Value In Emerging Markets

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Valuation in emerging markets

Mimi James and Timothy M. Koller
Procedures for estimating a company’s future cash flows discounted at a rate that reflects risk are the same everywhere. But in emerging markets, the risks are much greater.

s the economies of the world globalize and capital becomes more mobile, valuation is gaining importance inemerging markets—for privatization, joint ventures, mergers and acquisitions, restructuring, and just for the basic task of running businesses to create value. Yet valuation is much more difficult in these environments because buyers and sellers face greater risks and obstacles than they do in developed markets.

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In recent years, nowhere have those risks and obstacles been more serious than inthe emerging markets of East Asia. The Asian financial crisis, which began in August 1997, weakened a mass of companies and banks and led to a surge in M&A activity, giving valuation practitioners a good chance to test their skills. In Indonesia, Malaysia, the Philippines, South Korea, and Thailand—the hardest-hit Asian economies—cross-border majority-owned M&A reached an annual average value of $12billion in both 1998 and 1999, compared with $1 billion annually from 1994 to 1996.1
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Asian Development Outlook 2000, Asian Development Bank and Oxford University Press, p. 32.

The authors acknowledge the contributions of Cuong Do, Keiko Honda, Takeshi Ishiga, Jean-Marc Poullet, and Duncan Woods to this article.

Mimi James is an alumnus of McKinsey’s New York office, where Tim Koller isa principal. Copyright © 2000 McKinsey & Company. All rights reserved. This article is adapted from Tom Copeland, Tim Koller, and Jack Murrin, Valuation: Measuring and Managing the Value of Companies, third edition, New York: John Wiley & Sons, 2000, available at www.wileyvaluation.com.

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T H E M c K I N S E Y Q U A R T E R LY 2 0 0 0 N U M B E R 4 : A S I A R E VA L U ED

Yet little agreement has emerged among academics, investment bankers, and industry practitioners about how to conduct valuations in emerging markets. Methods not only vary but also often involve making arbitrary adjustments based on gut feel and limited empirical evidence. Our preferred approach is to use discounted cash flows (DCFs) together with probability-weighted scenarios that model therisks a business faces.2 The basics of estimating a DCF value—that is, the future cash flows of a company discounted at a rate that reflects potential risk—are the same everyplace. We will therefore focus on how to incorporate into a valuaExpertise in valuing nonperforming tion the extra level of risk that characterizes many emerging markets. loans has become an essential Those risks may includehigh levels element of Asian banking M&A of inflation, macroeconomic volatility, capital controls, political changes, war or civil unrest, regulatory change, poorly defined or enforced contract and investor rights, lax accounting controls, and corruption. Different assessments of these risks can lead to very different valuations, as one recent case in Asia demonstrates. During negotiations between aSouth Korean consumer goods company and a European counterpart, it became clear that the parties had arrived at very different valuations of the South Korean concern, largely because of different views about the impact of future changes in tax law and the deregulation of the industry. Macroeconomic volatility is another minefield in Asia, where the financial collapse and subsequent recessiongenerated a mountain of nonperforming bank loans. One company bidding for two Thai banks nationalized by the government during the financial crisis discovered that each had nonperforming loans of at least 60 percent of the value of its loan portfolio. Assessing the extent to which these loans might be recovered was crucial to the valuation of the banks and to the eventual structure of the deal. Indeed,...