re : equity investment fair value in turkey john ,
it seems to me that using a risk - free rate is not appropriate . i shall
elaborate on my
position and send you a longer message this afternoon ( my time ) .
vince
enron capital & trade resources corp . - europe
from : john bottomley 06 / 19 / 2000 05 : 55 am
to : vince j kaminski / hou / ect @ ect
cc : john sherriff / lon / ect @ ect , dale surbey / lon / ect @ ect
subject : equity investment fair value in turkey
vince ,
john sherriff recommended that i contact you regarding an interesting ( and
potentially contentious ) option valuation issue we are currently dealing with
in london . we hold longish term options in a private company in turkey which
is currently seeking to ipo . the issue we are discussing with rac is which
discount rate ( i . e . , risk - free ? and if so turkish or us ? ) should we use to
value these options
first , some additional information .
option characteristics :
- - 116 , 000 options ( representing 9 % of the company )
- - term : minimum of 3 years but possibly longer - - still being renegotiated
- - strike price : 20 % below the upcoming ipo price ( either priced in us $ or
turkish lire )
we currently hold the above number of options with a fixed price of $ 118 . 75
per option but 34 , 800 expire on july 15 , 2000 with the remainder expiring on
december 15 , 2000 . the company ' s investment bankers ( abn / amro rothchilds )
are concerned regarding the strike price because it values the company at
$ 118 million and they believe the company is worth approx $ 300 million . due
to such a large " valuation gap " , they originally encouraged us to exercise
all of the options by the end of june ( ipo target date in late sept / early
oct ) . our counter - proposal is to " swap " instrinsic value for time value by
repricing the options strike higher while extending their term .
we are currently negotiating with rac the most appropriate discount rate to
use to value the options . we are arguing that the us risk free is the most
appropriate discount rate and their current position is that the company ' s
historical senior debt cost ( 18 % ) is the more appropriate number to use
( although admit that this is not justifiable - - only a proxy )
a few key points :
- - rac is valuing the options via crystal ball simulations such that this " to
be negotiated " discount rate is used to calculate the pv of the future
options intrinsic value in 3 years
( i . e . , for black - scholes , a higher discount rate yields a higher value but
the opposite is true using crystal ball simulation )
- - the model simulates both an ipo / no ipo case and in the case of no ipo we
have put options for our equity priced at a fixed 17 % return
- - the model assigns a 30 % illiquidity discount
- - in the simulated cases where the options are out - of - the - money , we
obviously do not exercise .
we understand that for black - scholes option valuation , one needs to be able
to construct a comparable portfolio of cash flows using equity futures and
the risk free in order for the valuation to hold . and here is where we reach
our difficulty : since the company doesn ' t currently trade on a public market
and since equity futures do not exist for turkish equities , rac is arguing
that a us risk free is not appropriate to use . our argument is that the
non - ipo scenario , a 30 % illiquidity discount and a us $ based option
volatility are already in the factored into the simulation . as such , we feel
rac ' s approach is double counting .
if you managed to get through the above , your a patient man ! i ' ll give you a
call today or tomorrow after you ' ve had a chance to digest the information .
regards ,
john bottomley
re : equity investment fair value in turkey
john ,
it seems to me that using a risk - free rate is not appropriate . i shall
elaborate on my
position and send you a longer message this afternoon ( my time ) .
vince
enron capital & trade resources corp . - europe
from : john bottomley 06 / 19 / 2000 05 : 55 am
to : vince j kaminski / hou / ect @ ect
cc : john sherriff / lon / ect @ ect , dale surbey / lon / ect @ ect
subject : equity investment fair value in turkey
vince ,
john sherriff recommended that i contact you regarding an interesting ( and
potentially contentious ) option valuation issue we are currently dealing with
in london . we hold longish term options in a private company in turkey which
is currently seeking to ipo . the issue we are discussing with rac is which
discount rate ( i . e . , risk - free ? and if so turkish or us ? ) should we use to
value these options
first , some additional information .
option characteristics :
- - 116 , 000 options ( representing 9 % of the company )
- - term : minimum of 3 years but possibly longer - - still being renegotiated
- - strike price : 20 % below the upcoming ipo price ( either priced in us $ or
turkish lire )
we currently hold the above number of options with a fixed price of $ 118 . 75
per option but 34 , 800 expire on july 15 , 2000 with the remainder expiring on
december 15 , 2000 . the company ' s investment bankers ( abn / amro rothchilds )
are concerned regarding the strike price because it values the company at
$ 118 million and they believe the company is worth approx $ 300 million . due
to such a large " valuation gap " , they originally encouraged us to exercise
all of the options by the end of june ( ipo target date in late sept / early
oct ) . our counter - proposal is to " swap " instrinsic value for time value by
repricing the options strike higher while extending their term .
we are currently negotiating with rac the most appropriate discount rate to
use to value the options . we are arguing that the us risk free is the most
appropriate discount rate and their current position is that the company ' s
historical senior debt cost ( 18 % ) is the more appropriate number to use
( although admit that this is not justifiable - - only a proxy )
a few key points :
- - rac is valuing the options via crystal ball simulations such that this " to
be negotiated " discount rate is used to calculate the pv of the future
options intrinsic value in 3 years
( i . e . , for black - scholes , a higher discount rate yields a higher value but
the opposite is true using crystal ball simulation )
- - the model simulates both an ipo / no ipo case and in the case of no ipo we
have put options for our equity priced at a fixed 17 % return
- - the model assigns a 30 % illiquidity discount
- - in the simulated cases where the options are out - of - the - money , we
obviously do not exercise .
we understand that for black - scholes option valuation , one needs to be able
to construct a comparable portfolio of cash flows using equity futures and
the risk free in order for the valuation to hold . and here is where we reach
our difficulty : since the company doesn ' t currently trade on a public market
and since equity futures do not exist for turkish equities , rac is arguing
that a us risk free is not appropriate to use . our argument is that the
non - ipo scenario , a 30 % illiquidity discount and a us $ based option
volatility are already in the factored into the simulation . as such , we feel
rac ' s approach is double counting .
if you managed to get through the above , your a patient man ! i ' ll give you a
call today or tomorrow after you ' ve had a chance to digest the information .
regards ,
john bottomley