STATE BANK OF VIETNAM BANKING ACADEMY Foreign Language Faculty GRADUATION THESIS VALUATION CHALLENGES FACED BY VIETNAM- FOCUSED PRIVATE EQUITY FUNDS Student : Nguyen Hieu Linh Lecturers : Pham Tien Dat, Ph. Nguyen Tien Dung, M. 1st, June 2012 ii ACKNOWLEDGEMENTS I would like to express my heartfelt thanks to Mr. Pham Tien Dat, Ph.
Nguyen Tien Dung, M. – the two instructors who have helped and supported me throughout the completion of this thesis. I sincerely thank my teachers at the Banking Institute, especially those of the Foreign Language Department, who have provided me with valuable background knowledge during the last four academic years. In addition, I am very grateful to my colleagues from Lien Viet Holdings, who have assisted me in the process of collecting materials for the thesis.
Because of time constraints and limited capacity of the writer, this thesis will certainly not be free from defect. Therefore, it is my hope that teachers and readers of the thesis will sympathize and offer further contribution to it. Thank you! Hanoi, June 2012 iii ABSTRACT Playing an increasingly prominent role in the world economy, private equity funds control a vast number of companies, including market leaders which employ hundreds of thousands of people. For an emerging country like Vietnam, private equity could exert a huge impact on the development of the private sector, which has long been considered the key to economic growth and poverty alleviation.
This thesis explores the international best practices on private company valuation according to Professor Aswath Damodaran, who is widely recognized as the leading authority on valuation, and the Chartered Financial Analyst Program Candidate Body of Knowledge, which is considered the highest standards for investment professionals. Valuation approaches mentioned in the thesis include income approach, market approach, and asset-based approach. More importantly, the author directs this thesis towards finding out the fundamental valuation challenges that Vietnam-focused private equity funds are facing such as opaque bookkeeping, poor accounting and reporting standards, dysfunctional public equity market, lack of standard credit rating agencies, financial data vendors, market research firms, industry consultants, and investment professionals of right caliber etc. After that, a case study based on the author’s personal experience is analyzed to give readers an insight into the funds’ valuation practices.
Finally, the thesis recommends possible solutions to facilitate valuation of private companies, namely involving credible audit firms, utilizing local data vendors and human capital, improving public market, raising reporting and accounting standards, strengthening disclosure regimes and legal framework, and encouraging the establishment of independent and competent credit rating agencies. The data in the thesis were collected from a wide range of sources, namely academic research, country reports, industry reports, database of financial data providers, and conversations and interviews with practitioners. iv TABLE OF CONTENTS ACKNOWLEDGEMENTS. iii LIST OF TABLES AND FIGURES.
vi CHAPTER 1: INTRODUCTION. Motivation behind the research .5 CHAPTER 2: THEORETICAL FRAMEWORK .1 Overview of private equity. Definition of private equity. Classification of private equity.
Private equity funds. Overview of valuation. Definition of valuation. Valuation methods adopted by private equity funds.
Overview of the selection of private company valuation methods. Asset-based approach .19 CHAPTER 3: VALUATION CHALLENGES FACED BY VIETNAM- FOCUSED PRIVATE EQUITY FUNDS. Valuation challenges faced by Vietnam-focused private equity funds. Challenges from private companies.
Challenges from accounting standards. Challenges from the market. Challenges from the private equity funds themselves. Case study: VND125 billion acquisition of 50% in Thang Long Mineral Resources and Metallurgy JSC by Lien Viet Holdings.
Evaluation and remarks .32 CHAPTER 4: RECOMMENDATIONS AND CONCLUSIONS .34 LIST OF REFERENCES .35 vi LIST OF TABLES AND FIGURES Figure 1.1: Capital, revenue, and employment structure of enterprises by ownership .2: Private equity deals above US$5 million in Vietnam .1: Private equity classification .2: Private equity fund structure .3: Stages in making private equity investments .1: Breakdown of Thang Long’s costs of sales in 2010 .2: Valuation of Thang Long using discounted cash flow method .3: Sensitivity analysis of Thang Long’s equity value. Motivation behind the research Private equity remains a term unknown to the public and even to many people inside the financial world. However, as major forces in the capital markets, private equity funds are reshaping the world economy by controlling a vast number of companies, including market leaders. Remarkably, the total value of the five biggest private equity deals is larger than the annual budgets of all but the 16 largest countries in the world (Service Employees International Union, 2007).
The 20 biggest private equity funds together control companies employing nearly 4 million people. If venture capital is included in the broad sense of the term “private equity”, private equity funds have incubated and funded companies which dramatically change the world such as Apple, Yahoo!, Facebook, Google, Skype, Amazon, PayPal, Youtube etc. The reason why private equity is less known than public equity is that private equity is complex, illiquid (typically over a 3 to 5 year-time horizon), and inaccessible to most individual and institutional investors. Making private equity investments requires networks and relationships to source deals; expertise and effort to conduct due diligence and valuation; and lastly, negotiation skills and caution to structure and close deals.
Vietnam, as an emerging market, has been in a strong position to attract private equity investments. Since the reforms began in 1986, the economy, fueled by compelling demographics and domestic consumption, has been posting an annual per capita GDP growth of 5.3 percent, (McKinsey & Company, 2012) faster than any other Asian economies apart from China. More importantly, 90 percent of 300,000 companies in Vietnam are small and medium-sized enterprises (SMEs). Most of these are family-owned or privately-owned enterprises which have not realized their full potential due to the lack of capital and management expertise.
