Palms & Company Document

HOW THE VALUATION OF RUSSIAN COMPANIES IS CALCULATED BY WESTERN INVESTORS

by

Dr. Pyotr Johannevich van de Waal-Palms

Please note these definitions:

• Revenues= gross amount received for selling of production or services Gross profit= revenues less the cost of production of goods sold
• Cost of Goods sold = raw materials, expenses, labor force salaries,
• direct overhead ( electricity, heat, etc directly attributable to the production of a specific order of goods). These are variable expenses. They vary with the amount of production.
• General & Administrative Overhead = general expenses of business which are regular monthly expenses such as managers, non-production workssecretaries, advertising, services, consultants, rent, accountants, lawyers, etc. These are fixed expenses which do not vary with level of production
• Net profit before taxes: This is revenue minus cost of goods sold,
• minus general and administrative expenses
• Net profit after taxes = Net profit Before Taxes (NPBT) -minus all taxes
• Return on Investment: This is percentage that Net profit After Taxes represents to the total capital invested. i.e. If the investment is $100,000 and in one year profit is earned of $17,000 then the Return on Investment is 17%
• Price Earnings Ratio (PE): This is the ratio of the price of the shares to the earnings (per share) if a stock price is "12 times earnings" it means that a stock which is earning $1.00 is selling for $12.00. The average "Price Times Earnings ("PE") of all stocks trading on the New York Stock Exchange is "12". Privately owned companies not trading on exchanges generally are valued at lower multiples of earnings than companies listed on exchanges

Measuring Potential Profitability of Investment and the Value of Shares:

Assume a company's shares are valued today at $100,000 and it is earning $10,000. This means it's shares are selling at a P:E of 10. That may be high for the industry. It may be below the norm for other shares of other companies in the same industry. This is how the reasonableness of the price is measured.

If a P:E of 10 is reasonable for a stock in this industry, then if the company is earning $5,000 PNAT it is worth only $50,000 and the price is too high.

But, if $50,000 is invested for 50% of the company and with this $50,000 the company is able to expand and modernize the business and next year earns $30,000, it is now worth $300,000. So the investor that paid $50,000 for 50% now has a stock that should be (ought to be) worth $150,000 is the market accurately judges and reflects this. ( a perfectly responsive market). Notice that the value of land, buildings, machinery has stayed the same except, for perhaps some part of the $50,000 may have been used for more machinery.

So the value of a company's shares is determined not by it's physical assets but by what it earns. If a hotel cost $10 million and it is sitting in the desert and has no guests and no revenues it is worth nothing. If it is on Red Square it is worth a multiple of its after tax revenues. Western venture capital investors will expect over a 5 year period an ROI of 34% compounded ( which equals approximate a 10 times (1000%) return on investment over a 5 year period

Compared to possibly a 10% bank interest rate ( in the U.S.) this is a much higher return. It is justified because the bank takes no risk (in the west this is true) it has full collateral in the form of marketable assets both of the company and the personal assets of its owners [sometimes]. When a company has no marketable collateral { which is always the case in Russia due to absence of laws} then an investor will not make a loan at low rates of interest because if the business is not successful he will lose his money. If the is going to lose his money if the business fails then he also needs a higher profit it it succeeds , in order to cover his losses form other businesses which do not succeed. So the rate of return (whether in interest or in profit sharing) which an investor expects is related to the level of risk and not to some absolute abstract concept of an acceptable cost of obtaining money.

These are some brief comments on the complexity of valuation of businesses and expected profits by investors. It begins to show why an expert in western investment banking, capital investment etc. is needed to present the Russian proposals in the Western context of presentation.

More detailed information about

• Valuation of Russian companies
• How to justify request for Investment Capital
• Method of calculating projected return on investment (ROI)
• Method of substantiating (demonstrating the likelihood) of projected NAFP * Method of protecting investment from adverse effect of future laws that eliminate present profit possibilities
• Definition of collateral and guarantees

For discussions in Russian language

Comments: Russian General Directors will benefit from the advice of an experienced American Investment Banker in preparing investment capital proposals and dealing with questions about disclosures. we invite your inquiries

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