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The valuation of closely-held companies in Latin America Free essay! Download now

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The valuation of closely-held companies in Latin America

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The valuation of companies in Latin America

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The valuation of closely-held companies in Latin America

Abstract
M&A activity has greatly increased in Latin America in the recent past. As a result, the
improvement of valuation techniques has gained a prominent place in the agenda of investors
and financial analysts dealing with the region. The task entails two substantial challenges,
however. First, fundamental valuation requires the determination of an appropriate cost of capital,
and the traditional CAPM-based models which are normally used to compute it are difficult to
apply in such transitional, less efficient markets. Second, most companies and transactions in
Latin America are closely-held operations, and hence bear components of unsystematic risk
which classical appraisal techniques do not easily capture. In this paper, we develop a
comprehensive fundamentals-based valuation model and provide supporting empirical data for
valuing privately-held companies in Latin American emerging markets.
Keywords: Valuation, Latin America.

1. The issues at stake
In the last years, a substantial and increasing number of M&A deals have been forged on
privately-held assets in Latin America; as a result, appropriately appraising such investment
opportunities has become a relevant matter in the region.
However, traditional fundamental valuation techniques do not provide much guidance as to how
they should be applied to closely-held firms in transitioning markets. First, when using CAPMbased
methods for the cost of capital determination, it is not clear whether the hypotheses of
market efficiency hold, and then the straight application of the classical CAPM in such contexts is
controversial.
Indeed, neither diversification nor transparency—the main tenets of developed financial
markets—are present in the trading or real, closely-held assets in emerging Latin American
markets. First, diversification is imperfect when a single or only a handful of acquisitions is made,
in a market where only a few interested buyers and sellers are operating; this is truly the case in
the overwhelming majority of M&A deals in the region.
Second, in most company acquisitions, the final price of a transaction is not a transparent
reference arrived at by financial investors, but it is rather a compound of the different viewpoints
and dissimilar risk-return expectations of the entrepreneurs, strategic investors and venture
capitalists negotiating the deal; as a result, there is no single market for gauging “true” asset
prices.
Third, empirical evidence shows that even among financial investors, the existence of efficiency is
highly debatable in Latin America, since national stock markets are small, concentrated, and
prone to manipulation; to complicate matters further, stock market information tends to be scarce
and unreliable.
Fourth, practical problems do not, unfortunately, stop appearing at the stage of computing the
cost of capital. Indeed, CAPM-based methods for the cost of capital determination have not been
structured to deal with the unavoidable, unsystematic risk arising from imperfect diversification.
Such risk has been ...

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