Monday, August 24, 2009

Emerging Markets... and maturity....

Sorry about the long hiatus between posts but I took family time off to go to California. I am three weeks away from a new semester starting but I am on my way to Peru and Brazil over the next few days to talk about valuation. I have never been to Peru before and am looking forward to seeing Lima for the first time. I have been to Brazil once or twice each year since 1998 and I am looking forward to this trip just as much.

While I will never know as much about Brazil as I would like to, I have had the opportunity to watch the market change over the last decade. While each emerging market is different, I think that some of the changes I have observed in Brazil are common across emerging markets, as they mature:

1. From Macro to Micro: When I did my first valuation seminar in Brazil for the first time in 1998, almost every question that I got during the seminar related to macro variables, with little or no attention paid to individual companies. If fact, we spent more time discussing inflation than we did discount rates, cash flows or terminal value. Coming off the hyperinflation of the previous decade, this focus was understandable and reflected the belief that if you were right about the macro variables, company-specific information mattered little. In recent years, attention has shifted more towards company characteristics, including managerial competence and the quality of investing and financing choices , a healthy development, in my view

2. Foreign to Local Currency: In the late 1990s, spilling over into the first half of the decade, almost every valuation I saw of a Brazilian company and much of the capital budgeting was done in US dollars. Not only was there a profound distrust of the local currency (Brazilian Reais) among analysts, but the Brazilian government and large Brazilian corporations seemed to share that distrust by issuing long term debt only in US dollars. Estimating a risk free rate in Brazilian Reais was an impossible exercise. It is only in the last few years that the resistance has broken down, with the Brazilian government issuing long term Reai bonds and valuations in local currencies.

3. Foreign to Domestic Investors: When I did my first few sessions in Brazil, appealing to foreign investors (especially US institutional investors) seemed to be the key priority for corporate treasurers and Brazilian investment banks. One measure of maturity has been the increasing focus on domestic investors in recent years, with foreign investors being viewed as icing on the cake.

Like any emerging market, there have been political and economic shocks along the way, but the sessions that I do in Brazil in a couple of days will resemble closely the sessions I do in New York or Frankfurt. To me, that is a healthy development. The value of an asset is a function of its cash flows, growth and risk and that lesson should not vary across markets. I will let you know how this Latin American jaunt goes...

15 comments:

Manish Agarwal said...

I used to give daily visit to your blog to see any new entry there in and atlast after a long gap you posted one entry. I would like to say that if you can add some blogs name and newletter (free) providers it would be of immense help to professionals in distant world.

Felipe Bicalho said...

Hi there Mr. Damodaran. I'm a brazilian and I would like to know if you already have a schedule of your lectures, wich cities are you going, etc.

nac said...

Have a safe trip, and please be sure to share your findings.

Aswath Damodaran said...

Rio on August 26 and Sao Paulo on August 27. The contact in Brazil is Dauer (http://www.dauer.com.br/home.htm)

Hari said...

Mr. Damodaran, I completely subscribe to the idea of valuing a company based in its cash flows and growth rates. What about companies whose DCF or multiple valuations are lower than the market value of their assets? For instance, a heritage hotel company having prime real estate assets, but lower room rents and hence, lower cash flows.

Alpesh Jain said...

To Hari's question:

If the value of the real estate owned by the company is greater than its DCF valuation, assuming the assets are fairly liquid, the real estate valuation should supercede the DCF valuation.

There are two caveats though:

1) The assets should be fairly liquid. If not, there should be a liquidity discount.
2) The other caveat in this particular instance is that the value of a heritage hotel is often based on the cash flow it can generate, as it (the hotel) is not of much value as anything else to anyone, not even as a residence, given that most such hotels are in smaller towns or remote sites. Now, if we were talking of a hertiage hotel in a prime location like Manhattan for example, then the real estate value would be the value of the hotel.

Hope that makes sense. I would be interested in hearing Prof. Damodaran's thoughts on this.

Hari said...

Thanks Alpesh. That's precisely what I thought as well. But the real estate example was only to illustrate my question. But to this further, lets assume a Private Equity investment in such a Hotel company (for argument sake, lets assume that the real estate will not be liquidated, post the investment). On what valuation is the investment done?? Investment on the asset valuation, in all probability, means a lower return. On the other hand, the current shareholders might not be interested in selling their stake on a Cash flow valuation, as it means a lower price for their stake.

Alpesh Jain said...

Hari,
There is no unbiased valuation. If you are representing the hotel company, you use the value of the real estate to arrive at your valuation, and if you are the PE firm, you would use the value of the cash flows. Ultimately it would depend on how much each party wants the deal done.

Tiago said...

I am from Brazil and those things that you said are completely true. There is a point that is worth mentioning: this crisis has shown the world that Brazil is not as risky as it was in the past and that wdeserve a lower risk premium, and in the long run the brasilizian cost of debt in Reais should go lower.

Johnny said...

Excuse me Alpesh,

I satisfied with your first statement, but the second want is a lil bit confusing, why private equity must use cash flow while the Hari said that multiple valuations are lower than the market value of their assets? Shud we use market value instead.. But the problem is, how do we project the market value in 3 yrs time like private equity always do in using multiple valuations (this refer to second question from Hari) ?

Immortal said...

Aswath

Is it possible for you to shed some views of yours on technical analysis...i too belong to the class of fundamentalist but Psychological factors drivin the markets are clearly more than fundamental factors especially in emergin mrkts like ours(India)...i would like to hear from you if u ever happen to dissect this side of investing strategy and ur views on it...i wud be really grateful...

Regards,
Amar

Aswath Damodaran said...

If a retail company has real estate value that exceeds its retail cash flow value, here are the possible valuations:
a. To an acquirer (who will control the company's destiny), it will be the real estate value. You can buy the company and liquidate it.
b. To a passive or smaller investor, it will be a weighted average of the two numbers:
Retail value * Probability that the firm will remain a retail firm + Real estate value * Probability that the firm will be liquidated for its real estate
In fact, this is part of a more general concept of expected value of control. I have a paper on the topic on my website.

Aswath Damodaran said...

I think technical analysis has use in timing of investments, even if you believe in intrinsic value. I find volume indicators to be more useful than chart patterns.

Hari said...

Thanks for your comments Prof. I am assuming that the probability is equal to the passive investor's shareholding percentage.

On a different note, I was curious about your approach to valuing Socially responsible companies. Which is the best way to measure their social value or effect on communities? An example of such an organisation could be a handicrafts company that works with village artisans and retail their products. The financial value could be derived through their cash flows, but what about social value? Do you have any papers on this subject?

Aswath Damodaran said...

The probability has little to do with the passive investor's stockholdings and more to do with corporate governance and the presence of hostile acquirers in the market. Passive investors can piggyback on these acquirers and reap the benefits of increased value.