Business Valuation In Emerging Markets

As valuers, our role is to gauge the sentiment of a specific market at a particular point in time and draw conclusions concerning the worth of one company which operates within that mark

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Business Valuation in Emerging Markets

Emerging markets do not

g e n e r a l l y e x h i b i t a n y

characteristics which are not

present in developed markets, rather,

the usual challenges seen in developed

markets are amplified, sometimes

considerably Most financial theories

are based on a utopic set of market

characteristics which collectively

constitute a “perfect market”

However, reality interferes with this

to a greater or lesser degree depending

on which part of the world you operate

in This article explores those

differences and provides some insight

as to how professionals, working in an

imp erfe ct m arket , ma nage to overcome some, if not all, of these challenges

As valuers, our role is to gauge the sentiment of a specific market at a particular point in time and draw conclusions concerning the worth of one company which operates within that market In order to conduct a valuation

of a particular company, it is necessary

to obtain a complete understanding of the internal workings of the company, the specific industry sector it operates

in and the wider business environment

In a nutshell, it is obtaining complete

and unbiased data pertaining to these areas which valuers are most concerned with

Looking Within

Obtaining complete and accurate information about a particular company can be very challenging when accounting systems and management systems are less than perfect Frequently in Asia, accounting systems and requirements for the preparation

of audited accounts are inconsistent Furthermore, given the prevalence of fraud in many countries, reliance on

ma nag eme nt acco unt s c an be

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34 A CCOUNTANT

problematic In developed countries,

it is more common to be provided with

audited accounts which can be relied

on to provide an accurate financial

representation of the company being

valued In developing markets, valuers

need to investigate the financial

information provided in order to have

confidence in it This does not mean

conducting a full audit as part of a

v a l u a t i o n , b u t i t m a y m e a n

incorporating mini-audits or limited

scope financial due diligence into the

valuation process At the other end of

the scale, some valuers simply qualify

their reports, saying instead that they

have accepted information provided in

good faith and have not investigated its

accuracy Readers of a valuation

report should read it carefully to

d e t e rm i n e t h e e x t e n t o f t h e

investigation carried out by the valuer

and their degree of reliance on

unverified data

Another source of confusion not

limited to Asia, but less of an issue in

developed countries, is changing

accounting and/or tax policies The

purpose of analysing historical

financial statements is to identify

growth trends, cost relationships,

working capital requirements, capital

expenditure requirements and the like

However, where accounting rules or

tax policies have undergone material

changes, comparison of accounting

statements from different periods can

be pointless without proper adjustment

Particular areas where this is of

concern include the following:

l Depreciation policy and changes in

capital allowances

l Changes in tax rates or introduction

of new taxes

l Effect of preferential tax policies

and expiry of tax concessions

Changes within the company or

business environment not specifically

associated with accounting or tax

policies can also have a profound effect

on financial results Such areas

include:

l Changes in import/export tariffs and

effects on the cost/revenue structure

of the company

l Changes in labour laws and associated costs

l Other legislative changes which impact on costs on a one-off basis such as introduction of new environmental laws, changes in import restrictions, etc

l Changes in senior management and/

or the direction of the company

l The introduction of new products or services and/or deletion of existing product lines

l Acquisition or divestment of business units

l Expansion into new geographic markets

Therefore, valuers need to be aware

of the development of accounting and tax policies in the jurisdictions within which they operate and may need to restate historical financial statements

in order to compensate for any material

time we don’t have access to senior management Further, because the market sectors are often small and not consistent between countries, it can also be difficult finding market trend information to assist with development

of projections

To overcome these problems, valuers need to spend considerable time researching the market and competitors to the subject company The starting point for this will always

be a discussion with management of the company being valued We need to identify how much the company knows about its business environment in terms

o f co mp et it ors, m arke t si ze , accessibility, price comparisons, market share, growth trends, etc Using information provided by the company

we then conduct our own research using market data found during previous valuations in the same sector and found through independent searches of the

In developing markets, valuers need

to investigate the financial information provided in order to have confidence

in it

changes in policy Discussions with management clearly need to address the historical development of the company and any changes in accounting policy

Obtaining Perspective

Obtaining sufficient reliable data concerning the market sector within which a company operates can be even more problematic Firstly, given that most Asian markets are quite small, it can be very difficult to identify enough companies from which to draw comparisons Secondly, having identified a basket of comparable companies, the valuer then has to obtain sufficient data concerning the comparable companies which brings us back to our initial concerns, only this

i n t e rn e t , t ra de p u b l i c a ti o n s, government statistics, third party research providers, the main suppliers

to, and customers of, the company and competitiors

In situations where insufficient comparables can be found, it is common

to look to other markets as a guide This can mean looking at the same sector in other geographical markets

or looking at sectors which have similar characteristics in the same geographical market Valuers then have

to make adjustments to allow for differences between the subject and the comparables in order to draw conclusions The extent of the adjustments that need to be made determines the reliability of the results

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This can be especially difficult to

accomplish where no suitably

comparable markets exist and

conclusions have to be made in the

absence of reliable data A good

example of this is the internet market

in Asia Within the internet market

there are numerous sectors, each with

its own set of characteristics Even in

the US, the data pertaining to many

sectors is divergent and there is

obviously little to indicate the

long-term prospects of a particular sector

In this situation, it is common to use

other seemingly unrelated sectors as a

proxy to that being investigated Again,

using the internet market as an

example, we might look at other

markets which have already gone through an initial boom/bust cycle and have matured such as the computer hardware and software sectors or even pharmaceuticals, as an indicator of the long term direction of the internet market There have been numerous examples in history where people have flocked to a new sector which promised

to change the world, initially driving prices well beyond supportable levels only to see a rapid and violent backlash before market equilibrium was restored

In Closing

Valuations are, by their very nature, subjective to an extent They will

By Brett Shadbolt

Managing Director Sallmanns (Far East) Ltd

HKA

always be subject to the experience and knowledge of the person preparing them and the depth of investigation made by the valuer In developed markets, where there is greater emphasis on corporate governance, less possibility of fraud, more transparent markets and more depth to the markets, it is relatively easier to arrive at a supportable valuation This doesn’t necessarily mean that valuations in emerging markets are any less accurate, rather

it means that a greater depth of investigation is required to ensure the same level of reliability which can be

e x pe c t e d e l sewh e re C a ref u l consideration should be given to the appointment of valuers, based on their capability and previous experience rather than their eagerness to perform, fee quote or promised timetable

Within the internet market there are

numerous sectors, each with its own set

of characteristics