Valuation work informs every stage of the transaction process. Before an acquisition, a company's deal team projects cash flows and quantifies synergies to negotiate a purchase price and guide due diligence. After the closing, the valuations of tangible and intangible assets and the assignment of enterprise values to business segments and legal entities play a key role in financial reporting, in managing tax exposure, in communications with shareholders and in the development of business strategies.

Doing this valuation work is challenging enough on the familiar ground of established economies. For valuations in emerging economies, the ground gets shakier. Foundational principles, historical trends and commonly accepted economic models may be unusable, and traditional inputs may be nonexistent or so different as to be unrecognizable.

Especially tough is determining the value of intangible assets, of great importance to U.S. companies because of the move to fair-value accounting. In the developed world, acquirers can rely on experience and continually refined methodologies to value assets such as a skilled work force, a distribution network or a brand. In emerging economies there's much less experience to draw upon, and familiar patterns may mislead. In China, for example, customer attrition in some service sectors is extremely low. But this isn't brand loyalty; it's just a reflection of the historical lack of brand choice.

Other emerging markets pose different valuation challenges, as do deals of different sizes and in different industries. The hurdles range from unreliable financial data to a shaky financial infrastructure to mandates that a government co-owner be included in a transaction.

Our own experience is mainly in transactions of $200 million or more, in a variety of emerging markets. But we believe we've developed an approach to valuation in emerging markets that applies broadly. We've learned the importance of flexibility and resourcefulness. We have also identified four key areas for dealmakers to consider before, during and after the M&A valuation process.

1. Identifying multiple risks

Risk plays a pivotal role in any investment decision. But in emerging markets an array of less familiar risks -- political, currency, regulatory, operational and more -- may affect valuations. Investment scenarios must account for what could go wrong on multiple fronts.

Thus, in Thailand you may need to account for sovereign risk because government leadership can be uncertain. Argentina not long ago stood as an example of currency risk due to its rapid devaluation of the peso and also of regulatory risk. In India, operational risk can be an issue. While building a manufacturing facility, one company found it had to factor in its own contribution to site planning and road building because the government was moving so slowly. In Venezuela, which has nullified some private investments and contracts, it's clear that movement toward freer markets is not irreversible.

Security threats and natural disasters also must be added to the mix. Companies take for granted the relatively quick recoveries that follow disaster in a developed economy. In emerging markets, the risk of business disruption or shutdowns is greater. In case of violence, how secure will you be able to keep your property, equipment and employees -- and what kind of legal protection, and enforcement, can you count on?

The comparative lack of client and market data in developing economies is another hurdle. Companies often discover that information systems pale in comparison to those in developed markets. In China, concern for data confidentiality can impede due diligence even when the data is available. In many Latin American countries, meanwhile, transactions typically involve private enterprises. Data on the companies is therefore limited, making it hard to come up with comparables.

The list of risks in a particular market can be long, from potential intellectual property theft to differences in business culture that might lead to conflicts with the United States Foreign Corrupt Practices Act and beyond. But at some point you'll complete it and go on to the next step, which is to quantify all of these different risks.

Depending on the type and amount of information available, companies can choose from a variety of methods. Probability-adjusted analyses, traditionally used in biotech and pharmaceuticals industries, enable you to perform risk-weighted scenarios. You create a decision tree with several cash flow scenarios and then assign a probability to each scenario. The sum represents the risk-adjusted value. This method can be particularly useful to optimize capital allocation.

But this approach also has limitations, such as a reliance on subjective assumptions. For example, what discount rate do you use? Use of a risk-free rate assumes that you have accounted for all other risks in your probability scenarios -- which might not be the case, given the surprises that often define business in emerging markets.

A real options analysis employs complex modeling tools. Yet here, too, companies should be aware of the limitations. For example, how do you estimate inputs such as the cost of capital? Applying country risk premiums can capture general sovereign and political risks but may overlook risk specific to the target company.

Furthermore, the limited availability of debt-rate data in many developing countries may hinder calculations of your weighted average cost of capital. One common solution: Use a regional rate and then adjust for a spread compared with the United States. But keep in mind that the ability to lever a business may be more complicated, or even nonexistent, in extremely undeveloped nations.

Any approach has its limitations. Therefore it is vital that companies remain flexible and stay current in their use of models and assumptions and lean upon local practitioners and industry experts when available for their perspectives, knowledge and support.

