ITU-T Kaleidoscope 2009
Innovations for Digital Inclusion
New Model for Cost of Equity Evaluation
in Emerging Markets: The
Telecommunication Sector in Brazil
/Tullio Bertini (National
Telecommunications Agency, BRAZIL)
Session 7.2, Public policies, standards and
digital inclusion
Victoria Sukenik
Secretary of Communications, Argentina
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
Background 1
“New Model for Cost of Equity
Evaluation in Emerging Markets”
LRIC or FAC model implementation
process for setting wholesale tariffs…
Wacc (Weighted average cost of capital)
i.e., the minimum rate of return.
E
D
WACC =
Ke +
( 1 − t )K d
D+E
D+E
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Background 2
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Importance of the appropriate cost of
equity capital model to be used in the Wacc
estimation process.
E
D
WACC =
Ke +
( 1 − t )K d
D+E
D+E
CAPM
Different CAPM models in the Wacc
estimation process of North American
fixed-line companies (Gentzoglanis, 2004).
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Background 3
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Problems faced by the use of traditional
CAPM model in the cost of equity capital
assessment in emerging markets.
E (ri ) = rf + β i E (rm − rf )
Expected
return
Risk
free
rate
Systematic
risk
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Market
risk
premium
Background 3
“New Model for Cost of Equity
Evaluation in Emerging Markets”
CAPM model requirements:
global market integration
normally distributed asset returns
investors ability to diversify globally their
portfolios
If the Brazilian market is fully integrated to
the global market…
Emerging markets do not seem to be fully
integrated to the Global market.
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
The Blueprint for the New Model
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Investors add risk factors in the Global
CAPM models seeking recompense …
There are several modified forms of Global
CAPM models...
Are created to add non-diversifiable local
risks in the traditional CAPM model.
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
The Blueprint for the New Model
“New Model for Cost of Equity
Evaluation in Emerging Markets”
New modified form of global CAPM model, I
started from the following points:
Modified Global CAPM model proposed by
Mariscal and Lee (1993).
Harvey (2005)’s criticism about the Global
CAPM model proposed by Mariscal and Lee
(1993).
Some efficient portfolios theory’s assumptions.
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
The Blueprint for the New Model (1)
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Modified Global CAPM model proposed by
Mariscal and Lee (1993).
Ri = R + β
US
F
Global
Risk
Free
Rate
S&P
L
S&P
M
(R
Global
Systematic
Risk
(global beta)
− R ) + (R − R )
US
F
Global
market
risk
premium
ME
F
US
F
Country
risk
premium
New risk factor
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
The Blueprint for the New Model (2)
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Harvey (2005)’s criticism on the Global
CAPM model proposed by Mariscal and Lee
(1993).
Ri = R + β
US
F
S&P
L
S&P
M
(R
− R ) + (R − R )
US
F
ME
F
US
F
Same country risk premium for all assets…
Weight the country risk premium according
to the characteristics of each asset..instead
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
The Blueprint for the New Model (3)
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Some efficient portfolio theory’s
assumptions.
Correlations (ρ)
P=-1
P=0
P=0,5
Create an index
Weight the CRP
Model proposed
Mariscal and Lee
R
P
E
14
P=1
L
8
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
G
3
6
Standard-Deviation
The Model
“New Model for Cost of Equity
Evaluation in Emerging Markets”
a new modified Global CAPM model.
Index created to capture the diversification
potential of each asset…
Reduce global portfolio risk
Ri = R + β
US
F
S &P
L
S &P
M
(R
− R ) + (R
US
F
ME
F
− R ) × PoDi
US
F
Diversification
Potential
Index
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Methodology: Main Aspects (1)
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Calculate Pod value.
σG
PoD i value =
− ρ iG
σi
Attribute lower and upper limits
− 1 ≤ PoD i Value ≤ 2
Volatility ratio ranges from 0(zero) to 1(one)
Correlation coefficient range already existent
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Methodology: Main Aspects (2)
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Proceed to Pod Value standardization.
⎛ PoDi observed value ( X ) − PoDi better value (2) ⎞
⎟
⎜
PoDi index = ⎜
⎜ PoDi worst value (−1) − PoDi better value (2) ⎟⎟
⎠
⎝
Considering “Pod better value” equal to 2
and “Pod worst value" equal to -1.
Scalar value between zero and one.
Pod observed value , zero Pod index value.
Discount on the country risk premium v.v.
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Methodology: Main Aspects (3)
“New Model for Cost of Equity
Evaluation in Emerging Markets”
Ri = R + β
US
F
S &P
L
S &P
M
(R
− R ) + (R
US
F
ME
F
− R ) × PoDi
US
F
Country risk premium
Higher potential of risk diversification to the
global portfolio ( PoD )
Discount on the country risk premium v.v
Estimated PoD indexes for four Brazilian
fixed incumbents
Entire telecommunication sector in Brazil
i
i
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Results
PoD_TLPP4 = 0,677
PoD_TNLP4 = 0,697
PoD_BRTO4 = 0,703
PoD_EBTP4 = 0,710
PoD_ITEL = 0,720
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Results
“New Model for Cost of Equity
Evaluation in Emerging Markets”
The model to be applied for TNLP4 will
suffer a greater discount over CRP…
higher
discount
RTLPP4 = RFUS + β LS &P ( RMS &P − RFUS ) + ( RFME − RFUS ) × (0,677)
RTNLP 4 = RFUS + β LS & P ( RMS & P − RFUS ) + ( RFME − RFUS ) × (0,697)
RBRTO4 = RFUS + β LS &P ( RMS &P − RFUS ) + ( RFME − RFUS ) × (0,703)
REBTP4 = RFUS + β LS &P (RMS &P − RFUS ) + (RFME − RFUS ) × (0,710)
RITEL = RFUS + β LS &P ( RMS &P − RFUS ) + ( RFME − RFUS ) × (0,720)
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
lower
discount
Conclusions / Recommendations
New modified global CAPM model which
includes an index that weights the country
risk premium;
Brazilian market is partially integrated to
the global market;
Pod index was calculated for the Brazilian
telecommunication sector..
attempt to respond to criticisms about the
inclusion of the same country risk
premium…
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
Conclusions / Recommendations
The country-risk premium to be included in
the cost of equity capital of fixed line
companies should be, on average, 30.57%
lower;
The country-risk premium for the Brazilian
telecommunication sector (represented by
ITEL index) should be 28% lower;
These results are consistent with the
general principle of finance and with
efficient portfolio theory.
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion
THANK YOU FOR YOUR ATTENTION
Mar del Plata, Argentina, 31 Aug - 1 Sep 2009
ITU-T Kaleidoscope 2009 – Innovations for Digital Inclusion