How is IPO price set?
Youlanda asks:
Is it decided by i-banks or some others?
How is the exact price being caculated?
Is it decided by i-banks or some others?
How is the exact price being caculated?
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Revenue of the company, future growth rates, and many many other figures combined. It’s really just an estimated value of what a share should be with there current/future numbers in mind.
It’s somewhat arbitrary…but they estimate the value of the business less what is to be held by the original owners and the remainder is divided by the number of shares to be issued. This gives you the share price.
I have worked on over a dozen IPOS. There are several distinct methods for pricing: exploratory, competitive and set price.
First, you have to remember that going public is not just a one time deal. It acts as a conduit for the company to raise more money in the future and, perhaps more importantly, as a way for managers/owners to sell their shares in the future. As a result, the price of the IPO has to be at the “right level”, one that is high enough to raise enough money and low enough to make sure that there is still some upside to the shares on the secondary market (i.e. you don’t want a stock that just does nothing but fall).
IPOs are almost always an “exploratory” pricing method. I’d say about 98% are done this way. There are two parts: first, the company issues a “red-herring”, which is the initial form of the prospectus - but without pricing (and some other data) in it. It allows potential investors to look at the company. The i-bank comes up with a range that they think is a fair price in conjunction with its supporting brokerage analyst. The analyst comes up with his own independent valuation, then goes on a “pre-deal” roadshow with their analyst, highlighting the company. However, valuation always comes up in discussion, the “whisper numbers” on valuation is brought up. The fund managers then nod their heads or grumble about the price. If they grumble too much, then the range is lowered. If they all nod their heads, then the range is raised.
Then company goes out on the roadshow. This is for the same purpose, but it’s to get info straight from the horses mouth rather than from an analyst.
Thirdly, the prospectus is issued. This is when the range is set on the prospectus.
Fourth, the “book building” is started whereby the lead Investment Bank for the deal (since it’s usually a consortium) starts taking orders. Investors start bidding what they would buy (e.g. 2m at $15.00/share). The book starts to build with all these bids on them. The capital market guys then update the investors how their bid is doing. For example, if they are too low, then they are informed that they need to raise their bid to get any shares. Likewise, once a book goes over 1.0x subscribed, you will get less than what you bid for. For example, if a deal is 2x oversubscribed, you need to bid for 20m shares when you only want 10m shares. Deals that are “hot” become massively oversubscribed and are quickly pegged to the top of the range. Deals that are less hot (e.g. 2-5x oversubscribed) are priced within the range. Deals that are cool (1-2x oversubscribed) are pegged at or near the bottom and those that somehow become less than 1x oversubscribed are withdrawn and are either repriced with a new share offer or cancelled due to lack of demand.
The price, being a competitive process, therefore depends upon supply and demand - but primarily from the demand side as the supply is fixed.
Other ways of pricing an IPO is having a fixed price. This is quite rare - but you’ll occassionally get a company who is adamant about getting a certain price. I brought one company public that shouted down our I-Bankers and demanded a given price. Since it’s their company, they’re the boss. So they got their price. I just got a lot more people shaking their head during my roadshow.
The third method is through competitive pricing. This is extremely rare. I can really only think of Google, which did it through Dutch Auction without an exploratory period. I wasn’t involved with that one, but I must say that it certainly broke the mold.