INITIAL PUBLIC OFFERINGS (IPO)

1
Roadmap

1. IPO in a nutshell: BDM [Chapter: Raising Equity Capital]

2. The IPO process

3. Going public: pros and cons

4. IPO underpricing puzzle

5. IPO long-run underperformance puzzle

2
IPO in a Nutshell

3
IPO

• A private company “goes public”

– The company’s shares start trading on a stock market

• Special cases:
– Secondary IPO: by a once-public, now private company
– Carve-out: Parent company IPOs a fully-owned subsidiary
– Spin-off (“demerger”): Parent and subsidiary separate by creating subsidiary
shares and distributing them to existing shareholders
– Foreign listing: Company IPOs on foreign stock market
– Dual-listing (cross listing): Shares trade on several stock markets

4
• NYSE 2014

• IPO at $25bn: $21.8bn issue + 15% greenshoe (overallotment option)

• About 50% allocated to 25 institutional investors

• On first day, stock price rose 38% from $68 offering price to $93.9

• Underwriting fees: $300m (1.2% of proceeds)

– Credit Suisse Group, Deutsche Bank, Goldman Sachs, JPMorgan Chase, and
Morgan Stanley: 15.7% each
– Citigroup 7.9%
– 28 other underwriters: 1% or less each

5
• Nasdaq 2014

• Price/proceeds:
– IPO at $16  End of first day: $16.50 (+3.1%)
– Company valued at $3.93b
– 39.2m shares + 15% greenshoe (5.9m)  Proceeds $721m

• Structure
– Only primary (i.e. new) shares  Proceeds go the firm
– Owners PE firms TPG and Silver Lake retain 37% and 23% stakes
– Proceeds  Pay debt, redeem preferred stock, fee to owners

• Underwriters: Morgan Stanley, Goldman Sachs, Bank of America and Deutsche

Bank

6
ISS: 2014 Secondary IPO (Copenhagen)

• World’s largest cleaning company (founded 1901)

• 1977: IPO in Copenhagen

• 2005: LBO by EQT Partners and Goldman Sachs  de-listed

• March 2014: Secondary IPO in Copenhagen

– EQT Partners and Goldman Sachs sell some of their shares
– Raises DKK8bn ($1.5bn)

7
eBay – PayPal : 2015 Spinoff

• Spinoff:
– eBay Inc. shareholders get one PayPal share for every eBay share they own
– No cash changing hands

• Afterwards:
– eBay Inc. shares continue trading on Nasdaq
– PayPal shares start trading independently on Nasdaq

shareholders shareholders

8
IPO Process

9
In a nutshell

• Underwriters: Investment banks assist the company with

– Preparation: Procedure, “clean up” company structure,…
– Structure: Number of shares, primary/secondary, pricing,…
– Marketing, “equity story”, “educating” investors, roadshow…
– Selling (“firm commitment” vs “best effort”), share allocation,…
– Post-IPO price support,…

• Main IPO mechanisms

– Fixed-price
– “Book building”: Ask investors for view on suitable price

10
IPO preparation: Main “workshops”

Steering Committee

I – Corporate structure II – Accounting/Financials III – Due diligence IV – Documentation/Legal

Scope of the issuer (perimeter Preparation of historical Business due diligence Selection of legal advisors
definition, potential carve-out, audited accounts and IFRS Financial due diligence Drafting of prospectus
mergers between entities, reconciliation (3 years) Legal due diligence Relations with market
etc.) Preparation of pro forma Regulatory due diligence authorities
Corporate governance accounts in case of a Contracts:
Lock-up for exiting significant change of scope  Underwriting agreement
shareholders Auditors’ comfort letter  Agreement among managers
Capital structure and  Legal opinions
 Other regulatory releases
implications in terms of
financing of future growth and
shareholder return

V – Valuation VI – Equity story VII – Offering structure VIII – Employees

Business plan preparation Selection of PR / IR advisor Timing Employee offering
Modelling based on business Communication strategy pre- Size of the offering Management package and
plan IPO Offering structure (primary vs. incentive
Valuation updates Drafting of equity story secondary shares, institutional
Market watch / positioning vs. Presentation to research vs. retail, flexibility clauses
peers analysts incl. over-allotment)
Definition of mid term market Release of research reports Syndicate structure and
guidance Investors targeting for pre- recommendation (pricing,
marketing and roadshow allocation, etc.)
Investor education

11
 IPO timetable

D- 6/8 months D-6 months D-4 months D-2 months D-2 months D-15 days D D+1 D+3

Preliminary
IPO structuring process Market transaction
workshops

« Management Regulatory Research Filing Preparation Pre-marketing Pricing First quotation