2. Relying on the here and now

A market emerges when recent changes in government, policy or structure open it up to new ways of doing business. This climate of change can render historical data unreliable, or at least less useful, in making long-term projections. Customer behavior, competition policy and other factors are constantly changing.

Credit cards in China provide a good example. Unlike in the United States and developed economies, many customers actually prepay their accounts, making deposits and then spending off the account. Will this behavior continue? When you are looking at a huge market like the ones for credit cards users in China or consumer products in India, effective projection of potential risk scenarios is crucial to your entire business model.

How can you validate projections in such rapidly changing environments? One answer is to explore beyond the normal economic models. Looking elsewhere in the region to a market that's comparable, but more advanced, can inform your projections. What can the nearby market tell you about your chosen market's future profit margins, growth rates or trading multiples? The comparison can be enlightening -- but it's unlikely to be exact. Regional comparables often require adjustments to reflect regional differences.

While historical data may be less useful in an emerging market, one cannot ignore the past. Historical trends may indicate business cycles special to that market. More importantly, every target company has its own history. Companies investing in Latin America and other developing markets may fall into a sort of Christopher Columbus Syndrome, believing they're the first dealmakers in the region.

In reality, companies have been consolidating there for years, creating businesses that are amalgamations of many local deals, knit together poorly or not at all. Companies may close a single acquisition only to find they have really bought a collection of smaller, badly integrated companies, leading to execution risks and huge integration headaches.

3. When the usual economic models don't apply

Companies conducting valuations in emerging markets are often surprised by how different underlying economic assumptions can be. One might assume that the value of a bank's deposit portfolio, for example, should be easy to determine. And in the U.S., which controls its own currency and where the Fed's main lever is the bank lending rate, it is. But in China, which pegs its currency to the dollar and where the central bank typically tightens or loosens by shifting the reserve requirement, it's a different story.

In Argentina, years of hyperinflation in the 1980s and 1990s made it extremely difficult for companies to build projections based on local currency. During the devaluation of the peso in 2001-2002, as the exchange rate went from 1 peso per dollar to 4 pesos per dollar within months, regulated businesses that had conducted business in dollars lost big. Meanwhile, exporters and natural resource-based businesses flourished. The effects extended to the long term: The government didn't release price controls even as wages began to rise, which changed the relative prices in the economy.

In such circumstances, you must adjust your usual method for asset valuation. In the Argentina example, some valuation challenges could have been addressed by using probability-weighted analyses or applying a country-risk premium to U.S.-based costs of capital. During the height of the devaluation, one might use scenario and probability-weighted cash flow analyses, varying around when price controls might end for the industry under study.

4. Differences in culture and communications

Though differences in culture and language are obvious in emerging markets, their effects on valuation work are often overlooked. But it's worth remembering that valuation work takes place in a broader business context and that the same smart practices that help smooth the way in other situations are also valuable here.

A willingness to teach, and an ability to do so diplomatically, can be a great asset. In some countries, for example, the concept of an intangible asset in and of itself is a foreign notion. Using your own intangible asset appraisers to educate their counterparts, and ultimately win buy-in from the target company's management, may be the solution.

Language differences present an obvious communications challenge. But in your data gathering you may find more subtle barriers as well. Nonmanagerial employees may not have access to corporate e-mail. The importance attached to rank can slow communication among superiors and subordinates. Collaborative work styles may be viewed with suspicion.

These challenges add to the time it takes to execute valuations in an emerging market -- starting with evaluation and extending to projections. This process will likely involve mutual education, in which the company approaching the emerging market often must lay a great deal of groundwork.

In due diligence, remember that you'll face real limits on what you can find out -- and that you will need to define and manage expectations accordingly. Key areas to investigate about the company, the environment and the market should include infrastructure, work force, technology and cultural differences.

For all parts of the process, bring in the specialized resources early. These can include a due-diligence team familiar with local regulatory environment; forensic specialists, who can keep you in compliance with the Foreign Corrupt Practices Act; valuation, legal and tax teams with local knowledge; and the operations and merger integration team.

Like the transactions of which they are a crucial part, valuations in emerging markets require significant effort. But if you arrive prepared, stay flexible and remember that relationships and local knowledge count for a lot, you'll have a good shot at making your valuation -- and your deal -- a success. - James Marshall And Stamos Nicholas

James Marshall is a senior manager in the business valuation practice of Deloitte Financial Advisory Services LLP. Stamos Nicholas is a principal and national business valuation leader there.

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