MARKET ASSESSMENT ASSETS OF EMERGING MARKET - FEATURES OF THEIR INFORMATION

SECURITY

MARKET ASSESSMENT ASSETS OF EMERGING MARKET - FEATURES OF THEIR INFORMATION

SECURITY

Violeta Kasarova PhD (Bulgaria),Rumi Chuknyisky, PhD, Peter Chuknyisky, PhD, Dari Dobrovidel (USA)

2013

Baltic Valuation Conference 2013

Purpose of this report is to demonstrate the specifics at usage of the comparative approach for market assessment of assets at various types of markets and the necessary for the purpose information.

The focus falls on :

emerging market in Bulgaria in relation with the market assessment of companies as unique investment assets;

developed market of the USA in relation with the market valuation of estates.

All of the examples which are stated in the report are taken from the practice of the authors.

2

General terms

The economies in the world, in general are divided into:

Developed

Emerging.

Respectively the markets are also divided into developed and emerging.

According to the World Bank, an economy is considered as emerging economy, whenever its wealth creation level, measured by the gross domestic product per capita, is below that of the developed economies. Following this criterion, the World Bank classified in 2007, the economies of 209 countries as follows - 65 as developed and 144 as emerging.

These data are presented in the following table.

3

Classification of the economies in the world

Classification of the economies as per the income

Number of

countries

Gross domestic product, trillion $

Population, million people

Gross domestic product per

capita

Developing economies 144 12 984 5555,7 2337Low income ($935 and less) 49 1 1295,7 578Income from low to moderate ($936-$3705)

54 6 3437,1 1887

Income from moderate to high ($3706-$11455)

41 5750 822,9 6987

Developed economies 65 39682 1056 37566

High income ($11456 and more) 65 39682 1056 37566

World 209 52621 6612 7958

World Development Indicators Database, July 2008.World Bank

4

Classification of the markets

5

Classification of the markets

Developed MarketsDeveloped Markets Emerging Markets

Emerging Markets Frontier MarketsFrontier MarketsDeveloped

marketsEmerging markets

Frontier markets

AmericasEurope&Middle EastPacific

AmericasEurope, Middle

East&AfricaAsia

 

AmericasEurope&CISAfricaMiddle EastAsia

 

6

Developed markets

7

Emerging markets

8

Frontier marketsFrontier markets

Many analysts consider the emerging markets as a whole, without formation of a subgroup of the frontier markets. We have adopted the same approach.

9

Specific features of the market assessment of the emerging markets

The assessors of the emerging markets have to do more complex and responsible job, because they are:

• Deprived from historical data for the stock market, which makes them to face, as per Pereiro (2010), the beta dilemma for calculation of the price of the equity (САРМ - Capital Asset PricingModel);

• Restricted in use of the comparative approach in its classic way due to availability of country and specific risks, which do not allow to be build in a correct way, using market data, multiples for the branches of the economy, as well as to choose companies analogues. This process gets deeper also because of lack of sufficient market evidences for realized deals of the relevant market, which makes difficult the direct comparison.

• Charged with an uneasy task to integrate the specific conditions of the emerging markets in the models of the discounted cash flows.

10

Specific features of the market assessments of the emerging markets

According to a study of Bulgarian analysts, in the assessments of the Bulgarian experts:

dominates the expenses approach,

followed by the income apprоach and

the comparative approach takes the third place.

Every of the three above stated apprоaches, as per Damodaran (2002), has its advantages and disadvantages and its application is related with many limitations and difficulties, which influence the final results of the assessment.

The comparative approach is very suitable for assessment of emerging markets, but there are some problems for its usage.

11

THE COMPARATIVE APPROACH IN THE PRACTICE OF THE BULGARIAN ASSESSORS

The restricted usage of the comparative approach in evaluation of enterprises (business) is hidden in the problems, related with the access to relevant market data. In the meantime this approach is largely used for evaluation of estates in Bulgaria, precisely because of the availability of information for sufficient number of market analogues, with prices that are result of accomplished deals.

