Sulev Raik | TOP 101 methodology changed

Sulev Raik, Partner at Prudentia Tallinn

This year, we made some changes in the methodology for compiling the TOP 101 Estonia’s most valuable enterprises.

Previously, we used a combination of EV/Sales and EV/EBITDA ratios to estimate the values of companies, where EV/Sales provided up to 20% of the company value. In this year's top, we only used the EV/EBITDA multiplier, as the retrospective analysis showed that the results for the two methods do not differ significantly, so we opted in favor of a simpler and clearer methodology.

The second change concerns the publicly listed companies. In the case of the publicly listed companies, we decided to base our calculations on the stock exchange price and calculate the enterprise value from that. Basically we added the net debt to the stock exchange price, which is debt minus cash and cash equivalents. For the sake of clarity, I should reiterate that in the case of financial service providers, we value equity, as banking is a highly leveraged business and the structure of banks' liabilities is not comparable to that of conventional companies. The value of the banks listed on the Tallinn Stock Exchange, i.e. LHV and Coop, is thus their market value or market capitalization.

Why did we make that decision?

As a reminder, the TOP 101 methodology is based on history. For example, the recently published 2021 TOP 101 is compiled based on the 2018-2020 financial results and value multipliers of the comparison group, which reflect the market expectations as of 30 June 2021. At the same time, LHV share price already contains much more recent financial results and investors' expectations – publicly listed companies publish their unaudited financial results on a quarterly basis, LHV publishes their key figures on a monthly basis (while most unlisted companies publish their results once a year). Therefore in the case of publicly listed companies, we didn’t consider it right to disregard the currently disclosed information. We will continue to follow the principle that the market is (almost) always right, and in the case of listed companies we base our calculations on the stock exchange or market price.

This approach has its drawbacks. As stock exchange prices contain the latest available information, the values of listed companies are not quite comparable to the values of unlisted companies. To mitigate this problem, we took the stock prices as well on the 30the of June 2021, similarly to the market multipliers we use to evaluate other companies. You should also pay attention to the fact that according to the top methodology, only enterprise business activities are valued, but in the case of listed companies, the share price may also include, for example, valuable real estate or a successful investment in a startup company.

Let's take Harju Elekter for example. They have a stake in Skeleton Technologies Group and this is one of the reasons why the value of Harju Elekter in TOP 101 would be lower than the stock exchange value – the share price includes the potential of Skeleton's investment. The TOP 101 methodology would not take this into account. Considering all the pros and cons of this change, we came to the conclusion that it is justified. Among the 11 most valuable companies of 2021 TOP 101, 4 are publicly listed companies. Without this change, there would have been only 1. This reflects the good state of the economic environment and the positive outlook of investors. In another year, things may be very different.

The third major change concerns financial service providers. We have supplemented the methodology so that it now also takes into account the return on equity (ROE). As a reminder, in the past we only used P/B ratios to assess the value of banks and other financial service providers. This simplified approach meant that, for example, the value of banks did not depend on the return on equity, i.e. the ability to make a profit. Now the value of a bank doesn’t only depend on the size of its equity but also on its productivity.

Regarding financial service providers, we made another clarification. Previously, we derived the TOP 101 banks multipliers from the European stock exchange banks’ P/B ratios. Now we narrowed the comparison group geographically to only Scandinavian and Baltic banks. The reason is that our banks are more similar to Scandinavian banks. These changes had a significant impact on the values of this year's top banks. The values of Swedbank, Luminor and SEB doubled. It had a particularly positive impact on banks with a high return on equity, such as Bigbank, which more than tripled in value.

Finally, Prudentia offers advisory service on the mergers and acquisitions of companies. TOP 101 values should not be taken as an indication of the price levels of M&A transactions. Companies’ purchase and sale process is much more complicated and the price is formed in the course of negotiations. TOP 101 is based on European price levels and liquidity and does not take into account local circumstances (excluding local publicly listed companies). That's why you should take the TOP 101 as it is – a comparable ranking of Estonia's most valuable enterprises at some point in time, with no claims to the absolute truth.

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