Principles and Practices of Corporate Valuation and Investment in Emerging
Markets
Bryane Michael, Linacre College
How are investment opportunities in emerging markets found and exploited by
investment professionals? How can these companies be valued, bought and sold? This
course will introduce the student to some basic ideas in corporate finance, corporate
valuation, derivatives, and private equity. You will be exposed to the different markets,
the different practices, and players in emerging markets. This course is – extending off
the Oxford tradition -- designed to teach you the principles but more importantly, how to
think for yourself!
CAVEAT: This course is neither a technical introduction to corporate finance nor an
easy way of getting trained up for an Investment Banking job! We will not cover the
technical aspects of the topics intensively as you will do this either in your investment
bank training programme or for your MBA (you will hopefully delegate this to your staff
anyway!) As such, I will not assign the usual problem sets asking for specific calculations
– which you can follow up on your own.
This course is designed to make sure you don’t miss the forest for the trees with all these
complicated fancy investment strategies. The course is cumulative so that you will use
material from the first weeks in later weeks. Don’t fall behind. Many of the case studies
will draw on my own personal experience working in developing countries.
It would be helpful – though not required – to have some familiarity with corporate
finance. For students interested in the broader issues affecting international investment,
they can take my international political economy course. For students interested in
specific countries or regions, we can discuss. I hope you already see how knowledge does
not fall in courses but all knowledge interconnects.
I would like to thank two reviewers working for investment banks for their input into this
course.
Course Objectives:
By the end of the course, you should be able to:
a) think about the value of an asset in modeling terms.
b) be familiar with a number of data and empirical sources which will help you value an
asset in several emerging markets
c) think critically about investment theory, practice, and discourse.
Course Outline:
1. Identifying Opportunities in Emerging Markets
2. Estimating the Value of the Company
3. Valuing Financial and Non-Financial Options
4. Weighing Investment Options
5. Private Equity Finance
6. The Use (and Misuse) of Leverage
7. Mergers and Acquisitions
8. Supervision: The Graceful (and Profitable) Exit
Core Textbooks:
Brealey and Myers. Principles of corporate finance, McGraw-Hill. I am referring to the
5th edition. Here is the online version so you can see which chapter refers to what if you
are using a different version:
Luis E. Pereiro. Valuation of Companies in Emerging Markets.
Beim and Calomiris, (2001). Emerging Financial Markets. McGraw-Hill Irwin.
Burton G. Malkiel and J.P. Mei. Global Bargain Hunting: The Investor's Guide to Profits
in Emerging Markets.
Internet Resources:
Prof. J. P. Mei’s course on Emerging Market Finance for Professionals, Researchers and
Students
http://pages.stern.nyu.edu/~jmei/super/super1.html
Absolutely everything you wanted to know about investing in emerging markets
Professor Zhiwu Chen’s Emerging Market Finance course.
http://www.som.yale.edu/Faculty/zc25/EmergingMarkets/syllabus647-Fall2003.html
Week 1. Identifying Opportunities and Risks in Emerging Markets
In this first week, we will explore the main macroeconomic and international finance
variables affecting the return on investments abroad. We will build intuitions for how
economic variables behave and likely impacts of political and economic events on
various prices in the economy. We will also look at some of data sources. Don’t be fooled
into thinking “more is better” and go out seeking a Bloomberg machine. Focus on driving
forces instead of surface data! What are the main drivers of macroeconomic variables?
Please revise your macroeconomics and international finance to the extent possible.
Theory reading:
Revise your macroeconomics and international finance to the extent you have taken it.
You should try to remember how the following are determined: interest rates, output, and
inflation. If you have taken some international finance, you should know how the
exchange rate is determined. Don’t worry if it seems daunting, we will work together in
tutorial on this revision!
Readings:
Luis E. Pereiro. Valuation of Companies in Emerging Markets.
Chap. 1 and 2.
