the size factor in

addition to industry membership , it won’t improve

the accuracy of the P/E ratio valuation method.


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DCF approach :

The DCF approach is based on a firmer

theoretical basis than any other approach ,

but it is difficult to estimate future cash flows

and an appropriate discounted rate.


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Asset-based approach :It looks at the underlying value of a company’s assetsto indicate the company’s value. It is more relevantwhen a significant portion of the assets can beliquidated at a well-determined market price.

Disadvantage:In most IPOs , the asset-based approach isinappropriate because most of their value comesfrom the future growth opportunities.


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The extent of valuation studies in non-market

settings include the determination of an offer

price and management buyouts or leverage buyouts.

It is often assumed that insiders of IPO have better information than outsiders.

2.2 Valuation studies in a non-market setting

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Ritter (1984) , Kim et al. (1995) , Klein (1996) , and Van der Goot (1997) find that IPOs with a larger fraction of the equity retained by preissue shareholders have higher market valuation.

2.2 Valuation studies in a non-market setting ( Cont. )

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Kaplan and Ruback (1995) examine the DCF approach by using highly leveraged transactions , they find that transaction prices are close to the present value of projected cash flow, but they are unable to reject the hypothesis that the projections are made to justify the price.


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Kaplan and Ruback (1995) report that the CAPM-based DCF valuation approach has approximately the same accuracy as the comparable firms approach.

But their sample firms are large and mature firms , it is unlike our sample firms which are going public.


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Gilson et al.(1998) find that , for firms emerging from bankruptcy , DCF method has the same accuracy as the comparable firms approach.


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3. Data

This paper uses a sample of 190 domestic

operating company IPOs from 1992 to 1993.

Why it restricts sample to 1992 to 1993 IPOs??

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3. Data(Cont.)

Sample selection criteria:Sample selection criteria: NN

Universe of firm commitment, nonunit, noUniverse of firm commitment, nonunit, nonfinancial domestic operating company IPnfinancial domestic operating company IPOsOs

832832

Exclusion of reverse LBOs and total divesExclusion of reverse LBOs and total divestiture of subsidiariestiture of subsidiaries

164164

RemainingRemaining 668668

Exclusion of IPOs with proceeds < $ 5 milExclusion of IPOs with proceeds < $ 5 million or offer price < $ 5.00lion or offer price < $ 5.00

5656

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3. Data(Cont.)


Exclusion of firms with EPS 0 in the Exclusion of firms with EPS 0 in the

12 months prior to the offer12 months prior to the offer194194


Exclusion of firms with preissue book valExclusion of firms with preissue book value 0ue 0

4848


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3. Data(Cont.)

Exclusion of IPOs when there is no IPO iExclusion of IPOs when there is no IPO in the same (four-digit) industry in prior 1n the same (four-digit) industry in prior 12 months2 months

180180

The sample were used in this paperThe sample were used in this paper 190190

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3. Data(Cont.)

EPS:EPS:

Earnings per share (fully diluted) before Earnings per share (fully diluted) before extraordinary items and discontinued extraordinary items and discontinued operations for the most recent 12 months operations for the most recent 12 months prior to the IPO, adjusted for stock splits.prior to the IPO, adjusted for stock splits.

Sales:Sales:

Sales for the last 12 months reported in Sales for the last 12 months reported in the prospectus.the prospectus.

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3. Data(Cont.)

BPSpreissue:BPSpreissue: the book value per share reported in the pthe book value per share reported in the p

rospectus.rospectus.

BPSpostissue:BPSpostissue: the book value per share as adjusted for tthe book value per share as adjusted for t

he net proceeds and primary shares from the net proceeds and primary shares from the IPO. he IPO.

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3. Data(Cont.)

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4.1 The Comparable firms approach

Many market multiples can be used in theMany market multiples can be used in thecomparable firms approach, includingcomparable firms approach, includingindustry-specific ratios.industry-specific ratios.

Amir and Lev (1996) provide a valuationAmir and Lev (1996) provide a valuationstudy of wireless communication industry.study of wireless communication industry.

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4.1 The Comparable firms approach(Cont.)

Zarowin (1990) shows that long-term Zarowin (1990) shows that long-term growth is very important in determining growth is very important in determining E/P ratios.E/P ratios.

Liu and Ziebart (1994) find a significantLiu and Ziebart (1994) find a significantrelationship between E/P ratios and growthrelationship between E/P ratios and growth, dividend payout, and size., dividend payout, and size.

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Ohlson’s (1995) model shows that the M/B Ohlson’s (1995) model shows that the M/B ratio is a function of the firm’s abnormal eratio is a function of the firm’s abnormal earnings generating power and thus reflects arnings generating power and thus reflects the firm’s growth potential.the firm’s growth potential.