Presentation » process:  Drafting of the market  Pre-  Final price set
 Drafting of the analyst Valuation transaction marketing Delivery /
Accounting prospectus presentation  Preliminary  Analyst (D-21days)  Allotments Settlement
workshop: reports being meeting
 IFRS standards Communication provided  Price range  Agreements
 Comm. plan  Drafting (D-15 days) signed
Legal workshops: linked to the Investor
 Selection of the IPO presentation Placement  Stabilisation
legal entity to be  Road-Show starts
listed Regulatory
 By laws process
adaptation  Prospectus  Institutional
 Corporate finalization placement
governance (D-15 days)
Agreements
Due diligence:  Drafting
 Business
 Accounting
 Financial data
room Placing phase

12
IPO valuation process

D: Pricing / end
D – 6/8 months D – 1/2 months D – 2 weeks of bookbuilding

Fundamental
valuation of Pre marketing +/- x% IPO price range * IPO price
enterprise value

Valuation based Valuation based analysts Determination of the price Pricing within price range
valuations and investors feedback range: based on investors based on orders in the book
 Business Plan through the feedback and market
Discounted Cash Flow  Growing importance of trading environment  Price sensitivity into the book
methodology (DCF) multiples will strongly depend on market
 Primary methodology: Trading conditions
 Trading multiples Drivers: Equity story and multiples
acceptance of the guidance by the Drivers: subscription rate,
Drivers: growth, margins and market  Secondary methodology: DCF investors profile, aftermarket
cash generation trading

13
14
Going Public: Pros and Cons

15
Going public: Pros

1. Money for the company

– At IPO: Primary shares (new shares)  Fund investment, repay debt, etc.
– Later: Shares, borrowing, currency for acquisitions, etc.

2. Money for the owners

– At IPO: Secondary shares (sale shares)  Proceeds go to owners
– Later: Eases stock sales, loans against stock, company sale, etc.

3. Impact on the business

– Customers, suppliers, etc.: IPO as marketing
– Employees: Stock-based compensation

16
Going public: Cons

1. “Going public” costs

– Fees: listing, lawyers, underwriters (I-banks), accountants, etc.
– Management time
– Underpricing

2. “Being public” costs

– Scrutiny: Regulators, press, investors,…
– Public market pressure  Short-termism?
– Loss of control, conflicts, etc.

17
 Underwriting fees
Book Building Fixed Price
Region Fraction Spread Fraction Spread
Europe 65.7% 4.38% 34.3% 2.20%
Asia Pacific 46.6% 3.94% 53.4% 2.34%
Americas 100.0% 5.26% 0.0%
Africa/Middle East 78.2% 6.36% 21.8% 2.13%
World 63.8% 4.51% 36.2% 2.25%

• IPO direct costs tend to be very high

– Underwriting fees
– Other: registration fees, auditing costs, etc.

• United States:
– Spread (underwriter fees as % of IPO proceeds): 5.3%
– Other expenses: 1.7%
 Total direct costs: 7.0% of capital raised
IPO Underpricing “Puzzle”

19
 0%
100%
120%
140%
160%

20%
40%
60%
80%
China 137%

104%

Brazil 79%

74%

Greece 52%

47%

Switzerland 36%

36%

India 35%

34%

Mexico 33%
IPO first day return

33%

Singapore 31%

31%

Germany 28%

26%

Italy 24%

23%

23%
First Day Return 

Philippines

19%

U.S. 18%

18%

Hong Kong 16%

15%

Turkey 14%

13%

Australia 12%
IPO Price

11%

Portugal 11%

10%

Finland 10%

10%
(End - of - Day Price - IPO Price)

Chile 9%

7%

Canada 6%

5%

Israel 5%
20
21
IPO costs revisited

• IPO costs are even higher if you account for underpricing

• Company’s IPO proceeds = offer price – spread – other expenses

• United States:
– Spread: 5.3%
– Other expenses: 1.7%
–  Total direct costs: 7.0%
– Underpricing: 16.8%
–  Total cost: 24.0% of capital raised

22
Explanation #1: Investment bank conflict

Underwriting banks underprice IPOs to give their favored clients (hedge funds and
institutions) cheap access to a stock at the expense of the company’s owners

CONGRATULATIONS, LINKEDIN!
You Just Got Screwed Out Of $130 Million
Blog about LinkedIn’s IPO’s 100% first day return Henry Blodget

“Imagine if the trusted real estate agent you hired to sell your house persuaded you
to sell it to her best client for $1m by telling you this was the best price she could get.
And then, the next morning, the person who bought your house turned around and
sold it for $2m (using the agent to sell it, naturally). How would you feel if your agent
did that? Shafted.”

23
Explanation #2: The Winner’s Curse

• You demand 100 shares in each of 100 IPOs

– €120 per share 50% chance
– €80 per share 50% chance

• Your share allocation depends on oversubscription:

– 10x oversubscribed  100/10 = 10 shares
– 2x oversubscribed  100/2 = 50 shares
– Etc.

