mission: profitable

MISSION: PROFITABLEMISSION: PROFITABLEMISSION: PROFITABLEMISSION: PROFITABLE

Presentation April 30th, 2003

Emerging Financial MarketsProfessor JianPing Mei

APAACAditya Dugar

Pavel Nazarov

Alex Reznik

Alex Shaoulpour

Christine Nilsson

AGENDA

Russia Factoring

Valuation Opportunity

RussiaMacroeconomic Outlook

Political EnvironmentSocial ConditionsLegal Framework

-15%

-10%

-5%

0%

5%

10%

15%

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Source: CBR

GDP GROWTH

APAAC

-40,000-35,000-30,000-25,000-20,000-15,000-10,000

-5,0000

5,00010,00015,000

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

E

Source: CBR

CAPITAL OUTFLOW/FOREIGN DIRECT INVESTMENT

Capital flight

FDI

APAAC

0

50

100

150

200

250

300

350

95 96 97 98 99 2000 01 02 03E 04E 05E

0.0

0.2

0.4

0.6

0.8

1.0

1.2

INFLATION AND LABOUR COSTS

Source: CBR

Consumer Price ChangePercentage

Labor costsUSD per hour

APAAC

CURRENT POLITICAL ENVIRONMENT

Mr. Yeltsin becomes the 1st President of Russia.

New Constitution and democratic parliament

are adopted

1990 94 95 96 97 99 2000 01 02 200398939291

1991—1999 Political Instability,

Rapid Succession of cabinets

March 2000Mr. Putin wins election 53%

of vote

9/11 drastic change in

foreign policy towards Western direction

Russian financial

crisis

APAAC

POLITICAL ACCOMPLISHMENTS AND CHALLENGES AHEAD

AccomplishmentsAccomplishmentsAccomplishmentsAccomplishments ChallengesChallengesChallengesChallenges

• Economic growth

• Declining inflation

• Foreign debt repayment

• Unification of Federal and Regional laws

• Tax reform

• Judiciary reform

• Labor law reform

• Land reform

• Social security reform

• Exclusion from FATF ‘black list’

• Reduction of dependency of Russian economy on natural resources

• War in Chechnya

• Development of vast and strong middle class

• Elimination of Red Tape

APAAC

SOCIAL CONDITIONS

• Increase in poverty level since 1980-1999 to 37% of the entire population

• Corruption: 2.1 on a scale 1 (highly corrupt) to 10 (highly clean) Transparency International

• Since 1999 increased level of law enforcement, elimination of tedious licensing and registration procedures; tax reform

• Low level of trust in the banking system

• Need of Court reformAPAAC

LEGAL FRAMEWORK

Civil CodeCivil Code

• In line with Western standards

• Enforcement is lacking

Federal Law on ‘Banks and Banking Operations’Federal Law on ‘Banks and Banking Operations’

• Operating framework

Federal Law on ‘Financial Securities Market’Federal Law on ‘Financial Securities Market’

• Specifics on debt instruments

0%

5%

10%

15%

20%

25%

1998 1999 2000 2001 2002 2003

Rates on short-term credits extended by Russian credit institutions (adjusted for inflation)

Corporate borrowers

Individual borrowers

Source: CBR

AVERAGE RUSSIAN CREDIT RATES

APAAC

Russia

Valuation

Factoring

Principle of factoringImplementation in Russian Market

Opportunity

FACTORING

What is factoring?What is factoring?

• Financial management service designed to help firms better manage their receivables by offloading a firm’s receivables and credit management onto someone else

How does factoring work?How does factoring work?

1) Factor collect the accounts on the due dates

2) Effects payment to its client firm

3) Factor assumes the credit risk associated with collection for a fee

APAAC

PROS AND CONS

DisadvantagesDisadvantagesDisadvantagesDisadvantages

AdvantagesAdvantagesAdvantagesAdvantages

• Cash Flows improved due to quicker payments and available for reinvestment

• Can focus on growth as reduction in overhead costs by transferring troublesome chore of collection

• Factoring can be expensive

• Perceived as option of last resort

• Factor contacts your customers and may damage ongoing relationships

APAAC

RUSSIAN CREDIT MARKET — HISTORY AND PROBLEMS

• Commercial banking emerged in Russia in the late 1980s

• Russia had more than 2,500 banks by 1994

• Devaluation of the Ruble in 1997—1998 forced many banks into bankruptcy

• In mid 2002 Russia had just under 2,000 registered banks and credit organizations

• Industry dominated by a few large players

Main problemsMain problems

• The banking sector has failed to fulfill its main function to act as an intermediary

• Lack of transparency

• Lack of legal framework

• Banks are not willing to expand their credit card services to the middle class

APAAC

DEMAND ANALYSIS

• Increased level of lending by financial institutions, domestic investors and FDI since 1998