Burton G. Malkiel and J.P. Mei. Global Bargain Hunting : The Investor's Guide to
Profits in Emerging Markets
Chapters 1-2
World Bank Paper 1462. Stock Market Development and Financial Intermediaries:
Stylized Facts Asli Demirg-Kunt and Ross Levine
Cooper, “Chapter 11 for Countries,” Foreign Affairs, July/August 2002.
William Goetzmann and P. Jorion, "Re-emerging Markets"
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=7704
Supplementary Reading:
Jim Rogers Adventure Capitalist: The Ultimate Road Trip.
Skim the whole book to get a feel for the different markets.
Mark Mobius. Mobius on Emerging Markets.
This might or might not mean alot to you now. Read it through and be prepared to go
back to it toward the end of term.
Data sources:
Moody's Investors Service Country Credit Risk Ratings
Standard & Poor's Ratings Services Country Credit Risk Ratings
World Bank. Global Development Finance 2004: Analysis and Summary Tables
Possible Discussion Questions:
No need to write an essay this week. But come prepared to discuss one or more of the
following:
1. On Yahoo! Finance, Jon Markman claims that Philippine Long Distance Telephone is
a good investment. What macroeconomic factors does such an investment depend on?
What models would you use to assess the expected profits of the company?
http://biz.yahoo.com/ts/040917/10183405_1.html
2. Forbes thinks that Vimpel-Communications will be hot. What macroeconomic factors
does such an investment depend on? What models would you use to assess the expected
profits of the company?
http://www.forbes.com/strategies/2004/10/20/cz_as_1020sf.html
Week 2: Estimating the Value of the Company
Having looked at the broad macroeconomic environment and the possible variables
which can affect investment returns, we will now look specific investments. In order to
purchase assets at a price lower than their value, a valuation model is needed. For this
week, we will struggle with the factors that determine the value of an investment. We
will focus on corporate finance, but nothing is off-limits, including basic supply and
demand analysis from your introductory microeconomics. Try to “tie” this material with
what you already know and think about what makes assets valuable.
Theory reading:
Brealey and Myers. Principles of corporate finance, McGraw-Hill.
Chapter 2, skim Chapter 3 and 4, read Chapter 5. Basically get a feel for value as a
discounted stream of returns. If you have a firm grasp on that, it’s enough.
Brealey and Myers. Principles of corporate finance, McGraw-Hill.
Chapters 7 and 8. This is pretty important. Make sure you are comfortable with the
relationship between risk and return.
Reading:
For these readings, try to take their analysis and put into Brealey and Myers terms.
Luis E. Pereiro. Valuation of Companies in Emerging Markets.
Chap. 3 and 4.
Burton G. Malkiel and J.P. Mei. Global Bargain Hunting : The Investor's Guide to
Profits in Emerging Markets
Chapter 3-6
Valuation: Measuring and Managing the Value of Companies, 3rd Edition.
Tom Copeland, Tim Koller, Jack Murrin.
An easy read. Good for background.
Data sources for essays:
Amadeus. Has information on European Companies including Eastern Europe.
http://amadeus.bvdep.com/cgi/template.dll?product=2&user=ipaddress
Emerging Stock Markets Factbook. Standard and Poor’s, previously published by the
International Finance Corporation, World Bank.
Possible essay questions:
1. In Russia, there is higher risk. Therefore Russian assets have higher returns. Discuss.
or
2. Warren Buffet once said you should put all your eggs in one basket...and watch that
basket. Why would he say such a thing?
Week 3: Valuing Equity and Real Options
Options and other derivatives have become increasing popular in the last 10 years. For
this week, we will look mostly at options as the concept of “real options” has gained
currency in emerging market circles. Try to incorporate what you learned last week about
value to think about contingent valuation. Be critical of the theories and readings you
have encountered!
Theory Readings:
Brealey and Myers. Principles of corporate finance, McGraw-Hill.
Chapters 20 and 21
Reading
Luis E. Pereiro. Valuation of Companies in Emerging Markets.