1. How much are you willing to pay per share?

2. How should each issuer price the issue?
3. What is the average first day return (say true value is revealed at day end)?
4. What is your investment’s return?

24
Case 1: All investors are like you

• A priori identical IPOs  Same oversubscription (say 10x)  You get 10 shares

1. You would pay up to:

(50 IPOs ×10 shares × €120 value + 50×10×80)/(100 IPOs ×10 shares ) = €100

2. Issuers should set the IPO price just below €100

3. At end of first day (say true value is revealed):

– 50 IPOs underpriced at €100  20% price rise to €120
– 50 IPOs overpriced at €100  20% price drop to €80
– Average first day return = 50% × 20% + 50% × (−20%) = 0%

4. Your investment’s first day return:

– Invest 10 shares × €100 IPO price in each IPO  Your average return = 0%

25
Case 2: Some smart investors know the true value

Say issuers still priced their IPOs at €100 and you still demanded 100 shares

• For IPOs worth €120, smart investors partake  10x oversubscribed

• For IPOs worth €80, smart investors sit out  Lower oversubscription (say 2x)

3. At end of first day, 50% of IPOs gain 20% and 50% lose 20%  Average = 0%

4. Your investment’s first day return:

– 10 shares in each underpriced IPO  Get 20% return
– 50 shares in each overpriced IPO  Get – 20% return
– Investment: 50 IPOs × 10 shares × €100 IPO price + 50×50×100 = €300,000
– Payoff: (50 IPOs × 10 shares × 120 value + 50×50×80) = €260,000
Your average return = (260,000 – 300,000)/300,000 = – 13.33%
 You would not demand shares in the first place

26
So how should issuers price their IPOs if they want/need to attract you?

1. You would pay only up to:

(50 IPOs × 10 shares × 120 value + 50×50×80)/(50 IPOs×10 shares + 50×50)= €86.7

2. Issuers should set the IPO price just below €86.7

3. At end of first day:

– 50 IPOs underpriced at €86.7  (120 − 86.7)/86.7 = 38% price rise to €120
– 50 IPOs overpriced at €86.7  8% price drop to €80
– Average first day return = 50% × 38% + 50% × (−8%) = +15% (IPO underpricing)

4. Your investment’s first day return:

– 10 shares in each underpriced IPO  Get 38% return
– 50 shares in each overpriced IPO  Get – 8% return
– Investment: 50 IPOs × 10 shares × €86,7 IPO price + 50×50×86,7 = €260,000
– Payoff: (50 IPOs × 10 shares × 120 value + 50×50×80) = €260,000
 Your average return = 0%

27
Bottom line

• Winner’s curse:
– IPOs look like good deals on average (+15% one-day return)…
… but you cannot benefit

• Many other competing explanations

28
IPO Long-Run Underperformance “Puzzle”

29
30
The puzzle

• Factoid: Investing in shares of recent IPOs seems to generate lower returns than
investing in shares of otherwise similar companies

• Why is this a puzzle? An opportunity for profitable trading seems to exist 

Why isn’t it eliminated by arbitrage?

• Typical explanation:
– More optimistic investors buy the IPO shares
– More pessimistic investors cannot short sell
– The resulting price may exceed the fundamental value
– Over time more pessimists can short sell  the stock underperforms

31
Trading opportunity (?)

From a hedge fund prospectus:

Some companies buy back their own shares when they are cheap, and some
companies issue shares when they are expensive. The purpose of our fund is to
identify these firms and take a long position in the repurchasing companies and a
short position in the equity issuers.
The asset class is US equities due to the many buybacks and equity issues in the US
enabling the fund to form well-diversified portfolios.
According to XXX's practical experience and research, most under- and overvaluation
gaps close within 3 years. Therefore, investments should be made with a medium-
term perspective.
The strategy targets high returns of 18-22% p.a. net of fees and transaction costs at
high volatility rate of 16-22%.

32
IPO Valuation

33
34
Miuccia Prada and Patrizio Bertelli

35
Brands, Products, Distribution

36
IPO rationale

• Money for the operating company (primary tranche)

– Store openings
– Working capital
– Debt repayments

• Money for the owners (secondary tranche):

– Bank Intesa SanPaolo:
+ Cash out
– Prada Holding BV:
+ Debt repayments
+ Cash out

• Hong Kong: Branding (esp. China) + Valuation (15-20% premium)

• Now: Valuation at 3-year high and back to 10-year average level

37
 FY11 FY12 FY13
Sources of funds
Net income 333 432 527
+ Depreciation 135 159 177
= Total sources 468 591 704
Uses of funds
Capital expenditures (CAPX) 247 281 211
+ Increase in working capital (DWC) 54 65 58
= Total uses 301 346 269
Need = Total uses − Total sources (167) (245) (435)
Cumulative (167) (412) (847)

• Prada will generate more than enough money internally for:

– Financing new investments
– Repay fully (if needed) the €500m operating company debt
– Much of the €600m holding company debt
 Mostly about owners cashing out

38
IPO downsides

• Costs of “going public”

– Fees
– IPO under-pricing

• Costs of “being public”

– Compliance costs, financial reporting, investor relations, etc.
– Market pressure  Short-term management of brands?

