economics, statistics and research valuation of shares and other equity in the financial accounts of...

ECONOMICS, STATISTICS AND RESEARCH

VALUATION OF SHARES AND OTHER EQUITY IN THE FINANCIAL ACCOUNTS OF THE SPANISH ECONOMY (FASE). The use of discounted value of future profits for unquoted non-financial public limited companies

Begoña Gutiérrez del Olmo MoredaStatistics and Central Balance Sheet Data Office Department Specialist

TASK FORCE ON THE VALUATION AND MEASUREMENT OF EQUITY (TFVME)

Ottawa, Canada

13 April 2005

2Economics, Statistics and Research Department

VALUATION OF SHARES AND OTHER EQUITY IN THE FASE. The use of discounted value of future profits for unquoted non-financial public limited companies

1. Introduction to the Spanish valuation methods: Description and aggregates1. Issues of resident units2. Issues of non-resident units held by residents

2. Discounted value of future profits (method D): Conceptual framework References to the method in the SNA 1993 and in the ESA 95 Reasons for applying method D as an alternative to method C Requirements for applying method D

3. Description of method D Definitions Process of grossing up A particular case: Companies systematically reporting losses

Contents


INTRODUCTION TO SPANISH VALUATION METHODS: DESCRIPTION AND AGGREGATES Issues of residents

General criteria Specific criteria Aggregates

Market valuation in strict sense

Market capitalisation (A)

Quoted public limited companies (Non-financial and banks)

Net asset value (B) Mutual Funds

Approximations to market valuation

Capitalisation / Own funds ratio (C)

Unquoted banks

Discounted value of future profits (D)

Unquoted non-financial public limited companies

Book value Own funds (E)

Unquoted public limited companies (Financial except banks)Other legal forms (Other equity)


INTRODUCTION TO SPANISH VALUATION METHODS: DESCRIPTION AND AGGREGATES Issues of non-residents

held by residents (F)

Valuation methods based on:– Market value: In case of quoted shares– International Investment Position Statistics: In other

cases



1. Introduction to Spanish valuation methods: Description and aggregates1. Issues of resident units2. Issues of non-resident units held by residents

2. Discounted value of future profits (method D): Conceptual framework References to the method in the SNA 1993 and in the ESA 95 Reasons for applying method D as an alternative to method C Requirements for applying method D


Contents


DISCOUNTED VALUE OF FUTURE PROFITS (METHOD D): CONCEPTUAL FRAMEWORK

1993 SNA:– (13.28): “…market prices may be approximated by the present, or

discounted, value of future economic benefits expected from a given asset; this is the case for a number of financial assets, natural assets and intangible assets…”

– (13.34): “…although normal prices are used to value the ultimate output, a rate of discount must, in addition, be used to compute the present value of the expected future returns…”

ESA 95:– (7.27): “…In addition to prices observed on markets or estimated from

observed prices or costs incurred, current prices may be approximated for balance sheet valuation by:a)…b) the present, or discounted, value of future returns”

References to the method in the 1993 SNA and in the ESA 95


Why does Spain use an alternative method?

–are usually larger than unquoted ones

–usually have a different financial structure from unquoted companies

–are concentrated among particular economic activities which usually demand a larger volume of funds

–The number of quoted public limited companies is very small relative to the total

Only in the case of banks are unquoted companies well represented by quoted ones

Method D is the most commonly used by financial analysts

Unquoted non-financial public limited companies are not well represented by quoted ones because quoted public limited companies,


Reasons for applying method D (as an alternative to method C)



Some figures to measure the problem


Abs. Number % % %

TOTAL NON-FINANCIAL FIRMS 2546140 100,00 100,00 100,00A. Sole partnerships (individuals) 1629047 63,98 12,26 30,45B. Non-financial corporations 917093 36,02 87,74 69,55

1.- Public limited companies 122223 4,80 40,82 40,66 1. Quoted 210 0,01 2,05 3,08 1. Continuous market 111 0,00 1,86 2,74 Of which, IBEX-35 29 0,00 1,10 1,47 2. Floor trading 99 0,00 0,19 0,33 2. Unquoted 122013 4,79 38,77 37,592.- Private limited companies 764395 30,02 43,30 24,443.- Other corporate status 30475 1,20 3,62 4,45

Consolidated groups that file their accounts at Mercantile Registries 1264 … … …

(1)

(2) Source: INE and data estimated by the Banco de España Central Balance Sheet Data Office.

Source: Central Directory of Firms (DIRCE) of the National Institute of Statistics (INE) and author's calculations based on CNMV data.

NON-FINANCIAL FIRMS IN SPAIN. 2002

Memorandum item:

Number (1) Employees (2) GVA (2)



The problems of using multi-country ratios

Additional limitations arise when trying to use multi-country ratio data because of the differences between countries’ financial structures1. Some of these differences are:

1. The amount and the structure of assets2. Revaluation criteria3. Financing practice in each country4. Relationships between firms and banks5. Tax systems6. Guarantees offered to lenders7. Pensions8. Bankruptcy law insolvency rules


(1) According to the conclusions of the Own funds Working Group of the European Committee of Central Balance Sheet Data Offices set out in one of its studies



Quoted and unquoted companies: Some European figures


Total

Personally owned and no limit to personal liability 5995513 180934 1815794 2794864 7954 123917 266310 683805 121935

Rest of enterprises, of which: 4522435 117363 1102926 1425754 16598 158266 343524 1219680 138324

Personally owned limited and unlimited liability partnerships ( included are also other level forms such as co-operatives, associations,etc.)