Chap. 5
The Real Power of Real Options", McKinsey Quarterly 1997 No. 3. Find the article
online.
Making Real Options Real. McKinsey Quarterly 1998 No. 3: Find the article online.
Campbell R. Harvey, Identifying Real Options, View HTML
Romain G. Ranciere. International Capital Markets Credit Derivatives in Emerging
Markets. IMF Policy Discussion Paper. April 2002.
http://www.econ.upf.es/crei/people/ranciere/wpapers/imf.pdf
Extra Reading:
Jaime Sabal. Financial Decisions in Emerging Markets. 2002.
If you can do any of this book, I will be impressed.
Roger Lowenstein. When Genius Failed : The Rise and Fall of Long-Term Capital
Management
If you can do any of this book, I won’t be impressed (but it might help you think
about hedges and fancy investment vehicles).
Possible essay questions:
1. How can you put a price on the future?
Hint: You might want to look up Knightian uncertainty versus risk.
2. Risk is like matter, it can not be destroyed or created – only transferred.
Discuss.
Week 4: Weighing Investment Options
Having looked at some of the theories and stylised facts, we will now make a first
attempt at pulling everything together into a partial understanding. Think of this a midterm. It will be a light week to give you time to catch up. I am giving only light reading
so you can play with the heavy theory in light of this light reading.
Readings:
Campbell R. Harvey, Claude Erb and Tadas Viskanta. The Making of an Emerging
Market. Emerging Markets Quarterly (1997) 1:1 14-19.
Global Bargain Hunting : The Investor's Guide to Profits in Emerging Markets
by Burton G. Malkiel, J.P. Mei
Chapter 10
Valuation of Companies in Emerging Markets by Luis E. Pereiro, Luis E. Pereiro
Chap. 7
Mark Mobius. Mobius on Emerging Markets.
Data sources:
http://www.duke.edu/~charvey/Country_risk/couindex.htm
Discussion Questions:
1. Which real estate investment would you make -- the apartment in Marmaris or in
Tallinn?
http://www.viviun.com/AD-21235/
http://www.findaproperty.com/agent.aspx?agentid=3877&opt=prop&pid=292200
(I don’t care about the details, I want to know how you would think about the problem).
2. Should we invest in Tata Motors?
http://ir.tatamotors.com/PushFile.php?filename=./performance/a_reports/pdf/2003/Telco_
Roman_ i-xlviii.pdf
(Again, no number crunching and getting lost in details. Get a feel for the main issues
involved in the valuation of the company).
Week 5: Private Equity Finance
In this second half of the course, we will look at some of the ways of financing
investments in emerging markets. Given the lack of both equity market and banking
sector development, private equity (and retained earnings) is an important method of
finance. For this week, think about the conflict between valuation of the investor and the
financier. Think about how firm value is tied to the method of finance!
Theory readings:
Oliver Hart. Firms, Contracts, and Financial Structure (Clarendon Lectures in
Economics).
This is a hard reading. Focus on the main intuition. I want to give you a hard reading so
you get used to tackling the easy as well as the hard.
Readings:
Roger Leeds and Julie Sunderland. Private Equity Investing In Emerging Markets.
Journal of Applied Corporate Finance.
Global Private Equity 2003 Powerpoint slides.
http://www.pwcglobal.com/fr/pwc_pdf/pwc_gpe_report_2003.pdf
Natalya Volchkova. Does Financial-Industrial Group Membership Affect Fixed
Investment: Evidence from Russia.
http://www.cefir.org/Papers/cefwp9.pdf
Supplementary readings:
Economist magazine review of private equity
http://www.economist.com/surveys/showsurvey.cfm?issue=20041127
Rick Rickertsen, Robert E. Gunther and Michael Lewis. Buyout : The Insider's Guide to
Buying Your Own Company.
George W. Fenn and Nellie Liang. The Economics of the Private Equity Market
http://www.federalreserve.gov/pubs/staffstudies/1990-99/ss168.pdf
(A bit dated but still reviews some issues).
