Best Practices regarding Valuation Methodologies for Chinese Companies
Valuing an enterprise is never an easy task as there are various ways to value a private company and there is often a major difference between financial theory and market reality in China: Multiply this many times in the case of Chinese domestic firms. This leads to a stark contrast in valuation between seller and buyer. As business value, brand value and needs of each counterpart vary widely, we recommend you use many different analytical tools, many different sets of data from both private and public sources in order to give your firm a starting point for determining value prior to negotiations.
Using Comparable Company Analysis to value a company you use multiples by comparing multiples to similarly valued listed firms in the US, Hong Kong or on a tier 1 city, like Shanghai. To calculate Enterprise Value-EV, use EV/Sales, EV/ABITDA (Earnings Before Interest, Taxes, Depreciation, Amortization. One major drawback to this valuation method is ignoring profits) or EV/EBIT almost same as ABITDA. Alternatively you can use equity multiples like Price to Earnings.
Post Merger (Successful Chinese M&A) do a Precedent Transaction Analysis in order to estimate the proper valuation of similar Chinese M&A deals in the same industry of your previous target. Precedent Transaction Analysis deals utilize data from successful transactions within China rather than data submitted to the SEC from publicly traded firms. Getting actual data from outside firms regarding previous China M&A deals is not an easy thing, however.
Lastly definitely try a good old fashioned DCF (Discounted Cash Flow) Analysis. This valuation methodology differs from multiples approach that derives the valuation from the present value of forecast free cash flows and accounts for the time value of money. It works backwards: Future cash flows are estimated then discounted to their present value. Efficient Equity does a thorough DCF Valuation on every Asian company. The risk with DCF’s is that they tend to estimate future cash flows in straight lines not taking into account the wide fluctuations in the Chinese market, government restrictions which cause most local firms to have huge fluctuations from year to year.