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This paper uses two groups of firms forThis paper uses two groups of firms for

the comparables:the comparables:

1. recent IPOs1. recent IPOs

2. firms chosen by a research boutique2. firms chosen by a research boutique

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When we use recent IPOs as comparableWhen we use recent IPOs as comparable

firms using an algorithm that does notfirms using an algorithm that does not

necessarily pick the best comparable firmsnecessarily pick the best comparable firms

that a practitioner would choose.that a practitioner would choose.

The advantage and disadvantage of the algoriThe advantage and disadvantage of the algorithm??thm??

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Using price-earnings ratios, the comparable Using price-earnings ratios, the comparable firms approach for empirical analysis is firms approach for empirical analysis is expressed as:expressed as:

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Using market-to-book ratios, the comparable Using market-to-book ratios, the comparable firms approach for empirical analysis is firms approach for empirical analysis is expressed as:expressed as:

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Using price-to-sales ratios, the comparable Using price-to-sales ratios, the comparable firms approach for empirical analysis is firms approach for empirical analysis is expressed as:expressed as:

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We also use a ‘simple multiple’ approach, We also use a ‘simple multiple’ approach,

in which the predicted multiple of the IPO in which the predicted multiple of the IPO

is simply the mean or median of the is simply the mean or median of the

multiples of the comparable firms.multiples of the comparable firms.

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Figure 1 illustrates the logic of using Figure 1 illustrates the logic of using comparable firm multiples and the reality.comparable firm multiples and the reality.

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4.2 Recent IPOs as comparable firms

Comparable firms:Comparable firms:

1.Firms that go public no more than 121.Firms that go public no more than 12

months prior to the IPO’s offer date.months prior to the IPO’s offer date.

2.Firms with the same four-digit SIC codes.2.Firms with the same four-digit SIC codes.

3.Five IPOs with the closest last 12 months’3.Five IPOs with the closest last 12 months’

sales are selected.sales are selected.

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We use the EPS, book value, and sales We use the EPS, book value, and sales numbers from thenumbers from the prospectusesprospectuses instead of instead of those available from more recentthose available from more recent financialfinancial statementsstatements..

Why?Why?


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Newly public firms usually use the Newly public firms usually use the proceeds of the offering repay debt, invest proceeds of the offering repay debt, invest in their business, and put the balance in in their business, and put the balance in money market instruments.money market instruments.

Interest income generated in this case is Interest income generated in this case is unlikely to reflect the firm'sunlikely to reflect the firm's future growth future growth potentialpotential..


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P/E:P/E: PricePrice/Pre-IPO Earnings/Pre-IPO EarningsM/B:M/B: Market value/ Postissue book valuesMarket value/ Postissue book valuesP/S:P/S: PricePrice/ Sales/ SalesPricePrice::IPO firm--offer priceIPO firm--offer price Comparable firms--market price on the Comparable firms--market price on the day before issuingday before issuing


5050


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Prediction errors =Prediction errors =

ln (median comparables multiple)ln (median comparables multiple)

- ln (IPO multiple)- ln (IPO multiple)

The percentage of predicted valuations within The percentage of predicted valuations within 15% of the actual multiple =15% of the actual multiple =

log (predicted) – log (actual) < 0.15log (predicted) – log (actual) < 0.15


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4.3.OLS Regression4.3.OLS Regression

Dependent variables: IPO firm’s multipleDependent variables: IPO firm’s multiple Explanatory variables: comparable firms’ multiplesExplanatory variables: comparable firms’ multiples The null hypothesis: The null hypothesis: aa11 = 1 = 1

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The possible reason for The possible reason for aa11 < 1: < 1:

If the explanatory variable is measured If the explanatory variable is measured with error, then with error, then aa1 1 has an expected value has an expected value of of αα11/(1+σ/(1+σee

22/σ/σxx22))

where where αα1 1 = true slope coefficient= true slope coefficientσσee = the standard deviation of the measurement error = the standard deviation of the measurement errorσσxx = the standard deviation of the true explanatory = the standard deviation of the true explanatory variablevariable


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The performance of the comparable firms The performance of the comparable firms approach is surprisingly weak.approach is surprisingly weak.

1.Past accounting data for a young firm may1.Past accounting data for a young firm may

not reflect expectations of the firm's futurenot reflect expectations of the firm's future

performance.performance.


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The performance of the comparable firms The performance of the comparable firms approach is surprisingly weak.approach is surprisingly weak.

