Company Valuation in Emerging Markets - Executive Summary

Characteristics of Emerging Markets

The 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 worlds 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 Approaches

Country 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 = r f + 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 firms fortune.
Todays equity value is derived through the binomial tree method.