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Enron Mail |
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
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