Article - Finance - Business Valuation In Emerging Markets

FEATURES FEATURES Business Valuation in Emerging Markets E me rging ma rket s not generally exhibit any 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 constit ut e a “pe rfe ct m arket ” However, reality interferes with this to a greater or lesser degree depending on which part of the world you operate in Thi s article explore s those differences and provides some insight as to how professionals, working in an i m p e rfe c t m a rke t , m a na ge t o overcome some, if not all, of these challenges and unbiased data pertaining to these areas which valuers are most concerned with 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 Looking Within Obtaining complete and accurate information about a particular company c an be ve ry c ll engi ng whe n accounting systems and management syste ms a re le ss t n perfe ct 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 m a na g e m e nt a c c o unt s c a n be The Hong Kong FEBRUARY 2002 ACCOUNTANT 33 FEATURES 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 valuation, but it may mean 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 dete rmine the ext ent of the 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 l l Depreciation policy and changes in capital allowances Changes in tax rates or introduction of new taxes 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 l l l l l l effects on the cost/revenue structure of the company Change s in l abour la ws a nd associated costs Other legislative changes which impact on costs on a one-off basis such as introduct ion of new environmental laws, changes in import restrictions, etc Changes in senior management and/ or the direction of the company The introduction of new products or services and/or deletion of existing product lines Acquisition or divestment of business units 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 c o m p e t i t or s, m a r ke t si z e , 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 i n t e rn e t , t r a de p u b l i c a t i o n s , government statistics, third party research providers, the main suppliers to, and customers of, the company and competitiors 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 suffi c ie nt da ta c onc erni ng the comparable companies which brings us back to our initial concerns, only this 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 c om pa bl es i n orde r to dra w conc lusions The extent of the adjustments that need to be made determines the reliability of the results The Hong Kong 34 ACCOUNTANT FEBRUARY 2002 FEATURES Within the internet market there are numerous sectors, each with its own set of characteristics This can be especially difficult to a c com pli sh whe re no sui t abl y c om pa ble ma rket s e xist 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 longterm 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 m arket equilibrium was restored In Closing Valuations are, by their very nature, subjective to an extent They will 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 s e w h e r e C a r e f 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 HKA By Brett Shadbolt Managing Director Sallmanns (Far East) Ltd The Hong Kong FEBRUARY 2002 ACCOUNTANT 35 ... 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 valuation, but it may mean incorporating... mean 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... 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