IPO Valuation
IPO valuation is the process by which a company and its investment bankers determine the offering price range for a public issue, typically using a combination of price-to-earnings (P/E) multiples, EV/EBITDA multiples, and comparable company analysis benchmarked against listed peers, with the price band set in the Draft Red Herring Prospectus reflecting this assessment.
Arriving at the valuation for an Initial Public Offering involves both an analytical exercise and a commercial negotiation. The company (and its promoters) want to maximise the issue price to raise the most capital (or enable promoters to sell at the highest price via Offer for Sale), while the lead merchant banker and institutional investors want a price that leaves 'money on the table' — i.e., a discount to intrinsic value that rewards investors who participate and creates listing gains that generate goodwill for future transactions.
The primary valuation methodologies used in Indian IPO valuations were: (1) the comparable company analysis (CCA), which benchmarks the issuer against a peer group of publicly listed companies in the same industry using relative valuation multiples such as Price-to-Earnings (P/E), EV/EBITDA, EV/Revenue, and Price-to-Book; (2) the discounted cash flow (DCF) analysis, which estimates the present value of the company's future free cash flows discounted at the weighted average cost of capital (WACC); and (3) in some cases, sector-specific metrics such as price per subscriber (for telecom or SaaS companies), EV per bed (hospitals), or EV per MW (power companies).
The comparable company analysis was typically the most influential methodology in practice. Bankers identified two to six publicly listed peers and computed the median or mean of the relevant multiple. An IPO at a premium or discount to this median multiple was then justified by reference to the issuer's superior or inferior growth profile, margins, market position, or return ratios. The challenge was that comparable companies were often large-cap incumbents, while the IPO candidate was frequently a mid-cap or high-growth business — making direct multiple comparisons potentially misleading if not adjusted for growth differentials (often done using a PEG ratio or EV/EBITDA-to-growth ratio).
SEBI's ICDR Regulations 2018 do not prescribe a specific valuation methodology; instead, they require the merchant banker to include in the offer document a section on the 'Basis for Issue Price' that explains the P/E ratio, EV/EBITDA, and other metrics relative to industry peers. This section, along with the company's return on net worth and earnings per share, provides retail investors with the analytical framework the bankers used, though the information asymmetry between institutional investors (who interact directly with management during roadshows) and retail investors remained a structural feature of the IPO process.
For high-growth, loss-making companies — particularly in the technology, fintech, and new-age consumer sectors — traditional P/E valuation was inapplicable, and bankers relied on EV/Revenue, EV/Gross Merchandise Value (GMV), or price-to-forward-revenue multiples. The sustainability of such valuations became a matter of debate as several such companies listed at steep premiums in 2021 and subsequently saw significant price erosion as earnings failed to materialise at the pace expected by the initial valuations.