• Companies require advance payment terms or letters of credit

• High portion of transactions are conducted on a non-cash basis

DEMAND ANALYSIS

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

Personal Loans Corporate Loans Inter-Bank Loans

12/31/2000

12/31/2001

11/30/2002

$ million

247% increase 103% increase 126% increase

INTEREST RATES

APAAC

January 2001

January 2002

Interest rates on Personal loans

Percentage

Interest rates on Corporate loans

Percentage

POTENTIAL AND EXISTING COMPETITION

• Limited choices between three types of banks:

– Foreign-owned subsidiary

– State-owned Russian bank

– Variety of Russian private commercial banks

• Russian Private Commercial Banks are an aggressive component but still have a limited capacity to provide services

– Top 5 include: Gazprom Bank, National Reserve Bank, Sobinbank, MDM Bank, Bank of Moscow

APAAC

Existing competitionExisting competition Potential competitionPotential competition

BARRIERS TO ENTRY IN THE RUSSIAN MARKET

1.Not many regulations to protect either party

2.Corruption is wide-spread and deeply rooted

• Serious obstacle for private sector growth— In 2002, Russian Corporations allocated an

estimate of $60 billion towards bribes

Few alternative solutions to Cash Flow Problems

• Industry financing

• Banks or Corporations

APAAC

OpportunityFulfilling a needDeal economics

Russia

Valuation

Factoring

• Truckers’ clients are faced with cash flow problems – prefer to delay payments

• Few trucking companies agree to accept A/R― Drivers are instructed to stay until payment is

received― Such collection practice is detrimental to the

business

• A/R that are on the books = uncollectible debt

• Shadow accounting

FACTORING SERVICES TO THE TRANSPORTATION INDUSTRY

APAAC

• Capitalize on the unrealized existing need for factoring services

• No current market for factoring services, because nobody targets the transportation industry

• By offering the factoring services we will create the market

OPPORTUNITY

APAAC

THE STRATEGY

Merchandise $30K - $100K

Provide factoring services to the transportation companies and use the established connections to gain access to the trade transactions that the transportation companies service

Access to the buyers and sellers will open an opportunity to offer factoring and purchase order financing services for large trade transactions

Buyer Seller

APAAC

DEAL ECONOMICS — WITHOUT 3RD PARTY BUYER

Buyer

Transport Co Seller

goodsservice

M2 M1

APAAC Inc.

M1 – f2M2 – f1

Net: f1 + f2

M2 M1

Factoring – with partial collateral

DEAL ECONOMICS — WITH 3RD PARTY BUYER

Buyer (Wholesaler)

Transport Co

3rd Party(Retailer)

Seller

M3goods

M1

goodsservices

M2

APAAC Inc.M1M2

M1+f1

M2 – f2

Net: f1 + f2

M3 > M1 + M2

Factoring and purchase order financing – with collateral

M1

BUSINESS RISKS

• Collection and contract enforcement

• Forced litigation to prevent or recover losses

• Fraudulent actions towards APAAC

• Shadow economy – lack of transparency

• Unexpectedly large number of bad debts (>30%)

APAAC

MITIGATION OF BUSINESS RISKS

• Extensive due diligence— Use experienced lawyers and law enforcement officers

• Work only with ASMAP members (Association of International Transporters)

• Cooperation with law enforcement agencies

• Deal collateralization

• Build long-lasting relationships

APAAC

ValuationAssumptionsCash Flows

Cost of CapitalSensitivity Analysis

Russia Factoring

Opportunity

ASSUMPTIONS

Our Cash Flows are the same as Net Income asOur Cash Flows are the same as Net Income as

• We are all equity financed (no interest)

• Our CAPEX is immaterial as it will only consist of office equipment and other supplies

• We have no depreciation expense due to the absence of capital assets

Other AssumptionsOther Assumptions

• Our non-cash working capital is assumed to be stable in the short and medium term

• Our terminal growth rate is assumed to be 10%

APAAC

VALUATION — METHOD USED

Benefits of DCFBenefits of DCF• It incorporates all of the relevant cash flows• Easy to use • Easy to amend if the macro or micro environment changes• Drawback — does not include the value of real options

Drawbacks of other methodsDrawbacks of other methods• Option valuation — difficult to use, not accepted• Comparables — not available due to lack of public

companies in this line of business

Discount rate Discount rate Risk free rate*Risk premium

20%20%12%8%

* MinFin (2030 Eurobond rate) APAAC

PROCEEDS FROM FINANCING OF TRANSPORTATION SERVICES

2003 2004 2005 2006 2007

Total Sales per company $240,000 $249,600 $259,584 $269,967 $280,766# of customers per year 25 30 36 43 52Total sales per year $6,000,000 $7,488,000 $9,345,024 $11,662,590 $14,554,912% of sales that are on credit $3,000,000 $3,744,000 $4,672,512 $5,831,295 $7,277,456% of credit sales that will be factored $2,400,000 $2,995,200 $3,738,010 $4,665,036 $5,821,965Revenues (from fee)0 - 30 Days $90,000 $112,320 $140,175 $134,120 $167,38131 - 45 Days $240,000 $299,520 $373,801 $384,865 $480,31246 - 60 Days $150,000 $187,200 $233,626 $250,746 $312,931Total Revenue from all credit periods $480,000 $599,040 $747,602 $769,731 $960,624

