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08-06-2016 | Original Paper

IPO valuation and profitability expectations: evidence from the Italian exchange

Authors: Matteo Bonaventura, Giancarlo Giudici

Published in: Eurasian Business Review | Issue 2/2017

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Abstract

This paper analyses the valuation process of companies listed on the Italian Exchange in the period 2000–2009 at their initial public offering (IPO). One the most common valuation techniques declared in the IPO prospectus to determine the offer price is the discounted cash flow (DCF) method. We develop a ‘reverse engineering’ model to discover the short term profitability implied in the offer prices. We show that there is a significant optimistic bias in the estimation of future profitability compared to ex-post actual realization and the mean forecast error is substantially large. Yet we show that such error characterizes also the estimations carried out by analysts evaluating non-IPO companies. The forecast error is larger the faster has been the recent growth of the company, the higher is the leverage of the IPO firm, the more companies issued equity on the market. IPO companies generally exhibit better operating performance before the listing, with respect to comparable listed companies, while after the flotation they do not perform significantly different in term of return on invested capital. Pre-IPO book building activity plays a significant role in partially reducing the forecast error and revising expectations, while the market price of the first day of trading does not contain information for further reducing forecast errors.

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Footnotes
1
Alternatively, we consider 4 years for robustness checks.
 
2
See among others Dechow et al. (2000), Gebhardt et al. (2001), Easton (2006), (Easton and Somers 2007), Cogliati et al. (2011).
 
3
In fact, if h and ROIC are constant, each year the invested capital will increase for the ploughed back profits, that will be equal to h × ROIC × IC. The percentage increase is therefore equal to h × ROIC. This assumption is not a limitation for the model: h and ROIC can be interpreted as the mean values during the period considered.
 
5
We also assume that the leverage ratio is constant; this allows to keep constant the weighted average cost of capital.
 
6
We employ data from international datasets for unlevered beta and target leverage ratio, while information on 10-year Italian government bonds and historical risk premium are specific for Italy.
 
7
We find 12 IPO companies in this group; 11 have been taken over and delisted (among which 7 industrial firms and 4 financial companies), while 1 went default. In order to control for any survivorship bias, we compute the forecast errors also for this group based on the last available interim financial statement prior to the delisting date. We still find on average large and positive forecast errors.
 
8
As most of the firms cited as ‘comparable’ in the IPO prospectus belong to the same industry of the issuer, industry is implicitly considered as a matching criterion. We also control that each comparable belongs to the same 3 digit SIC industry.
 
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Metadata
Title
IPO valuation and profitability expectations: evidence from the Italian exchange
Authors
Matteo Bonaventura
Giancarlo Giudici
Publication date
08-06-2016
Publisher
Springer International Publishing
Published in
Eurasian Business Review / Issue 2/2017
Print ISSN: 1309-4297
Electronic ISSN: 2147-4281
DOI
https://doi.org/10.1007/s40821-016-0049-1

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