Company Valuation in Emerging Markets - Executive Summary

Characteristics of Emerging MarketsThe business world of the 21st century is still lacking a universal definition of Emerging Markets (EM). Some definitions use an annual GDP growth exceeding the increase in GDP of developed countries or a GDP-per-capita ratio of $2,000 - $12,000 to recognize EM. EM are the world’s fastest growing economies. Rapidly changing market environments and highly volatile markets offer higher than average market returns, but are paired with higher risks. Further, significant characteristics are fragmented markets and the challenges to develop stable infrastructure, education systems and economies. Lastly, the cultures of EM often differ in comparison to the cultures found in the developed nations.

Risks and ApproachesCountry Risk

● Estimating country risk for emerging markets (1) and exposure of individual companies to country risk (2) is often difficult to determine

○ Other approaches have to be used volatility relative to US-market (1); beta or lambda approach (2).

Currency volatility● Currency switches during valuation, e.g. discount rates in US$ and Cash Flow in local currency,

lead to inconsistencies in valuations.○ This can be avoided by using consistently the same currency for all parts of a valuation

e.g. all in US$.Unreliable market measures

● Due to limited liquidity in EM, companies rather borrow from banks than issuing market-traded bonds. Therefore, cost of equity and debt cannot be determined reliably through the market.

○ This can be avoided by using the beta or lambda approach for estimating beta and including both country and company default spread in the calculation of the cost of debt (Cost of debt = rf + Default SpreadCountry + Default SpreadCompany)

Information gaps● EM companies often fail to deliver critical information. Many analysts simply ignore the absence

of information, which results in the valuation lacking important aspects.○ Data can often be estimated off other report parts or extrapolated from current year

information. Lastly, it is possible to use industry averages for the valuation.Corporate governance

● Market structures and systems often prevent investors from replacing management boards. Those risks are usually ignored in bull markets and blamed in bear markets.

○ Combining weighted status quo and optional valuations to identify the total risk.Discontinuous risk

○ Measuring and including risks of sudden and significant changes within a firm’s fortune.○ Today’s equity value is derived through the binomial tree method.