39
Multiples

• Standard ratios:
– P/E
– EV/EBITDA

• Growth-adjusted ratios as rough controls (esp. given Prada’s superior growth)

– PEG
– EV/EBITDA-to-Growth

• Comparison groups:
– Core Luxury Tier 1: Burberry and LVMH
– Core Luxury Tier 2: Richemont, Tiffany and Tod’s
– Asian Consumer Panel: Belle International, L’Occitane and Trinity

• Prada’s higher growth + Hong Kong high valuations  Add 20% premium

40
 Stock Price Shares Market
10/03/2011 Outstanding Cap Debt Cash EV EBITDA EV/EBITDA Net Income P/E
(€) (millions) (€m) (€m) (€m) (€m) FY 2011E 2011E FY 2011E 2011E
Belle International 1.32 8 404.3 11 094 6 556 10 544 597 17.7x 470 23.6x
Bulgari 7.60 302.0 2 295 494 283 2 506 193 13.0x 95 24.2x
Burberry 13.85 431.3 5 974 287 398 5 863 468 12.5x 278 21.5x
Hermès 154.94 105.2 16 300 64 989 15 375 828 18.6x 495 32.9x
L'Occitane 1.83 1 453.6 2 660 85 280 2 465 197 12.5x 120 22.2x
LVMH 113.11 490.6 55 492 5 266 2 802 57 956 5 965 9.7x 2 936 18.9x
Richemont 41.35 575.8 23 809 701 1 213 23 297 1 947 12.0x 1 330 17.9x
Tiffany 44.56 126.3 5 628 372 487 5 513 572 9.6x 296 19.0x
Tod's 78.07 30.6 2 389 75 196 2 268 220 10.3x 123 19.4x
Trinity 0.70 1 713.7 1 200 65 47 1 218 62 19.6x 43 27.9x
Coach 40.39 301.6 12 182 18 684 11 516 1 064 10.8x 646 18.9x
Swatch 84.41 148.7 12 552 83 2 517 10 118 1 341 7.5x 942 13.3x
PPR 108.92 126.3 13 757 4 464 3 125 15 096 2 188 6.9x 1 078 12.8x
Polo Ralph Lauren 90.40 97.8 8 841 201 461 8 581 774 11.1x 420 21.1x
Pandora 41.65 129.6 5 398 66 208 5 256 470 11.2x 344 15.7x

Luxury Tier 1 Mean 11.1x 20.2x

Median 11.1x 20.2x
Luxury Tier 2 Mean 10.6x 18.8x
Median 10.3x 19.0x
Asian ConsumerMean
Panel 16.6x 24.6x
Median 17.7x 23.6x
All peers Mean 13.0x 21.3x
Median 12.2x 20.5x

41
• P/E ratio
– Luxury Tier 1 mean: 20.2x
– Prada’s FY11 net income: €333m
– Prada’s number of shares: 2.5 billion
 Prada’s FY11 EPS 333/2,500 = €0.1332
 Value per share 20.2 × €0.1332 = €2.69
– Add 20% premium (1 + 20%) × €2.69 = €3.23
– Value 2.5b × €3.23 = €8.072b

• EV/EBITDA ratio
– Luxury Tier 1 mean: 11.1x
– Prada’s FY11 EBITDA €652m
– Enterprise Value (EV): 11.1 × €652m = €7,237m
– Prada’s net debt: (€191.7m + €299.5) − €116.3m = €374.9m
Prada’s equity value €7,237m − €374.9m = €6,862.3m
– Add 20% premium (1 + 20%) × €6,862.3m = €8.235b
– Value per share €8.235b/2.5b = €3.29
42
DCF

• Discount rate:
– WACC
– Must unlever comps’ equity betas
– Here, focus on Luxury Tier 1 peers excluding Hermes and Bulgari

• Cash flows
– Explicit forecast period: Free Cash Flows
– Terminal value: growing perpetuity and EV/EBITDA exit multiple

• Add cash and subtract debt (i.e. subtract “net debt”)