CostsBad Debts $144,000 $179,712 $149,520 $115,460 $144,094Other costs $150,500 $242,525 $284,701 $277,041 $329,559

Operating Margin $329,500 $356,515 $462,901 $492,690 $631,065Less Taxes $98,850 $106,955 $138,870 $147,807 $189,320

Net Income $230,650 $249,561 $324,030 $344,883 $441,746

APAAC

15%20%25%

30%

~25% growth

(decreasing percentage)

PROCEEDS FROM MERCHANDISE FINANCING

2003 2004 2005 2006 2007

Average price of a 20t cargo $50,000 $52,000 $54,600 $57,330 $60,197Average # of transactions per month per truck 4 4 4 4 4Average number of trucks per company 5 5 5 5 5Total Price of the cargo transported $1,000,000 $1,040,000 $1,092,000 $1,146,600 $1,203,930per month per company

Number of customers per year 35 37 39 42 47Total Price of the transported assets $35,000,000 $38,220,000 $42,137,550 $48,668,870 $56,212,545Average number of transactions we can factor 5 10 15 20 25Average Volume of factoring amount per year $5,000,000 $10,400,000 $16,380,000 $22,932,000 $30,098,250

Revenues (from fee)0 - 30 Days $150,000 $312,000 $491,400 $573,300 $752,45631 - 45 Days $425,000 $884,000 $1,392,300 $1,719,900 $2,257,36946 - 60 Days $250,000 $520,000 $819,000 $1,146,600 $1,504,913Total Revenue from all credit periods $825,000 $1,716,000 $2,702,700 $3,439,800 $4,514,738

CostsBad Debts $82,500 $171,600 $135,135 $171,990 $225,737

Operating Margin $742,500 $1,544,400 $2,567,565 $3,267,810 $4,289,001Less Taxes $222,750 $463,320 $770,270 $980,343 $1,286,700Net Income $519,750 $1,081,080 $1,797,296 $2,287,467 $3,002,300

APAAC

12%17%20%

4% growth

(decreasing percentage)

DCF VALUATION

Net Income

• Transportation

• Merchandising

Total NI Cash Flows

2003200320032003 20052005200520052004200420042004 20072007200720072006200620062006 TV 2008TV 2008TV 2008TV 2008

123,762

1,081,080

1,204,842

129,850

519,750

649,600

264,061

2,287,467

2,551,528

340,880

3,002,300

3,343,181 44,174,987

219,366

1,797,296

2,016,662

Present value of APAAC Inc’s NICF with 20% discount rate Present value of APAAC Inc’s NICF with 20% discount rate

$17,434,979$17,434,979


$17,434,979$17,434,979

APAAC

RECEIVABLE FINANCING NEED DURING FIRST YEAR

Total funds requiredTotal funds requiredTotal funds requiredTotal funds required $7.7 million$7.7 million$7.7 million$7.7 million

APAAC

Working capitalWorking capitalTransportation industryMerchandising financing

Start-up costsStart-up costs

$7.4 million$7.4 million$2.4 million$5.0 million

$0.3 million$0.3 million

POTENTIAL EXIT STRATEGIES AND TERMINAL VALUE

Attractive target for larger financial institution eg, NIKoil, Sberbank

– Strong customer base

– Foothold in growing market

APAAC

Value of option to close operations anytime– 60 day credit period

Need working capital for factoring services– Initial capital raised not a sunk cost

(most should be recovered) but must be discounted from exit date

DCF VALUATION REVISITED

Net Income

• Transportation

• Merchandising

Total NI Cash Flows

2003200320032003 20052005200520052004200420042004 20072007200720072006200620062006 TV 2008TV 2008TV 2008TV 2008

123,762

1,081,080

1,204,842

129,850

519,750

649,600

264,061

2,287,467

2,551,528

340,880

3,002,300

3,343,181 44,174,987

219,366

1,797,296

2,016,662

Which equals an IRR of Which equals an IRR of

44%44%

Which equals an IRR of Which equals an IRR of

44%44%


$12,213,224$12,213,224


$12,213,224$12,213,224

APAAC

SENSITIVITY ANALYSIS

The sensitivity analysis shows the range of firm values depending on pessimistic, average and optimistic scenarios

The most reasonable range of values is between the growth rates of 8%—12 % and the discount rates of 18%—24%

APAAC

Discount rate

18%

20%

22%

24%

Growth rate

6% 10% 12%

11,138,212 17,227,108 23,316,005

8%

13,573,771

8,374,512 12,213,224 15,572,0979,973,975

6,336,690 8,913,719 10,975,3437,441,131

4,778,835 6,588,970 7,946,5715,570,769

SALES PITCH

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We make YOUR risk OURS™

QUESTIONS?

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mission: profitable

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