12

THE COMPARATIVE APPROACH IN THE PRACTICE OF THE BULGARIAN ASSESSORS

The comparative approach is based on:•Principle of substitution – a fundamental principle in the market evaluation, which suggests that no rational buyer will pay for the object more than the value of analogous object that has already changed its ownership on the functioning market and there is direct price information for it. •The law of one price (LOP), according to which the price of two identical assets should not differ in conditions of well functioning market and rational behavior of the investors. The main advantage is that encounters the circumstances of the market and the real priorities of the investors, while its application requires a presence of active market and accessible financial information for evaluated asset and its analogues. However, these two prerequisites, make in principle the comparative approach to be fast and easy for application, but hard for usage under conditions of emerging market, such as Bulgaria due to the low volumes of sales and transactions (mergers and acquisitions of companies), which limits the opportunities for choice of analogues. The solution of this situation is to use foreign analogues, which requires however, a series of additional adjustments to be done in order to achieve unified measures of the information.

13

Algorithm of the comparative approach in the market valuation

Searching of objects that are

comparable with the

valuated one

Identification of the

differences in the main

quantitative and quality

features

Introducing adjustments aiming to ignore the differences

between the analogue and

valuated object

Weighing of derived results

Determining of market value of

the object

Good results after using the comparative approach in the market assessments of the emerging markets can be achieved if:

An information is used for analogues from the developed markets, as for instance the Аmerican market

There are sufficient market evidences (realized sales) in specific emerging economy.

14

EXAMPLE 1. Market evaluation with usage of analogues of the Bulgarian economy

OBJECT OF THE ASSESSMENT – Bulgarian- American Credit Bank AD (ВАСВ) , owner of 12 624 725 tradable shares

DATE OF THE ASSESSMENT - 30.09.2011

BANKS ANALOGUES: Used in the assessment market multiple Р/В and

•Corporate Commercial Bank AD (6C9/CORP), market multiple Р/S. Adjustments for leveling the

•Central Cooperative Bank AD(4CF /CCB), differences in the effectiveness of the evaluated object

•First Investment Bank AD (5F4/FIB) and its analogues.

№ Parameters of BACB AD Value (at share price as per 30.09.2011)

1 Number of shares in circulation (numbers) 12 624 725 2 Equity (thousands leva) 170 137 3 Equity per single share (r.2/r.1) (leva) 13.476 4 Market multiple Р/В (adjusted) 0.156

5 Value of a single share (r.4*r.3) 2.102 6 Number of shares in circulation (number) 12 624 725 7 Net income of interest (thousands leva) 14 433 8 Net income of interest per single share (leva)

(r.7/r.6) 1.143

9 Market multiple Р/S (adjusted) 0.596

10 Value of a single share (r.9*r.8) 0.681

Fair market value per single share is =

(2.102 + 0.681)/2 = 1.392 leva

Information sources for the assessment – Bulgarian stock exchange (http://www.bse-sofia.bg/), Bulgarian national Bulgarian National Bank (http://www.bnb.bg/), sites of the banks analogues - http://www.corpbank.bg/investor_relations.html; http://www.ccbank.bg/bg/about-us/annual-reports/; http://www.fibank.bg/bg/za-nas/page/698 15

Example 2. Market assessment with use of analogues of the developed American market

OBJECT OF THE ASSESSMENT – Bulgarian enterprise DATE OF THE EVALUATION – 31.12.2011.ANALGOUES – two enterprises from USA

Information sources for the assessment:Bloomberg - URL: http://www.bloomberg.com/ Yahoo! Finance - URL: http://finance.yahoo.com/Moody’s - URL: https://www.moodys.com/Value Line - URL: http://www.valueline.com/Bulgarian Stock Exchange – URL: http://www.bse-sofia.bg/Index of Economic Freedom - http://www.heritage.org/index/pdf/2011/index2011_highlights.pdf

  ParametersAssets total Equity Net

profit Net

income ROE

%ROA

%ROS

%

Assessed enterprise - Bulgaria

1 005 566 75 157 6 544 16 920 12.15 0.88 21.15

Analogue 1 – USA 1 112 651 87 818 7 864 41 491 9.00 0.71 15.92

Analogue 2 - USA 1 121 390 76 167 5 694 25 311 7.25 0.53 15.11

Main parameters of the assessed object and its analogues as per 31.12.2011 (thousands leva)

