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 and unbiased data pertaining to these areas which valuers are most concerned with.
Looking Within
Obtaining complete and accurate information about a particular company can be very challenging when accounting systems and management systems are less than perfect. 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 management accounts can be 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 doesn't 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 determine the extent 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:
- 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:
- Changes in import/export tariffs and effects on the cost/revenue structure of the company
- Changes in labour laws and associated costs
- Other legislative changes which impact on costs on a one-off basis such as introduction 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 compensate for any material changes in policy. Discussions with management clearly need to address the historical development of the company and any changes in accounting policy.
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 sufficient data concerning the comparable companies which brings us back to our initial concerns, only this 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 of competitors, market size, 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 internet, trade publications, Government statistics, third party research providers, the main suppliers to, and customers of, the company and competitors.
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 comparables in order to draw conclusions. The extent of the adjustments that need to be made determines the reliability of the results. This can be especially difficult to accomplish where no suitably comparable markets exist 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 long term 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 market 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, it means that a greater depth of investigation is required to ensure the same level of reliability which can be expected elsewhere. Careful 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.