This is where private equity comes in to offer private companies an alternative source of funding and offer investors diversification with attractive returns. For a 2 developing country like Vietnam, it must be said that private sector development is the key to economic growth and poverty alleviation. While the amount of capital allocated to private enterprises equaled roughly 83% of the amount given to state- owned enterprises, the private sector generated 34% more revenue and created nearly 8 times more jobs than the public sector. Therefore, private equity can play a prominent role in Vietnam’s socio-economic development.1: Capital, revenue, and employment structure of enterprises by ownership Source: General Statistics Office 2009 However, private equity investment in Vietnam has slowed sharply since 2007, when 63 deals worth US$840 million were completed, with merely 18 deals worth US$220 million being closed in 2010.2: Private equity deals above US$5 million in Vietnam Source: Asian Venture Capital Journal 2011 3 Major on-shore players include Mekong Capital with 3 dedicated funds capitalized at US$181 million, VinaCapital with US$232 million allocated to private equity and venture capital, IDG Ventures with US$100 million invested in Vietnam to date, BankInvest with its emerging markets-focused fund totaling US$100 million, Prudential Asset Management with 13 private equity investments valued at US$130 million, BIDV Vietnam Partners Investment Management with the largest domestically raised fund amounting to US$95 million, Vietnam Investments Group with two funds amounted to US$75 million.
Other fund management companies with a small proportion of assets under their management for private equity are VietFund Management, Vietcombank Fund Management and Deutsche Bank Asset Management with US$22 million, US$45 million and US$42 million, respectively. Although Vietnam opens up great opportunities for private equity funds, there remain serious challenges to conducting due diligence and valuation such as few disclosure requirements, severe information asymmetries, unreliable accounting and reporting standards, lack of credit rating agencies, and lack of market data etc. It is beyond dispute that valuation is the cornerstone of almost all investment decisions. Private equity funds have to not only decide on a fair value for a target company to make a bid but also understand the drivers of the company’s value to assist it in business development and efficiency improvement.
Importantly, if the fund overpays on the entry valuation for a deal, its return will be severely hurt. Conversely, if it underpays, it runs the risk of losing the deal to competing firms. Research objectives In order to promote international best practices on valuation and encourage private sector development through private equity investment, this thesis aims at finding out the fundamental challenges of private company valuation in Vietnam and recommending possible solutions. Research questions This thesis aspires to provide answers to two questions of concerns to practitioners, potential private equity investors or those who are interested in studying this asset class in academia: What are the key challenges of valuation that Vietnam-focused private equity funds are facing? What are the possible solutions to better valuation practices of the private equity funds? 1.
Data sources Primary data are collected from conversations and interviews with practitioners. Especially, the case study analyzed in this thesis is based on personal experience of the author. As an investment analyst intern at Lien Viet Holdings (the private equity arm of Lien Viet Post Bank), the author had an invaluable opportunity to be involved in a private equity deal in the mining industry. The case study is expected to provide a useful example of how a private company is actually valued in a real deal.
Secondary data are collected from a wide range of sources, namely country reports, industry reports, news reports, and database of reliable market data providers (Standard & Poor’s and Economist Intelligence Unit). Limitations Due to the nature of private equity, funds are often limited partnerships and operate virtually free of public accountability and scrutiny by the business media. On the other hand, private companies do not have disclosure requirements like publicly traded companies that are subject to securities laws. As a result, information on acquisition prices, exit price, contract terms, and internal rate of returns in private equity market are often confidential and unavailable.
This is the reason why the 5 thesis cannot provide the comprehensive situation of private equity valuation in Vietnam. Thesis structure The thesis consists of four main chapters: I) Introduction, II) Theoretical framework, III) Valuation challenges faced by Vietnam-focused private equity funds and IV) Recommendations and conclusions. The first chapter introduces the reason why this topic is chosen. The Introduction part also states research questions, objectives, data sources, limitations and structure of the thesis.
Next comes the theoretical framework, which provides an overview of private equity and methods of private company valuation. Theories on valuation methods are credited to Aswath Damodaran, a Professor of Finance at the Stern School of Business at New York University, who is widely recognized as the leading authority on valuation, and the Chartered Financial Analyst Program Candidate Body of Knowledge. 6 CHAPTER 2: THEORETICAL FRAMEWORK 2.1 Overview of private equity 2. Definition of private equity In contrast to stocks or public equity, which is categorized as traditional investment products, private equity is among alternative investment products, along with commodities, hedge funds, venture capital, and financial derivatives.
Private equity is an asset class which consists of equity securities that are not listed on a stock exchange. In the broadest sense of the term, private equity runs the gamut from small venture capital investments in start-up companies to buyouts of public companies which then become private through the investments (Metrick, 2010). Classification of private equity However, private equity is most commonly classified in terms of strategy and type of financing (see Table 2.1: Private equity classification Broad Category Subcategory Brief Description Funding provided to conduct market Seed stage research, research business ideas, or develop prototype products. Funding to recently created companies Start-up stage with well-articulated marketing plans Venture capital and business.
Funding to companies that have started their selling effort and may be already Expansion stage breaking even. Financing may serve to provide working capital or expand production capacity.