The Role of Valuation in Southeast Asia’s Technology Industry

Rapid Growth in Technology Sector

Southeast Asia’s (SEA) internet economy is expected to reach US$363 billion by 2025, growing at over 100% from US$170 billion in 2021¹ and on its way towards a US$1 trillion economy in 2030. COVID-19 has accelerated digital transformation and online spending. The technology sector’s share of PE/VC² investments in 2021 for Singapore, Malaysia and Indonesia was 64%³, an increase from single digit percentages a few years ago. The region has been home to 42 unicorns as of December 2021, 75% of which attained the unicorn status in the past 3 years and over 50% did so in 2021⁴ itself. While a few of them have successfully gone public or merged with public companies, there are several of them actively looking for listings in the US or SEA, either directly or through SPAC⁵ vehicles. The year 2021 has witnessed significant de-SPAC transactions from Southeast Asia valued at US$59 billion. There have also been multiple SEA based investors and sponsors who have SPACs listed or being listed in the US and many are vying for the attractive Singapore SPAC regime. These facts and trends depict the transformation of SEA from a tangible-asset led economy a decade ago (focusing on real estate, shipping, energy and retail) to an intangible-asset focused economy in the recent past, with an increased impetus on fintech, ecommerce, logistics to support ecommerce, online marketplaces and other internet-led businesses.

Urgent need for Exit Options

Between 2018 and 2021, there have been 600 plus PE/VC investments into the technology sector in Singapore, Malaysia and Indonesia, valued at over US$31 billion⁶. Hence, it is not surprising that there is a significant need for exit options for investors in the immediate or near future and that there is a large volume of companies that would need to seek listings, de-SPAC deals, trade sale or merger. With over 100¬200 investments every year, but only a handful of exits so far, and a typical investment holding cycle of 4-7 years, we are staring at several hundreds of investments that will be striving for the capital market or transactions in the immediate future.

Valuation Requirement and Challenges

The need for valuations to support these exits as well as the continued growth of the industry cannot be undermined. Such valuations tend to be highly complicated and challenging, considering that the technology industry is complex and continuously reinvents itself; many such companies are looking at high growth in disruptive businesses focusing on break-through business models; and many such businesses are at a pre-profit stage. While the valuations for a capital market or M&A transaction is likely determined by market participants such as shareholders, cornerstone investors and underwriters, there is still a critical need for independent professional valuation that would support such transactions, both directly and indirectly.

Financial Reporting

Early stage and growth companies, which typically have a high cash-burn, tend to reward their employees and management through share-based compensation through Employee Share Option Schemes (ESOS), Restricted Stock Unit (RSU) etc. Such share-based payments are required to be fair valued as per IFRS or other equivalent global / local accounting standard, and such value needs to be amortized over a period of time. This would typically require a valuation of the underlying shares such as common equity, which would be different from the value of any preference shares issued in a recent transaction, and a valuation of the options, if any.

It is also common for such companies to issue optionally convertible preference shares, convertible debt, warrants etc. to investors, and accounting standards require these financial instruments to be fair valued.

As several well-funded technology companies have also been growing through acquisitions, they require a valuation of all tangible and intangible (on and off-balance sheet) assets and liabilities for the purposes of purchase-price allocation. In addition, a valuation of any non-cash payment and earn-outs needs to be carried out. Post such business combinations, the goodwill and any long-lived assets accounted for need to be tested for impairment on an annual basis or when there is a trigger.

While these are commonplace requirements by accounting standards, these are not necessarily completely followed, due to the nature of startups, significant demands from and limited bandwidth available to management teams. As the businesses grow, have more sophisticated investors and companies retain auditors with deeper expertise in fair value accounting, there will be a drive to seek assistance of valuation professionals to support with the restatement of financials, in order to proceed with any capital market initiatives.

Specific Valuation Requirements During SPAC and De-SPAC

In addition to the financial reporting requirements outlined earlier, there are other specific valuation requirements in a SPAC situation. The instruments created in a SPAC include public units, that include public shares (Class A) and public warrants. The SPAC sponsors are issued founders shares (Class B) and private warrants. The warrants are detachable after a certain period of time, and they can be exercised or redeemed, based on certain conditions. As per accounting standards, these warrants need to be treated as a liability and hence their fair value determined in the books of the SPAC at the time of IPO and every reporting date until detachment. The valuation would typically be done based on a variety of option pricing models.

Similarly, the fair value of the founder shares and private warrants need to be determined in the books of the sponsor. The valuation of Class B shares will be carried out based on inputs from the trading price of Class A shares, the probability of SPAC completing a successful Initial Business Combination (IBC or De-SPAC), the time expected for the same and any contractual lockup period. The valuation of private warrants will follow a similar approach based on inputs from the traded price of the public warrants and other assumptions on business combination.

At the time of the IBC, the fair valuation of the target needs to be determined. For certain SPAC regimes, the responsibility solely vests with the board of directors. The boards could require an independent professional valuation to support with the IBC transaction. In some situations, the board may need a fairness opinion, if there is an interested party angle. For some SPAC regimes like Singapore, an independent valuation is required for the IBC when there is no PIPE⁷ investment prior to the IBC.

Other Valuation Requirement

As technology businesses and their investors in SEA explore exit options including global listings or M&A, they may need to embark on certain changes to corporate holding and tax structures to facilitate such listing processes or transactions. This could involve tax or transfer pricing related valuation of legal entities, assets or liabilities, depending on the nature of the structure and jurisdiction.

Engaging Suitable Experts

It is critical for boards and company management to engage appropriate valuation professionals who have the experience in valuing continuously evolving technology business models and highly complex financial instruments with a deep understanding of stringent requirements from regulators as well as accounting and valuation standards. Thus, it is important to select the suitable valuation professional with the right qualification, certification and affiliation to VPOs8, who place significant weight on maintaining the quality of the profession and continuous professional development. While valuation will continue to have elements of subjectivity, it is of utmost importance that such subjectivity is backed by deep experience, informed judgement, and adherence to best practices, standards and governance.

 

Sources
¹e-Conomy SEA 2021 report by Google, Temasek, Bain & Company
²Private Equity / Venture Capital
³Kroll - Duff & Phelps Transaction Trail Report, 2021
⁴Dealstreet Asia
⁵Special Purpose Acquisition Companies
⁶Kroll - Duff & Phelps Transaction Trail Reports
⁷Private Investment in Public Equity