PRIVATE EQUITY IN RUSSIA: APPLICATION OF ACCOUNTING-BASED VALUATION MODEL FOR NON-TRADED COMPANIES
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LIST OF TABLES AND FIGURES 5
INTRODUCTION 6
1. LITERATURE REVIEW 8
1.1 Valuation theory 8
1.2 Private equity industry in Russia 17
2. RESEARCH METHODOLOGY AND DESIGN 21
2.1 Research problem: test of applicability of Residual Earnings Model for valuation of non-traded
companies 21
2.2 Research goal and objectives 24
2.3 Research questions 26
2.4 Research hypotheses 29
2.5 Formalization of the Residual Earnings Model 31
2.6 Data collection 36
3. EMPIRICAL RESULTS OF APPLICATION RESIDUAL EARNINGS MODEL 38
3.1 Comparison of IFRS-based and RAS-based valuation models 38
3.2 Test of the regression model with different required rates of return on equity 48
3.3 Application of the model for IPO price estimating 50
CONCLUSIONS 56
LIST OF REFERENCES 58
INTRODUCTION 6
1. LITERATURE REVIEW 8
1.1 Valuation theory 8
1.2 Private equity industry in Russia 17
2. RESEARCH METHODOLOGY AND DESIGN 21
2.1 Research problem: test of applicability of Residual Earnings Model for valuation of non-traded
companies 21
2.2 Research goal and objectives 24
2.3 Research questions 26
2.4 Research hypotheses 29
2.5 Formalization of the Residual Earnings Model 31
2.6 Data collection 36
3. EMPIRICAL RESULTS OF APPLICATION RESIDUAL EARNINGS MODEL 38
3.1 Comparison of IFRS-based and RAS-based valuation models 38
3.2 Test of the regression model with different required rates of return on equity 48
3.3 Application of the model for IPO price estimating 50
CONCLUSIONS 56
LIST OF REFERENCES 58
The problem of corporate valuation and estimation of fundamental value of a firm remains unresolved in finance literature. Although there are many valuation techniques that can be effectively applied to companies on developed markets, valuation of the companies operating on developing markets can be challenging. Most of the valuation methods require well- developed financial market and large number of traded companies with comparable characteristics. Valuation process of private equity deals and non-traded companies on developing markets can be even more complicated. Even though many of the valuation techniques applicable to public companies can be used to value private companies as well, estimating the true intrinsic value of a private company can be a challenging task.
The topic of the research paper is: “Private equity in Russia: application of accounting-based valuation model for non-traded companies”. The relevance of the research topic is determined by specifics of Russian private equity market and organizational structure of non-public companies. According to the information reflected in the Unified State Register of Legal Entities there are approximately 151 000 stock companies in Russia. At the same time, only 300 Russian joint-stock companies are listed on the stock exchange and about 50 of them are traded on a regular basis. Thus, most of the Russian join-stock companies are non-traded ones and it is very difficult to evaluate fair market value for these companies. Regarding facts mentioned above, accounting-based valuation approach can serve as simple and effective valuation method applicable for private equity deals and non-traded companies.
The goal of this research paper is to test reliability of valuation model based on accounting data. In order to achieve stated goal two major tasks should be done. Firstly, it is necessaryto test whether accounting information is relevant to market values of Russian companies. Secondy, it is important to define whether accounting-based valuation model can be used for implementing unified valuation approach for non-traded companies in Russia.
The object of the research - Russian companies that performed IPOs. The subject of this research paper is applicability of accounting-based valuation method for assessing values of non-traded companies in Russia.
The practical research questions: 1) Do the value of residual earnings and equity book value have explanatory power over real market values of the Russian companies? 2) Does the IFRS-based Residual Earnings model is more effective in estimating market capitalization of the companies than the RAS-based model? 3) Does the accounting-based valuation approach can be used for estimating IPO prices?
Objectives of the research:
• to provide description and formalization of the valuation model;
• to conduct regression analysis;
• to execute analysis of the regression descriptive statistics;
• to apply regression coefficients for valuation of Russian companies;
• to compare results derived from the application of the model to actual values;
• to make conclusions about efficiency and applicability of the model.
The research paper is structured as follows. The first chapter is devoted to the critical overview of corporate valuation theory and applicability of different valuation techniques for valuation of private equity deals and non-traded companies in Russia. The emphasis is put on accounting-based valuation methods, Residual Income model in particular. The second chapter defines methodology of a current study and elaborates further on the research goal, objectives, questions, hypotheses. Empirical results of application of Residual Earnings model are presented and discussed in the third chapter. The summary of key findings, as well as research limitations and further directions, are outlined in the conclusion section.
The topic of the research paper is: “Private equity in Russia: application of accounting-based valuation model for non-traded companies”. The relevance of the research topic is determined by specifics of Russian private equity market and organizational structure of non-public companies. According to the information reflected in the Unified State Register of Legal Entities there are approximately 151 000 stock companies in Russia. At the same time, only 300 Russian joint-stock companies are listed on the stock exchange and about 50 of them are traded on a regular basis. Thus, most of the Russian join-stock companies are non-traded ones and it is very difficult to evaluate fair market value for these companies. Regarding facts mentioned above, accounting-based valuation approach can serve as simple and effective valuation method applicable for private equity deals and non-traded companies.
The goal of this research paper is to test reliability of valuation model based on accounting data. In order to achieve stated goal two major tasks should be done. Firstly, it is necessaryto test whether accounting information is relevant to market values of Russian companies. Secondy, it is important to define whether accounting-based valuation model can be used for implementing unified valuation approach for non-traded companies in Russia.
