'What's the value of this thing?' (valuation of Eastern European businesses) (Chairman's Agenda: Acquiring in Eastern Europe).

• Author: Krawitt, Edward P.

Some practical considerations in coping with the uncertainties of East Bloc business valuation.

Most business people would throw up their hands if asked to value a company operating amidst the accelerating political, economic, and social changes in Eastern Europe. Valuing Eastern European companies poses unique challenges compared with valuing Western firms; nevertheless, the same general concepts and approaches apply. As the move toward capitalism continues, the need for valuation expertise grows daily. Foreign capital is essential to privatization and allows companies to invest in more competitive and efficient technologies. In addition, public policy requires that these investments occur at fair values. Potential investors, government agencies, and company management must have access to reasonable valuations to facilitate the transition to market economies.

Valuation Methods

Business valuation focuses on two general approaches: market multiples and discounted cash flow. The market multiple approach capitalizes a normalized, or sustainable, level of earnings or cash flow with a multiple developed from analyzing trading prices or change-of-control transactions for similar public companies. The discounted cash flow method first projects company cash flows for three to 10 years, then calculated a present value using a discount rate that incorporates the risks of achieving the forecasts. These approaches can be applied to Eastern European firms as long as the important differences with Western companies are considered.

Due Diligence and Historical Financial Analysis

Performing due diligence and obtaining data in Eastern Europe has the same goals as in the West -- a thorough understanding of the business, including historical performance, current competitive and financial situation, operating and strategic plans, and future prospects. Obtaining this information is quite a different story.

Financial statements from Eastern European companies do not compare with those in the West. Local accounting practices typically have changed from year to year, making historical trend analysis difficult. Fortunately, many companies are turning to outside accountants to restate their results in U.S. Generally Accepted Accounting Principals (GAAP) or similar standards.

In many cases, management may be unfamiliar with, or even uncomfortable, discussing performance in terms of cash flow and profitability. State-owned enterprises were often judged and managed on...