Friday 24 February 2012

Bursa should ban the use of DCF valuations

Catcha Media Bhd is proposing to buy over 50% of Auto Discounts Sdn Bhd (ADSB) for RM 5,000,000, valuing the whole company at RM 10,000,000. Auto Discounts operates a website with on-line car classifieds.

The circular can be found here:

The financials of ADSB are as follows:

The numbers do not look exactly attractive, cumulative revenue over the first 3 years of operating were not even RM 100K. Due to the history of loss making the shareholders' funds are minus RM 1.7 million.

Moore Stephens AC Advisory Sdn Bhd is brought in to value this company. They use two methods:

[1] Revenue Multiple (RM) and
[2] Discounted Cash Flow (DCF).

Their findings:

[1] RM: Moore Stephens uses a multiple of 6.0, but this is a very high multiple, much more normal are revenue multiples of between 1 and 2. Also, since RM 5.85 million represents 50% of ADSB, they value the whole company at RM 11.7 million. Given the multiple of 6.0 they expect a revenue of RM 1.95 million for this year, which seems very high given the first half year revenue of only RM 0.29 million.

[2] DCF: Moore Stephens calculates the value of ADSB to be RM 12 million. This is a very high valuation and unfortunately, as always in Malaysia, the whole basis of this valuation (the projections regarding revenue, expenses, profits, etc) are not revealed, so the readers can't check anything at all. Although the whole report contains 79 pages and the DCF data can be packed in a single page, this information (probably the most important part of the whole report) is always left out.

Apart from that, DCF valuations are only reliable if the underlying business (or asset) has a very stable income and revenue stream, like a toll bridge or a bond or sometimes a blue chip with a history of 40 year stable growing profits and dividends. A young internet startup with a history of losses and a very uncertain growth path is therefore the least suitable to be used for this kind of valuation: a small change in growth rate will give hugely different outcomes.

Bursa Malaysia really should ban the usage of DCF models in circulars, readers have no way of evaluating the quality of these (often sky-high) valuations since all important details are left out.

Disclosure: I own indirectly a company that owns a website which is a competitor to I have a Masters degree in Maths, have used mathematical models for 30 years and have put my money where my mouth was (by actively investing using the models, not just coming up with theoretical values). I have used DCF valuations before, but have stopped using them due to the highly uncertainty of the outcome, and the limited possibilities to use them.


  1. Sorry to offend I think DCF is the soundest method to evaluate a company. In my opinion the best way to stop those financial genius from giving sky high valuation in circulars is they must review how they plug in their assumption like growth rate, discount rate and they must punished if the result is totally different from their valuation.

  2. Sorry typo error it should be "reveal" rather than review.

  3. I am not so quickly offended .....

    I agree that DCF is sometimes good and sometimes highly unsuitable. If there is tough enforcement and DCF is only used in the right cases, then I have no problem with allowing DCF's. I am scared though that again DCF's will be (ab)used in the wrong cases, like in the above acquisition by Catcha Media.

    However, revealing the basic assumptions and projections would already be great, it at least gives minority shareholders a fighting chance, something they don't have at the moment.

    Basically, it is a healthy dose of honesty and integrity that is very much needed. And if that is absent, then enforcers, without fear or favor, should swing into action.

    I hope one day we will see these changes, for the time being I am very skeptical.

  4. I STRONGLY AGREE that Bursa Malaysia should ban the usage of DCF. The calculation made by Moore Stephens is shockingly comical. An utter farce.

    ( ps: I made made a reference to the flaws in DCF. See DCF Can Lead To Large Mistakes! )

  5. Thanks, yes, DCF's are useles, they can come up with any price they want, and nobody can check a thing. Bursa is aware of it, nothing happening, business as usual ....