Randall E. Stross. eBoys : The First Inside Account of Venture Capitalists at Work
This is an American only context. But it gives a flavor for Venture Capitalism. This
should be your lowest priority reading (which means you’ll probably read this one first).
Possible essay questions:
1. In today’s world, financiers must provide more than simple capital. Discuss.
2. To what extent does the person who provides the money and the person who invests
profitably have diverging interests?
Week 6: The Use (and Misuse) of Leverage
In the US and in certain parts of Western Europe, debt finance has been – at various times
– a popular method of finance. In this week, we will look at the use of debt finance. We
will briefly cover fixed income assets (mostly to provide an overview of debt finance
rather than as an investment vehicle). Think about how debt changes the way we think
about valuation.
Theory reading:
Brealey and Myers. Principles of corporate finance, McGraw-Hill.
Chap. 17, 18, 23, and 24.
Readings:
Michael Pomerleano. Corporate Finance Lessons from the East Asian Crisis. Note No.
155 October 1998. Available at: http://wb-cu.car.chula.ac.th/papers/corpgov/cg022.pdf
Debt or Equity?: How Firms in Developing Countries Choose (Discussion Paper, No 22)
World Bank.
Jaime Sabal. Financial Decisions in Emerging Markets. 2002.
Chapter 11. This is manageable.
Michael Jensen. (1989). Eclipse of the Public Corporation. Harvard Business Review
September-October.
(I’m being naughty and putting this here because it is so important).
Data:
An assortment of indicators:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html
http://faculty.darden.virginia.edu/liw/emf/resources.htm
http://www.preqin.com/
Possible essay questions:
1. Dispersing ownership disperses incentives, so debt finance is better.
2. In today’s world, financiers must provide more than simple capital. Discuss.
Week 7: Mergers & Acquisition (M&A) Valuation
Much investment is not by portfolio investors but by other companies as part of a merger
of operations. Think about company valuation and contingent value in the context of
merger with another company.
Theory reading:
Gaughan, P.A. (2002). Mergers, Acquisitions, and Corporate Restructurings.. 3rd
edition
Read this first. Chapters 1, 7, 12 and 14.
Brealey and Myers. Principles of corporate finance, McGraw-Hill.
Chapter 33
Reading:
Bower, Joseph L. (2001). Not all acquisitions are the same – and that matters. Harvard
Business Review 79 (3).
Roll, R. (1986). The hubris hypothesis of corporate takeovers. Journal of Business, 59 (2)
1: 197-216.
Campbell, A (1998). Desperately seeking synergy. Harvard Business Review 76 (5): 130
– 143.
Souder, W.E. and A.K Chakrabarti. (1984). Acquisitions: do they really work out?
Interfaces 14 (4). Jul-Aug : 41-47.
Ramanujam, V. and Varadarajan, P. (1989). Research on corporate diversification.
Strategic Management Journal 10(6): 523-551.
No essay question. Get ready for next week’s revision.
Supervision: The Graceful (and Profitable) Exit
In this final week, we will review everything you have learned so far. Please review all
the weeks (including the first week because you will need to do a holistic analysis). We
will cover a couple of cases to make sure you have grasped the main ideas. Don’t worry
that you can not crunch numbers like a second year banking associate. If you get the
intuitions wrong, all the number crunching in the world won’t help you.
Reading:
Robert G. Hagstrom. The Warren Buffett Way: Investment Strategies of the World's
Greatest Investor.
An influential book on me for some reason.
Burton G. Malkiel and J.P. Mei. Global Bargain Hunting: The Investor's Guide to Profits
in Emerging Markets.
Chapter 11
Jim Rogers. Adventure Capitalist: The Ultimate Road Trip.
Data sources:
http://rru.worldbank.org/DoingBusiness/
Supervision Discussion:
Please choose a company from an emerging economy and prepared to talk about its
value. Be specific about the model(s) you are using and be critical!!!!!