2.Using comparable firm multiples without2.Using comparable firm multiples without

further adjustments for differences infurther adjustments for differences in

profitability and growth may ignore tooprofitability and growth may ignore too

much relevant information.much relevant information.

3.The comparable firms may have been3.The comparable firms may have been

chosen inappropriately.chosen inappropriately.


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4.4 The relative importance of multiples at different stage of the offering

We use three separate prices to compute We use three separate prices to compute the market value of equity.the market value of equity.

1.POP:the midpoint of the minimum and1.POP:the midpoint of the minimum and

maximum offer prices from the maximum offer prices from the

preliminary prospectus.preliminary prospectus.

2. OP : final offer price2. OP : final offer price

3.P3.Pmarketmarket:the first market price:the first market price

5959

Preliminary offer price

range (POP)

Final offer price

(OP)

First market price (Pmar

ket)

Additional information:

market demand

Comparable firms’ market

multiples

First day closing price


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P/EP/Eii = a = a00 +a +a11 P/E P/Ecomp,icomp,i + e + eii

The following relation is expected to hold:The following relation is expected to hold:

AVEAVEPOP POP < AVE< AVEOP OP < AVE< AVEmarketmarket

where AVEwhere AVE = log (predicted multiple)= log (predicted multiple)

- log (actual multiple)- log (actual multiple)

= = the average absolute valuationthe average absolute valuation

errorerror


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5. Valuation using earnings 5. Valuation using earnings forecasts and comparables forecasts and comparables from Renaissance Capitalfrom Renaissance Capital

Picking comparable firms with Picking comparable firms with Renaissance CapitalRenaissance Capital research reports, research reports, not with the same SIC codes.not with the same SIC codes.

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What’s the Renaissance What’s the Renaissance Capital ?Capital ?

A ‘A ‘boutiqueboutique’ firm specializing in IPO ’ firm specializing in IPO research.research.

It lists the ‘street’ estimate for current It lists the ‘street’ estimate for current fiscal year, next year, and the latest 12 fiscal year, next year, and the latest 12 months’ EPS numbers for IPO and two months’ EPS numbers for IPO and two comparable firms.comparable firms.

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How to calculate P/E ratios ?How to calculate P/E ratios ?

For IPO firms:For IPO firms:

P: offer price P: offer price

E: last 12 monthsE: last 12 months

current fiscal year’s forecastcurrent fiscal year’s forecast

next year’s forecastnext year’s forecast

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How to calculate P/E ratio ?How to calculate P/E ratio ?

For comparable firms:For comparable firms: P: closing market price of the stock P: closing market price of the stock on the day before the report is on the day before the report is issued.issued. E: last 12 monthsE: last 12 months current fiscal year’s forecastcurrent fiscal year’s forecast next year’s forecastnext year’s forecast

6666

What’s the difference between the What’s the difference between the Renaissance Capital and the same Renaissance Capital and the same SIC codes for comparable firms?SIC codes for comparable firms?

Based upon firms mentioned in the Based upon firms mentioned in the prospectus as the prospectus as the major competitorsmajor competitors of of the firm going public, not restrict itself to the firm going public, not restrict itself to companies with the same SIC codes.companies with the same SIC codes.

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The data informationThe data information

Size: 143 IPOsSize: 143 IPOs Sample period: September 1992 to Sample period: September 1992 to December 1993December 1993 IPOs evaluations are available from IPOs evaluations are available from

RC, and comparable firm multiples RC, and comparable firm multiples are available from Compuatatare available from Compuatat

Dow Jones: < 4000Dow Jones: < 4000

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5.2. Valuations using 5.2. Valuations using forecasted earnings, and for forecasted earnings, and for

young and old firmsyoung and old firms

Explanatory variable: Explanatory variable:

geometric mean of the RC comparables firgeometric mean of the RC comparables firm P/E multiplesm P/E multiples

Dependent variable: Dependent variable:

three P/E ratios of IPOsthree P/E ratios of IPOs

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Why use geometric mean ?Why use geometric mean ?

puts less weight on extreme valuesputs less weight on extreme values For example:For example:

4 and 464 and 46

√√4*16 = 13.56 …geometric mean4*16 = 13.56 …geometric mean

(4+46)/2=25 …….midpoint (4+46)/2=25 …….midpoint

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What’s the assumptions ?What’s the assumptions ?

If one of comparables has a negative EIf one of comparables has a negative EPS, then use another one.PS, then use another one.

All IPOs and comparables midpoint P/All IPOs and comparables midpoint P/E ratios to be no greater than 100.E ratios to be no greater than 100.

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Some information of the Table 6Some information of the Table 6

RC does not cover small IPOs for which RC does not cover small IPOs for which there is little institutional interest.there is little institutional interest.

