Feature Article

Asian companies: Closing the valuation gap

A focus on ROIC and a better strategy for communicating with investors are key.
James Ahn and Nicolas Leung
eb e!clusive" January #$$%
Record inflows from foreign investors hel&ed Asia's stock markets record hefty gains in
#$$(. )ut des&ite the region's attractions" Asian com&anies still tend to trade at a discount
to estern ones. At the end of #$$*" for instance" the median +,- ratio for com&anies in
the ./+ ($$ was 01.1" com&ared with 00.2 for big listed com&anies in 3ong 4ong and
%.2 for those in .outh 4orea. In other words" even if a estern com&any and an Asian
one have the same earnings in any one year" investors tend to be willing to &ay more for
the shares of the former" believing it will create more shareholder value.
3igher risk factors" such as corru&tion and uncertain regulatory regimes" are often cited
as the e!&lanation5and in some cases they &lay a &art. )ut an im&ortant and sometimes
overlooked reason why many large Asian com&anies are valued lower than their estern
&eers is because of their historical focus on growth rather than on returns on invested
ca&ital 6ROIC7. Asian com&anies seeking to im&rove their valuations need to rethink
their strategies" and consider carefully not only how best to create sustained shareholder
value but also how to communicate &rogress on this front to investors.
Com&anies create value when their ROIC e!ceeds the cost of ca&ital 6which takes into
account" by itself" any &erceived risk7. 8rowth" while an im&ortant com&onent" doesn't
create value automatically. 9he cost of growth5the goodwill added on to the &rice of an
ac:uisition" for e!am&le5needs to be calculated as well. 8rowth only creates value if it
also delivers a decent return on ca&ital.
Although these &rinci&les sound sim&le" they are not always well understood by
cor&orate managers. 9hey are" however" understood by many investors and reflected in
stock market valuations. It is not uncommon to find two com&anies in the same industry
with similar growth rates but :uite different +,- ratios5a measure of investors'
e!&ectations of a com&any's future &ros&erity5because of different rates of return.
9he &roblem is that many Asian com&anies have often &laced more em&hasis on growth
rather than on ma!imi;ing their ROIC. In the 012$s and much of the 011$s" it wasn't
uncommon for Asian com&anies to boast growth rates of 0( to #$ &ercent a year. .i;e
was often e:uated with &restige and &ower" but ra&id growth didn't necessarily mean
better &erformance. 9oday the ROIC of many Asian cor&orations remains relatively low
5about 1 &ercent" on average" for large Asian com&anies" com&ared with 0< &ercent for
their =. counter&arts" according to >c4insey analysis.
Asian com&anies seeking to create more shareholder value need to ensure that their
cor&orate strategies strike the right balance between growth and ROIC. It also means
balancing solid short?term financial results and longer?term &erformance.
0
As many estern com&anies have discovered" there is a noisy section of the investor
community that is fi!ated on short?term financial results. Conse:uently" e!ecutives find
themselves tem&ted to manage their businesses to meet :uarterly earnings e!&ectations
by" for e!am&le" delaying new investments?even if those &ro@ects offer good returns over
the longer term. .uch actions undermine a com&any's ability to deliver sustained
shareholder value.
9he goal of the cor&orate manager should be to deliver solid short?term results while also
tending to the longer?term health of the businessA that is" making the kinds of decisions
that will ensure that the com&any &erforms well year after year. 9hat's what so&histicated
investors e!&ect. 3ence" in almost all industry sectors in the =nited .tates and other
develo&ed markets" B$ to 1$ &ercent of stock market value can be e!&lained only by the
cash flows &redicted beyond three years. .hort?term results have far less im&act than
many e!ecutives might imagine.
Cinally" senior e!ecutives need to e!&lain to investors @ust where value lies in the
business and how they e!&ect to create more5even if their &lans entail sacrificing some
short?term &rofits. 9he &ur&ose of investor communications is not to sim&ly talk u& the
share &riceD overly high as&irations will only tem&t e!ecutives to make short?term
decisions that &ro& u& the com&any's stock but damage future &ros&ects. Rather" the
ob@ective is to align the share &rice with the com&any's intrinsic value.
Eifferentiating between various ty&es of investors is also im&ortant. A com&any could"
for e!am&le" craft a long?term strategic message directed at those investors who are
highly focused on cor&orate fundamentals over a five?year &eriod and another message
for others whose interests center on how strategic decisions or news events will affect the
com&any's short?run value.
8iven the flow of funds into the region" Asian com&anies will increasingly come under
the scrutiny of institutional investors looking for the best o&&ortunities. )y striking the
right balance between growth and ROIC" by caring for the long?term health of the
com&any" and by sharing strategies for value creation with key investors" Asian
com&anies should stand u& well to such scrutiny.
About the Authors
James Ahn is an associate &rinci&al and Nicolas Leung is a &rinci&al in >c4insey's
3ong 4ong office.
9his article is ada&ted from FClosing the valuation ga&"F &ublished in the Wall Street
Journal Asia on January 1" #$$%. Re&rinted by &ermission of the the Wall Street Journal
Asia. Co&yright G #$$% Eow Jones / Com&any" Inc. All rights reserved worldwide.
Notes
0
Ian Eavis" F3ow to esca&e the short?term tra&"F The McKinsey Quarterly" eb
e!clusive" A&ril #$$(.
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Co&yright G 011#?#$$% >c4insey / Com&any" Inc.