• Sensitivity analysis: growth rate, WACC and exit multiple

• No 20% premium for DCF, as already reflected in the projections

43
 Market
Cap Debt Cash Equity Unlevered
WACC Belle International
(€m)
11,094
(€m)
6
(€m)
556
Beta
1.11
Tax Rate
18%
Net Debt
- 550
Beta
1.17
Bulgari 2,295 494 283 0.68 16% 211 0.62
Burberry 5,974 287 398 1.24 30% - 111 1.26
Hermès 16,300 64 989 0.25 33% - 925 0.27
L'Occitane 2,660 85 280 0.98 25% - 195 1.06
LVMH 55,492 5,266 2,802 0.97 33% 2,464 0.93
Richemont 23,809 701 1,213 1.12 15% - 512 1.14
Tiffany 5,628 372 487 1.91 34% - 115 1.95
Tod's 2,389 75 196 0.47 32% - 121 0.50
Trinity 1,200 65 47 0.76 34% 18 0.75
Coach 12,182 18 684 1.34 33% - 666 1.42
Swatch 12,552 83 2,517 1.12 25% - 2,434 1.39
PPR 13,757 4,464 3,125 0.82 28% 1,339 0.75
Polo Ralph Lauren 8,841 201 461 1.29 40% - 260 1.33
Pandora 5,398 66 208 0.40 18% - 142 0.41

Luxury Tier 1mean 1.10

median 1.10
• Unlevering peers’ betas: U = E/(1+D/E)
• Say mean U = 1.10 Luxury Tier 2mean 1.20
median 1.14
• Target leverage = 0%  No need to relever
Asian Panel mean 0.99
• Cost of equity = 3.55%(rf) + 1.10(E)× 5%(rm-rf) = median 1.06
9.0%
All peers mean 1.09
• Target leverage = 0%  WACC = 9.0%
median 1.10 44
PROJECTIONS FY 2010A FY 2011E FY 2012E FY 2013E FY 2014E FY 2015E FY 2016E
Net sales 2 047 2 392 2 804 3 173 3 506 3 765 4 040
% growth 16.9% 17.2% 13.2% 10.5% 7.4% 7.3%
EBITDA 534 652 814 964 1 065 1 144 1 227
% Net sales 26.1% 27.3% 29.0% 30.4% 30.4% 30.4% 30.4%
Depreciation and Amortization 118 135 159 177 140 151 162
% Net sales 5.8% 5.6% 5.7% 5.6% 4.0% 4.0% 4.0%
EBIT 416 517 655 787 925 993 1 066
% Net sales 20.3% 21.6% 23.4% 24.8% 26.4% 26.4% 26.4%
Capital expenditures 174 247 281 211 133 133 133
Working capital 321 375 440 498 550 590 634
% of Net sales 15.7% 15.7% 15.7% 15.7% 15.7% 15.7% 15.7%
DCF FY10-end FY 2011E FY 2012E FY 2013E FY 2014E FY 2015E FY 2016E
EBIT(1-t) with t =27% 377 478 575 675 725 778
- CAPX 247 281 211 133 133 133
+ Depreciation 135 159 177 140 151 162
- Change in WC 54 65 58 52 41 43
FCF 211 292 483 630 702 763
TV as growing perpetuity 12 034
Implied TV/EBITDA 9.8x
Discount factor 1 0.917 0.842 0.772 0.708 0.650 0.596
PV of FCF (01/31/2011) 194 245 373 446 456 455
Sum of discounted FCF 2 169
PV of TV 7 175
Implied TV/EV 77%
Enterprise value (EV) 9 344 Central values
Cash 116.3 WACC 9.0%
Long-term debt 299.5 Terminal g 2.5%
Short-term debt 191.7 Exit EV/EBITDA 9.7x
Pre-money equity value 8 970
45
Sensitivity analysis

Pre-Money Equity Value (€m)

growth rate g
##### 2.00% 2.25% 2.50% 2.75% 3.00%
8.0% 10 050 10 427 10 837 11 287 11 782
8.5% 9 174 9 487 9 825 10 193 10 594
9.0% 8 425 8 687 8 970 9 275 9 605
9.5% 7 776 7 999 8 238 8 494 8 770
10.0% 7 210 7 401 7 604 7 822 8 056

Pre-Money Equity Value € m)

EV/EBITDA exit multiple
##### 8.7x 9.2x 9.7x 10.2x 10.7x
8.0% 8 604 8 991 9 378 9 765 10 151
8.5% 8 380 8 756 9 132 9 508 9 884
9.0% 8 161 8 527 8 893 9 259 9 625
9.5% 7 950 8 306 8 662 9 018 9 374
10.0% 7 745 8 091 8 438 8 784 9 131

46
Conclusion

• DCF  ≈ €9.0bn

• FY11 P/E + 20% premium  ≈ €8.0bn

 For our calculations, let’s use €8.5bn

– Taking a single value is only for simplicity in our further calculations

– In fact, bankers would continue dealing with a range of values until the end
– As the IPO draws closer, multiples take increasing precedence over DCF

