How Do Investment Banks Value Initial Public Offerings (IPOs)?

We investigate the valuation and the pricing of initial public offerings (IPOs) by investment banks for a unique dataset of 49 IPOs on Euronext Brussels in the 1993-2001 period. We find that for each IPO several valuation methods are used, of which Discounted Free Cash Flow (DFCF) is the most popular. The offer price is mainly based on DFCF valuation, to which a discount is applied. Our results suggest that DDM tends to underestimate value, while DFCF produces unbiased value estimates. When using multiples, investment banks rely mostly on "future" earnings and cash flows. Multiples based on post-IPO forecasted earnings and cash flows result in more accurate valuations. Copyright (c) 2008 The Authors Journal compilation (c) 2008 Blackwell Publishing Ltd.