The object of the research - Russian companies that performed IPOs. The subject of this research paper is applicability of accounting-based valuation method for assessing values of non-traded companies in Russia.
The practical research questions: 1) Do the value of residual earnings and equity book value have explanatory power over real market values of the Russian companies? 2) Does the IFRS-based Residual Earnings model is more effective in estimating market capitalization of the companies than the RAS-based model? 3) Does the accounting-based valuation approach can be used for estimating IPO prices?
Objectives of the research:
• to provide description and formalization of the valuation model;
• to conduct regression analysis;
• to execute analysis of the regression descriptive statistics;
• to apply regression coefficients for valuation of Russian companies;
• to compare results derived from the application of the model to actual values;
• to make conclusions about efficiency and applicability of the model.
The research paper is structured as follows. The first chapter is devoted to the critical overview of corporate valuation theory and applicability of different valuation techniques for valuation of private equity deals and non-traded companies in Russia. The emphasis is put on accounting-based valuation methods, Residual Income model in particular. The second chapter defines methodology of a current study and elaborates further on the research goal, objectives, questions, hypotheses. Empirical results of application of Residual Earnings model are presented and discussed in the third chapter. The summary of key findings, as well as research limitations and further directions, are outlined in the conclusion section.
Nowadays the problem of developing a unified valuation approach, suitable for most sectors of the Russian economy, applicable to non-traded companies and private equity deals is of great importance. This problem is especially significant because the the valuation approaches used for private companies can not be applied to companies operating on Russian market due to the lack of comparable firms and transactions, poor liquidity and transparency. The absence of such valuation method inhibits the consolidation of holding structures, transactions with shares of non-traded companies, divestments, and the development of private equity market. The persistent problems in valuation of Russian companies have attracted increased attention of researchers and practitioners likewise and initiated a number of studies. This research is logical sequel of previous works in which authors studied the reliability of accounting-based models, in particular, Residual Earnings Model.
Empirical tests of accounting-based valuation model proved that accounting data from consolidated financial statements prepared under IFRS allows estimating market capitalization of Russian companies more precisely than RAS accounting data. Even though in some cases the discrepancy between model estimations and observable market values can be significant, Residual Earnings model still remains a useful tool for assessing the fundamental value of a company.
The regression analysis revealed that various required rates of return on equity can be utilized for valuation and can produce meaningful results. Usage of different required rates of return can be helpful for implementing unified valuation approach. It allows developing correctional factors depending on the reason of valuation (IPO, consolidation, divestments etc). Those correctional coefficients will improve the accuracy of the valuation process.
The results of application of the Residual Earnings model for IPO price estimation allow making a conclusion about applicability of the model. It is unlikely that the model can be used by owners of the company for determination of initial price level during the IPO because the mismatch between the price estimated with model and market prices can be significant. However, the usefulness of the model is associated with the opportunity for outside investors to evaluate the fundamental value of a company with publicly available accounting data. In such way, investors may measure potential benefits from participation in IPO. In addition, this valuation approach can be used by key shareholders for determining IPO timing.
From the theoretical point of view, the results of this research contribute to explaining the relevance of accounting data to value of a company and interdependence between market capitalization its fundamental value. From the practical point of view, the test of applicability of the model demonstrated its practical importance for non-traded companies valuation. Accounting-based valuation methods such as Residual Earnings model can be used for implementing unified valuation approach for Russian companies. However, further tests with more representative and broad sample are needed.
The research presented in this paper is interim step towards the developing of an adequate valuation model for the Russian market companies. Further research may be conducted in the following areas. Firstly, it is necessary to conduct research over non-accounting factors influencing the market capitalization of the company. Secondly, the connection between required rate of return on equity and market capitalization should be studied and fundamental principles of its determining should be developed.
Empirical tests of accounting-based valuation model proved that accounting data from consolidated financial statements prepared under IFRS allows estimating market capitalization of Russian companies more precisely than RAS accounting data. Even though in some cases the discrepancy between model estimations and observable market values can be significant, Residual Earnings model still remains a useful tool for assessing the fundamental value of a company.
The regression analysis revealed that various required rates of return on equity can be utilized for valuation and can produce meaningful results. Usage of different required rates of return can be helpful for implementing unified valuation approach. It allows developing correctional factors depending on the reason of valuation (IPO, consolidation, divestments etc). Those correctional coefficients will improve the accuracy of the valuation process.
The results of application of the Residual Earnings model for IPO price estimation allow making a conclusion about applicability of the model. It is unlikely that the model can be used by owners of the company for determination of initial price level during the IPO because the mismatch between the price estimated with model and market prices can be significant. However, the usefulness of the model is associated with the opportunity for outside investors to evaluate the fundamental value of a company with publicly available accounting data. In such way, investors may measure potential benefits from participation in IPO. In addition, this valuation approach can be used by key shareholders for determining IPO timing.
From the theoretical point of view, the results of this research contribute to explaining the relevance of accounting data to value of a company and interdependence between market capitalization its fundamental value. From the practical point of view, the test of applicability of the model demonstrated its practical importance for non-traded companies valuation. Accounting-based valuation methods such as Residual Earnings model can be used for implementing unified valuation approach for Russian companies. However, further tests with more representative and broad sample are needed.
The research presented in this paper is interim step towards the developing of an adequate valuation model for the Russian market companies. Further research may be conducted in the following areas. Firstly, it is necessary to conduct research over non-accounting factors influencing the market capitalization of the company. Secondly, the connection between required rate of return on equity and market capitalization should be studied and fundamental principles of its determining should be developed.
