Private company
Valuing a Frontier Market Company—A Practical Framework from Uzbekistan
- Frontier Market – Uzbekistan
- Discounted Cash Flow (DCF)
Background
I recently undertook the valuation of an Uzbekistan-based company using the Discounted Cash Flow (DCF) method, with a focus on Free Cash Flow to Equity (FCFE). The central challenge was determining an appropriate discount rate—critical for credible valuation—when Uzbekistan lacks a liquid stock exchange and reliable government bond yields.
The Challenge
The Solution: An Adapted Cost of Equity Framework
Since traditional Capital Asset Pricing Model (CAPM) inputs were unavailable, I developed a pragmatic approach drawing from international best practices and economic theory.
- 1. Adjusted Risk-Free Rate
- Problem: No stable Uzbek government bond yield exists.
- Solution: Used the U.S. 10-Year Treasury Yield as a starting point, then adjusted for inflation differentials: Adjusted Risk-Free Rate=U.S. Risk-Free Rate + (Uzbekistan Inflation−U.S. Inflation) Example: If U.S. inflation is 3% and Uzbekistan’s is 11%, the local risk-free rate = U.S. Treasury yield + 8%.
- 2. Bottom-Up Beta Estimation
- Problem: No local market or comparable Uzbekistan firms to derive beta.
- Solution: Calculated a bottom-up industry beta using global listed companies in the same sector—sourced from Prof. Aswath Damodaran’s publicly available global industry betas.
- The beta was then unlevered (to remove financial risk), and re-levered to match the Uzbekistan company’s capital structure.
- 3. Equity Risk Premium (ERP) & Country Risk Premium (CRP)
- Problem: Local market risk premium and country risk premium are unavailable or unreliable.
- Solution: Used a mature market ERP (for example, U.S.) from global databases. Estimated Country Risk Premium (CRP) using Prof. Damodaran’s methodology: CRP=Default Spread × (Bond Volatility / Equity Volatility)
- This ensures the higher volatility and credit risk of frontier markets like Uzbekistan are reflected in the discount rate.
- 4. Putting It Together: The Final Cost of Equity Formula
- Cost of Equity = Adjusted Risk - Free Rate + β× Mature Market ERP + Country Risk Premium
- All intermediate calculations (for example, inflation differentials, beta adjustment, CRP source data) were documented transparently for investor and auditor scrutiny.
Takeaways & Key Insights
- Global benchmarks, local adjustments: When local data is unreliable, global proxy data (yield curves, industry betas, ERPs) must be customized for frontier market risks (inflation, credit, volatility).
- Documentation is critical: In markets with limited local transparency, documenting every adjustment and its rationale builds trust and withstands regulatory or investor review.
- Replicable framework: This approach can be applied in other emerging/frontier markets with similar data constraints, providing defensible and credible cost of capital estimates.
Conclusion
This Uzbekistan case highlights how valuers can blend international best practices with local market reality to solve seemingly intractable problems in frontier-market valuations. The result is a credible DCF output, despite difficult data environments—empowering investors and companies to make sound decisions.