The mean gross proceeds of the sample The mean gross proceeds of the sample is $45.4 million, with the range of $11.3 is $45.4 million, with the range of $11.3 million to $299.3 million, exclusive of ovmillion to $299.3 million, exclusive of overallotment options.erallotment options.

All reverse leveraged buyouts are excluAll reverse leveraged buyouts are excluded.ded.

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Note:Note:

The ‘street’ earnings forecasts for the IThe ‘street’ earnings forecasts for the IPOs are typically provided by analysts POs are typically provided by analysts who are affiliated with investment bankwho are affiliated with investment bankers, so there may be a conflict of interesers, so there may be a conflict of interest.t.

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Why the slope coefficients are Why the slope coefficients are below 1 and the Rbelow 1 and the R22s are below s are below

100%?100%? difference growth ratesdifference growth rates The standard growing perpetuity The standard growing perpetuity

valuation model:valuation model:

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Rapidly growing firms going pubRapidly growing firms going public may be view by the market as lic may be view by the market as having transitory component in thaving transitory component in t

heir earings.heir earings.

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Why doesn’t Renaissance Capital choose Why doesn’t Renaissance Capital choose

M/B ratio?M/B ratio?

Other multiples:Other multiples: price-to-salesprice-to-sales

enterprise value to operating cash flowenterprise value to operating cash flow

enterprise value to salesenterprise value to sales

5.3 Valuations using multiples5.3 Valuations using multiples that invariant to leverage that invariant to leverage

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5.3 Valuations using multiplesthat invariant to leverage(Cont.)

Table7:(please turn to page 432)

In Panel A: price-to-sales ratio

In panel B: use enterprise value-to-sales ration

In panel C: enterprise value-to-operating cash flow

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=1,if the sales of the IPO are growing faster than the midpoint of the comparable firms’ growth rate.

=0, otherwise

Dummy

variable


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Definition:

I. Sales of IPO and Comparables are the last 12 months sales.

II. Operating Cash flows of IPO and Comparables

are defined as EBITDA for the last 12 months.


8383

Definition:

III. Price of IPO = pro forma of shares times the midpoint of the offering price range.

IV. Enterprise value of IPO = MV + pro forma book value of debt – pro forma cash.


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Definition:

V. Price of Comparable firm is computed the market price at the time that IPO is valued.

VI.Enterprise value of Comparable firm is computed using accounting information and market price at the time that IPO is valued.


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Definition:

VII. Comparable multiple is computed as the geometric mean of the multiples for the two comparable firm.


8686

Absolute Prediction errors

P/S:(1) 56

EV/Sales:(5) 52.8

EV/OCF:(9) 43.2

Mean(%)

Table 7


(1)12-month historical 55

(1)12-month historical 55

(2)Current year forecast 43.7

Mean(%)

Table 6


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Table8:

=1,if the percentage increase in sales in the prior year of the IPO is > the midpoint of the percentage increase in sales for each of the two comparable firms.=0, otherwise

PROFIT-

ABILITY


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Mean(%)

Table 7


(1) 50.3

(2) 48.8

(3) 48.5

(4) 38.2

Mean(%)

Table 8

Panel B:(5) 52.8

(6) 52.1

(7) 50.4

(8) 51.6


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Parameter estimates

(2) 0.218 0.199

(4.18) (2.90)

Profitability ˙multiple

Table 8

˙multiple


9090

6. Conclusions

First, P/E vs. EV/sales and EV/OCF If earnings are the historical numbers, and then EV/Sale and EV/OCF would be more accurate than P/E. If earnings are the forecast numbers, and then using P/E is similar to EV/sales and EV/OCF to evaluate IPO price.

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Secondly, boutique works better than recent IPO.


P/E 5.0 56.5

Mean(%)

Table 4:recent IPO


Mean(%)

Table 6:boutique

(1) 8.3 52.8

6. Conclusions(Cont.)

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Thirdly, the authors also find out The valuation accuracy is higher for older firms than young firms.



Mean(%)

Table 6

Young 31.9

Old 23


Mean(%)

Table 7

Young 48.2

Old 28.2


Mean(%)

Table 8

Young 48.5

Old 38.2

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Finally, additional adjustments can more improve the valuation accuracy.

And the magnitude of adjustments is consistent with the industry practice.


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THE ENDTHE END

1 valuing ipos moonchul kim,jay r. ritter presenter ： 蕭靜雯 姜佳瑗 汪欣如 林惠琴...

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1 valuing ipos moonchul kim,jay r. ritter presenter ：蕭靜雯姜佳瑗汪欣如林惠琴...