47
Primary shares

• Value per share

8,500/2,500 = €3.4 or HK$ 36.49

• Primary tranche proceeds = €230m

 Must issue
230/3.4 = 68 million new shares

• Post-money value
8,500 + 230 = €8,730bn

48
 Main IPO workshops
Steering Committee

1. Corporate Structure 2. Accounting/Financials 3. Due Diligence 4. Documentation/Legal

• Issuer scope (carve- • Historical audited • Business • Select legal advisors

outs, mergers, etc.) accounts and IFRS • Financial • Drafting of prospectus
• Corporate governance reconciliation (3 years) • Legal • Liaison with mkt authorities
• Lock-up period • Pro forma accounts in • Regulatory • Contracts:
• Capital structure and case of significant • Underwriting agreement
effect on future change of scope • Agreement among mgrs
funding and • Auditors’ comfort letter • Legal opinions
shareholder return • Other regulatory releases

5. Valuation 6. Equity Story 7. Offering Structure 8. Employees

• Business plan • Select PR/IR advisor • Timing • Employee offering

• Modelling • Communication strategy • Size • Mgt package and incentive
• Valuation updates • Drafting of equity story • Structure (primary vs.
• Market watch / • Analyst presentation secondary, institutional
positioning vs. peers • Research reports vs. retail, green-shoe)
• Mid term mkt • Investors targeting for • Syndicate structure and
guidance pre-marketing/roadshow recommendation
• Investor education (pricing, allocation, etc.)

49
 Main steps

D- 6/8 months D-6 months D-4 months D-2 months D-2 months D-15 days D D+1 D+3

Phase 1:
Preliminary Phase 2: IPO structuring process Phase 3: Market transaction
workshops

« Management Regulatory Research Prospectus Preparation Pre- Pricing First

Presentation » process:  Drafting of  Filing transaction marketing  Final price quotation
 Drafting of analyst  Analyst  Pre-
Accounting: prospectus presentation Valuation meeting marketing  Allotments Delivery /
 IFRS standards  Prelim. (D-21days) Settlement
Comm. reports  Drafting of  Agreements
Legal:  Comm. Investor  Price range signed
 Select legal plan linked pres. (D-15 days)
entity to list to the IPO  Stabilisation
 Adapt by laws Regulatory Placement starts
 Corporate process  Visa
governance  Prospectus prospectus
finalization  Road-Show
Due diligence:  Institution
 Business Agreements placement
 Accounting  Drafting (D-15 days)
 Data room
Placing phase

50
The “Equity Story”

• Century long heritage and tradition

• Worldwide leading premium luxury group
• Leadership in design: reflects cultural/social trends and quality focus
• Balanced portfolio representing each major product category
• Presence in all key markets worldwide, focus on emerging markets
• Strong and experienced management team
• Direct control over the entire value chain of each brand
• Innovative and prestigious store concepts
• Powerful communications
• Brand integrity
• And most important perhaps, superior growth potential

51
Valuation

D: Pricing / end of
D – 6/8 months D – 1/2 months D – 2 weeks bookbuilding

Fundamental
IPO price
valuation of Pre marketing IPO price
range
enterprise value

Valuation Valuation: analysts Price range: based on Pricing within range

valuations + investors investors feedback and based on order book
 Business Plan (DCF) feedback market environment
 Mostly multiples  Price sensitivity into
 Trading multiples  Growing importance of the book will strongly
 Secondary: DCF
trading multiples Drivers: structure depend on market
Drivers: growth, margins
(primary / secondary; conditions
and cash generation Drivers: Equity story and
free-float), market
acceptance of the guidance Drivers: subscription
conditions, investors
by the market rate, investors profile,
feedback, acceptance of
aftermarket trading
the guidance by market
52
Pricing: What happened?

• Initial price range: HK$36.50 – HK$48.00

• Revised (June 16): HK$39.50 – HK$42.25

• Final price (June 17): HK$39.50

53
Pre-marketing

• Two CLSA analysts met with over 300 investors over 1 month
– Present the IPO
– Get feedback

54
 Investor feedback

Key positives: Key concerns:

• Luxury is the best play within the • Execution risk of expansion, esp.
consumer/retail sector beyond first tier cities in China
• Brand, store growth and margin catch- • Aggressive 3-year assumptions for like-
up story for-like growth
• Geographic mix, esp. China • Use of proceeds given the strong cash
• Business profile and margin increase in flows
the last two years • HK listing prevents/limits some
• New DOS opening strategy European funds’ investment
• Track record/management • Dependence on key-persons
• Scarcity value • Italian taxes

55
Roadshow: June 6-17

• 99 one-on-ones
• 500 investors in larger meetings

56
 “Book-building”