16

Example 2. Market assessment with use of analogues of the developed American market

№ Market multiples Analogue 1 Analogue 21 Price/Earnings P/E 19.69 14.712 Price/Book value of equity P/B 1.76 1.103 Price/Sales revenue P/S 3.08 2.31

Market multiples

Estimating the country risk

An adjustment coefficient is calculated for the purpose (Cac) using a selected method. In the current assessment for determining the adjustment coefficient (Ca) for the country specific risk is used the method of Index of EconomicFreedom for 2011. The value of this index for USA is 77.8 points, which means that the country is in the area „dominating freedom”, and the value for Bulgaria is 64.9, i.e. the country falls within the borders of the „moderate freedom”. Concerning these data, Ca for the country risk (Cac ) is calculated using the following formula:

Cac = Country risk for Bulgaria / Country risk for USA = 64.9/77.8 = 0.83

Every of the market multiples is multiplied with the derived Cac.

Eliminating the differences in the return The coefficient of adjustment for return (Car) is calculated for each and every pair

„assessed enterprise – foreign analogue”, after which an average value of the adjustment coefficient is calculated for the relevant analogue.

Caranalogue 1= ROEassessed /ROEanalogue 1 = 12,15 / 9,00 = 1,35 Caranalogue 1= ROАassessed /ROАanalogue 1 = 0,88/0,71 = 1,24 Caranalogue 1= ROSassessed / ROSanalogue 1 = 21.15/15,92 = 1,33 Average meaning of Caranalogue 1 = (1,35+1,24+1,33)/3 = 1,31

Caranalogue 2= ROE assessed /ROEanalogue 2 = 12,15/7,25 =1,68 Caranalogue 2= ROА assessed /ROАanalogue 2= 0,88/0,53 =1,66 Caranalogue 2= ROS assessed / ROSanalogue 2 = 21,15/15,11 = 1,40 Average value of Caranalogue 2 = (1,68+1,66+1,40)/3 = 1,58

17

Example 2. Market assessment with use of analogues of the developed American market

Market multiples adjusted with the country risk and with adjustment for effectiveness

№ Parameters Analogue 1 Analogue 2 1 Price/Earnings P/E 19,69 14,71

2 Price/Book value of the equity P/B 1,76 1,10

3 Price/Sales revenue P/S 3,08 2,31

4 Coefficient for adjustment for country risk Cac 0,83 0,83

5 Market multiple "Price/Net earnings ", adjusted for country risk (r.1*r.4)

16,34 12,21

6 Market multiple "Price/Book value of the equity ", adjusted for country risk (r.2*r.4)

1,46 0,91

7 Market multiple "Price/Net income ", adjusted for country risk (r.3*r.4)

2,56 1,92

8 Average value of the coefficient for adjustment for the difference in the return Car

1,31 1,58

9 Market multiple "Price/Net earnings ", adjusted for the difference in the return (r.5*r.8)

21,41 18,32

10 Market multiple "Price/Book value of the equity", adjusted for the difference in the return (r.6*r.8)

1,91 1,44

11 Market multiple "Price/Net earnings", adjusted for the difference in the return (r.7*r.8)

3,35 3,03

Evaluation of Bulgarian company using analogues U.S. № Parameters Value Analogue 1 Analogue 2

1 Equity (thousands leva) 75 157 X X 2 Net profit (thousands leva) 6 544 X X 3 Net sales revenue (thousands leva) 16 920 X X

4 Market multiple "Price/Net profit " – adjusted X 21,41 18,32

5 Market multiple "Price/Equity " – adjusted X 1,91 1,44

6 Market multiple "Price/Net earnings" – adjusted X 3,35 3,03

Average value of

both analogues

Value of analogue 1

Value of analogue 2

7 Market value by equity 125 888 143 550 108 226

8 Market value by net profit 129 997 140 107 119 886

9 Market value by net sales revenue 53 975 56 682 51 268

10 Weighted market value (thousands leva) 103 287

18

Examples of Search Engines in Business Evaluation of Commercial and Residential Real Estate Properties in the USA Developed Market

19