1681381 46811 216566 886545 1845 51116 111317 345020 22161

Private or publicly quoted joint stock companies with limited liability for those owning shares, of which:

2841054 70552 886360 539209 14753 107150 232207 874660 116163

Listed companies (b) 3816 208 211 (c) 288 48 152 285 2438 186

All legal forms 10517948 298297 2918720 4220618 24552 282183 609834 1903485 260259Database at NIS 861799Difference (d) 241127

(b) European Securities Exchange Statistics: Number of listed companies ( both financial and non financial)(c) CNMV database: Non financial enterprises.(d)Desviation between Eurostat database, obtained from Mercantil Registries, and INS

(a) Obtained from Eurostat Database. Selection criterion: Number of existing companies along the year (excluding bearths) of industry, trade and services excluding NACE J

BUSINESS DEMOGRAPHY (Non Financial Corporations):Number at 2001(a)United

Kingdom NorwayFinlandDenmark Italy Luxemburg SwedenSpain


1. A quality data source for non-financial companies’ profit and loss accounts to estimate future profits to be discounted

2. A market reference to estimate the discounting rate

3. Demographic statistics for non-financial companies

In Spain the information comes from:

Central Balance Sheet Data Office Database: Accounting information and a conversion table to go from business accounting to National accounts

National demographic statistics for corporations: DIRCE from National Institute of Statistics


Requirements of the method

The application of this method requires:



1. Introduction to Spanish valuation methods: Description and aggregates1. Issues of resident units2. Issues of non-resident units held by residents

2. Discounted value of future profits (Method D): Conceptual framework References to the method in the SNA 1993 and in the ESA 95 Reasons for applying method D as an alternative to method C Requirements for applying method D


Contents


This method estimates the market value of shares issued by unquoted firms by calculating the present value of the future profits generated by such firms

RONc

dc

Capitalisation = VMc =

WhereRONc is the expected profit for the following year,and dc is the implicit discount factor

The method is based on the fact that the market value of quoted firms can be obtained by dividing their expected profits by a discount factor

DISCOUNTED VALUE OF FUTURE PROFITS (METHOD D): DESCRIPTION OF THE METHOD

Underlying this method is the hypothesis that the profits generated by such firms are considered to be perpetual.

Risk-free interest rate

Risk premium

Expected growth rate of profits



Likewise, the following expression can be deduced for unquoted shares:

RONnc RONnc

dnc dc + 0,03VMnc = =



Ordinary Net Profit is defined as:

Definitions

RON (Ordinary Net Profit)

Gross Value Added at factor cost<Personnel Costs>

<Net Financial Charges><Operating Depreciation and Provisions>

Ordinary Net Result<Corporate income taxes>

<Other net provisioning><Capital losses and extraordinary expenses>

Capital gain and extraordinary revenueNet Result



RONnc is calculated, company by company in the database, as the weighted average of the ordinary net profit over the last five years, as follows:

Definitions

RON (Ordinary Net Profit)

5RONncn +4RONncn-1 +3RONncn-2 +2RONncn-3 +RONncn-4

15RON nc =



dnc is defined as :Where,– dc is the discount rate associated with quoted shares

– 0.03 is the illiquidity premium. This premium should consider not only the illiquidity but, also, the possibility that unquoted public limited companies’ profits are not as perpetual as those of quoted ones. Therefore, an increase in the discount rate, because of the different time horizons, must be consideredThe level of this premium has been quantified according to theoretical analysis of the gap between perpetual income and temporary income

Definitions: dnc

dnc = dc + 0,03



dc is calculated as the median of the discount rates of all the quoted non-financial corporations traded on the continuous market, which means excluding floor-traded companies

Extremely volatile corporations are stripped out of the aggregate by means of the trust interval, which is defined as the average plus/minus twice the standard deviation.

Sector differentiation is only applied in the case of the electricity sector because of its specific features

Definitions: dnc



The discount factor obtained by this method is as follows:

Definitions: dnc

Compared evolution of risk free and dnc rates

0,0

3,0

6,0

9,0

12,0

15,0

1995 1996 1997 1998 1999 2000 2001 2002 2003

%

dncdcrisk-free rate



The Central Balance Sheet Data Office Database provides information on approximately 30,000 unquoted public limited companies

Using the conversion table which allows one to go from business accounting to National Accounts, a full chart of accounts, including those relating to other changes in volume and revaluation, is prepared.

Finally, there must be a process of grossing up, from the original aggregate to the whole unquoted non-financial public limited corporations aggregate.

Process of grossing up



Unquoted public limited companies systematically reporting losses

A weighted average RONnc below zero implies a negative market value when using method D. That is not possible in legal and economic terms, so, therefore, an alternative method is necessary for these specific cases

Since

– Shareholders of a limited company are never liable to third parties for more than their capital contribution

– Quoted corporations reporting systematic losses never trade on the market below their share capital

– Spanish laws lays down minimum limits for net worth

the criterion adopted for these cases is to value their shares at their nominal capital

A particular case



The final revaluation rates for the quoted and unquoted shares of non-financial public limited corporations, resulting from the whole process, are as follows:

Process of grossing up

Quoted and Unquoted share revaluation rates in the FASE

-100%

-75%-50%

-25%0%

25%

50%75%

100%

1996 1997 1998 1999 2000 2001 2002 2003

Quoted shares

Unquoted shares


BEGOÑA GUTIÉRREZ DEL OLMO

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