• The book was covered

through the range on day 1
• Many orders were pulled in
the final days as the market
situation worsened
• The IPO was still supported
by quality long-only
investors

57
 Final IPO price (June 17): HK$39.50

• 15% premium to luxury peers

P/E EV/EBITDA
Market Cap EV Price Performance
Company Closing Price
(US$ m) (US$ m) (Jun 6-17)
2011E 2012E 2011E 2012E

Prada EUR 8,950m EUR 9,082m HKD 39.50 - 22.8x 17.3x 12.8x 10.1x

Tier 1 +11% +18%

LVMH 78,971 84,347 EUR 112.75 -4.7% 18.5x 16.3x 10.3x 9.1x
Burberry 9,278 8,829 GBP 1,317 0.9% 22.5x 19.1x 12.5x 10.8x
Average -1.9% 20.5x 17.7x 11.4x 10.0x
Median -1.9% 20.5x 17.7x 11.4x 10.0x

Tier 2
Richemont 34,486 25,877 CHF 50.90 -6.9% 17.5x 15.2x 11.1x 9.9x
Tiffany 9,425 9,490 USD 73.80 1.2% 20.9x 18.2x 10.7x 9.6x
Tod's 3,680 3,552 EUR 84.10 -7.8% 19.9x 17.6x 10.9x 9.8x
Average -4.5% 19.4x 17.0x 10.9x 9.8x
Median -6.9% 19.9x 17.6x 10.9x 9.8x

Tier 3
L'Occitane 3,598 3,265 HKD 18.98 -4.1% 20.5x 16.3x 11.1x 9.2x
Trinity 1,541 1,549 HKD 7.08 -8.5% 24.9x 18.8x 17.7x 13.4x
Belle 15,652 14,878 HKD 14.46 -9.5% 24.1x 20.0x 16.6x 13.8x
Average -7.4% 23.1x 18.4x 15.1x 12.1x
Median -8.5% 24.1x 18.8x 16.6x 13.4x

Excluded
Hermes 28,520 27,395 EUR 189.00 2.2% 40.1x 35.3x 22.3x 19.7x
Bulgari 5,260 5,266 EUR 12.17 0.2% 41.4x 31.5x 19.4x 16.4x
PPR 20,859 28,164 EUR111.05 -2.0% 13.6x 11.9x 9.4x 8.6x

+13%
Ferragamo (at IPO) EUR 1,512m EUR 1,481m EUR 9.00 ns 20.1x 15.4x 11.9x 9.7x

58
Information Asymmetry and Winner’s Curse –
The Case of Zillow

59
Intermediation Opportunity in the Housing Market

• When households plan to purchase a new house, they need to pay for the new
house before they can sell their old house
• As a result they face a liquidity problem
• Banks can provide funding, but higher mortgage leads to higher borrowing costs
and limits the size of the new property
• Alternative market solutions required to overcome mismatch in timing of
payments
Intermediation Through I-Buyers

• Idea: I-Buyers buy property from sellers

– Pay lower price in exchange for quicker payment
• This allows seller to use funds for purchase of new property
– Reduces amount required to borrow
• I-Buyer generates a profit by selling the house at market price (above their own
purchase price)
Intermediation Through I-Buyers
Intermediation Through I-Buyers
Zillow Group, Inc.

Seattle, WA 98101, USA

Sector: Communication Services
Industry: Internet Content & Information
Full-time Employees: 6,429

December 31, 2023 In thousands$

Total Revenue 1,945,000
Operating Income -247,000
EBITDA 118,000
EBIT -117,000
Total Assets 6,652,000
Current Assets 3,149,000
Tangible Assets 1,468,000
Total Liabilities 2,126,000
Debt 1,832,000
Zillow Group, Inc. – Business Model

• Predict home prices based on a wide range of characteristics (e.g., size,

location, age, type, etc.)

• Buy houses below market value: ~3% below market value

– Sellers are willing to accept lower price in exchange for quicker
transaction

• Later sell the houses at market price

• At some point Zillow started to list offers for most houses on their
website
Zillow Group, Inc. – Business Model
Zillow Group, Inc. – Challenges

1) Accuracy of pricing model

• 𝑃 =𝑎+𝑏∗𝑋+𝑒

• The pricing model relies on observable house characteristics (X); the

less accurate the model, the larger the error in predicting prices

• For example, the more important unobserved characteristics (Z) for the
house price, the less accurate the pricing model (i.e., Z goes into the
error term e)

• Other sources of prediction errors: estimate a and b inaccurately,

mismeasurement of X
Zillow Group, Inc. – Challenges

2) Information asymmetry: Seller has more information than Zillow

– Put differently, the seller may have additional information on Z
(unobservable to Zillow) and may have a more accurate measure of
X

3) Adverse selection: Seller uses Zillow whenever the seller has private
information about factors that negatively affect price, i.e., when Zillow
overestimates the price

4) Winner’s curse: Competition amplifies the adverse selection problem.

When there are multiple iBuyers with competing pricing models, sellers
choose the one that overestimates the house price the most
Zillow Group, Inc. – Early Days

• Limited Competition

• House prices increase over time

• Zillow does not list offer prices publicly

• Zillow’s business model seems to be successful

Zillow Group, Inc. – Later

• Nov 2, 2021: Zillow announces that it will stop to buy and sell houses
(Zillow Offers)

• Discloses losses of $304 million in Q3, 2021

• Rich Barton (Zillow Group Co-Founder and CEO): “We’ve determined

the unpredictability in forecasting home prices far exceeds what we
anticipated and continuing to scale Zillow Offers would result in too
much earnings and balance sheet volatility”

• Company will cut 25% of its workforce of more than 6,400 employees
iBuyer Market in Early 2020s

• What happened to other iBuyers?

• Opendoor: Net losses of $1.4bn in 2022

• Offerpad: Net losses of $149m in 2022

• November 2022: Redfin shuts down its iBuying operations

Zillow Group, Inc. – What went wrong?

• Competition increased with entry of new iBuyers

– Different pricing models
– More competitive pricing

• Winner’s curse
– More severe under competition
– More severe under competition with information asymmetry

• Zillow started to list offers leading to higher adverse selection

– Non-owners of houses could exploit problems in pricing model
Zillow Group, Inc. – Example

• Suppose that there are 100 houses

• Zillow’s pricing model is imperfect:

– It estimates 20 house prices correctly
– It overestimates 20 house prices by 5% and 20 house prices by 2%
– It underestimates 20 house prices by 5% and 20 house prices by 2%

• Zillow is the only iBuyer in the market and pays 3% below their
estimate

• Sellers value quick selling at 6% of the house price, i.e. they are willing
to sell to an iBuyer at 6% below the market value of the house
Zillow Group, Inc. – Example

• Who sells to Zillow?

– Everyone, except those for whom Zillow underestimates house price
by 5%. In this case Zillow offers 100-5-3=92 percent of the market
value. For all other cases, Zillow’s offer is >94% of market value

• Zillow’s profits:
– (-20*2%+20*1%+20*3%+20*5%)/80=1.75%

• On average Zillow overestimates prices of houses it buys (information

asymmetry + adverse selection), but the 3% discount as a compensation
for speed is sufficient to be profitable, i.e., the average overestimation is
below 3%

• In addition, increasing house prices between buying and selling helped to

increase profits (not part of the example)
Zillow Group, Inc. – Example

• Suppose again that there are 100 houses

• Zillow’s pricing model is imperfect:

– It estimates 20 house prices correctly (Group A)
– It overestimates 20 house prices by 5% (Group B) and 20 house prices by 2% (Group C)
– It underestimates 20 house prices by 5% (Group D) and 20 house prices by 2% (Group E)

• Zillow pays 3% below their own estimate

• Sellers value quick selling at 6% of the house price, i.e. they are willing to sell to an iBuyer at 6%
below the real market price of the house

• Now there is another iBuyer with a different model:

– Overestimates prices for Group A by 2%
– Underestimates prices for Group B by 2%, and overestimates prices for Group C by 5%
– Underestimates estimates prices for Group D by 5%, correctly estimates prices for Group E
Zillow Group, Inc. – Example

• Who sells to Zillow?

– Groups where Zillow pays more and price is at least 94% of house
value
+ This only applies to Group B (winner’s curse)

• Zillow’s profits:
– (-20*2%)/80=-2%

• On average Zillow overestimates prices of houses by 5%, the 3%

discount is insufficient to make it profitable

• The more competition the stronger the winner’s curse effect

Zillow Group, Inc. – Listing Prices

• What happened when Zillow started to list prices?

– Other investors went out to evaluate houses in person
– Bought houses for which Zillow overestimated the price at the
cheap and flipped them to Zillow for a profit: Zillow overpaid and
could not sell the house at the same price
– Making Zillow’s offer prices visible to everybody, including non-
owners, amplified adverse selection by allowing sophisticated
market participants to exploit errors in Zillow’s pricing model
– Adverse selection effect was turbocharged
Key Takeaways

• Information asymmetry can lead to adverse selection when less informed party
sets prices
• In competitive markets, information asymmetry can lead to a winner’s curse -
successful buyers overpay
• When adverse selection and winner’s curse occur jointly, it is unlikely for the
buyers in the market to remain profitable
• Zillow Inc., and the iBuyer market more broadly are subject to all of these issues
and the market has been very unprofitable for iBuyers