At the present time, the growing number of population has increases the total of resources that it is needed to gain sustainability. In particular, having to generate electricity along with the advancement in technology has greatly bring an impact on people’s daily life – to be more modernised and mechanical. This also includes by bringing an ease to the businesses in operating and to close the broaden gap in lifestyle between the rural and urban through an access to energy (Kammen, 2011). With that being said, as a developing country, Malaysia is known to have wide renewable sources of energy for example, biomass, biogas, solar and mini hydro (Suruhanjaya Tenaga, 2016). Additionally, Malaysia’s Gross Domestic Product growth rate for 2016 was anticipated to increase at 4% to 5% for that one of the factors to the growing numbers for energy supply has been the growth of population and “…economic activities especially in the manufacturing sector…” (Suruhanjaya Tenaga, 2016). It is expected to grow at a modest with the growth of the domestic demand.
In brief, being one of the leader of IPP in Malaysia with the power plants that focuses on oil, coal and gas, Malakoff that is attained by Nucleus Avenue (M) Berhad “…made its debut…” – an Initial Public Offering on the Bursa Malaysia in 2015 (Malakoff, 2017). It was said to receive different ratings due to the different methods that are being used by the analyst. Therefore, it is apparent that the process of valuing the business can bring a profound effect as to know where the business worth will the company to in the long run. The methods that are used in valuing Malakoff namely Discounted Cash Flow, Capitalization of Cash Flow, Capital Excess Earnings, Book Value and Asset Accumulation will be further discussed in the following.
2.0 Discounted Cash Flow
Discounted Cash Flow (DCF) or Discounted Earnings method is used to determine the value of a business by using the components like discounted future earnings, terminal value and discount rate (Morningstar, 2013). The discounted future earnings are to be summed up with the terminal value as to get the valuation of the company. Besides, the future earnings is defined generally as the company could use any of it but not limited to the following types of cash flow namely the operating cash flow, discretionary cash flow, after-tax cash flow and the like (White, 2017). For instance, Malakoff has a 5 years of earnings historical figures and a discount rate of 10%. It is to be used as a present value factor that can be obtained from present value table to discount the value of future earnings to now, in which for 5 years in this illustration.
On top of that, this method is also commonly used as it is the only method that will conceptually correct the valuation with the characteristics of being precise, to deliver a measured forecast on and every relation to generating cash flows that is correlated with the operations like, administrative and sales expenses, collection of sales and loan repayments for each period (Fernandez, 2007). As previously mentioned, terminal value are also known as the residual value that is being projected into perpetuity. With the earlier representative case, terminal value is equal to the present value of former year’s earnings divided by the discount rate of 10% and the value computed is to be discounted back to the present using present value factor as aforementioned while the discount rate used is the rate of return that is modifiable depending on the level of risks of the business takes. Thus, the difference of capitalization earning method and discounted earning method is that – for discounted earning method, instead of using capitalization rate to convert future earnings and terminal value into present; discount rate is being used in this method.
Consequently, by turning into DCF, it gives the investors a good notion of the essential factors that drives the share value of a company, the efficiency in its capital, forecasted growth in operating earnings and duration of growth and the like by extending a “…more transparent metric…” for measuring the performance than the earnings (Fernandez, 2007). It will also be noticeable as in the long run, the changes in growth rates and interest rates will bring a great impact on evaluating the share (Fernandez, 2007). In particular, Malakoff, which in 2015 traded on the market at RM1.80, is valued above its offering price with an assumption of long-term growth rate at 10%. If the growth rate is assumed to falls below, the share valuation will falls below RM1.80 and likewise, if the growth rate is assumed to increase more than 10%, the value of the shares will go above RM1.80. In brief, this method acts as a sanity check to the company and investors if the company’s share price is being over-valued or under-valued by plugging in the present share price and calculating it in reverse of how fast Malakoff would need to expand as it is focused on a long-term investment.
3.0 Capitalization of Cash Flow
To expect a company to have a consistent growth and level of margins in the future, Capitalization of Cash Flow or Capitalization of Earnings is often used as it assumed that “…it grows at a steady rate into perpetuity…” (Saari, 2017). In comparison to the Discounted Cash Flow, this method is usually have relevance to the company that is matured with a satisfactory estimated future growth. With that, the estimated future gain are capitalised by “…using an appropriate capitalisation rate…” (Institute of Business Appraisers, 2012; Saari, 2017). Besides, the assets – be it tangible and intangible are assumed to be identical elements in the business and that the values are not separated. Thus, this method exhibit an association of having the ability to generate future earnings to the the estimated future earnings, the required rate of return on the capitalization rate and the estimated business’s value (Institute of Business Appraisers, 2012). For instance, Malakoff has five years weighted average earnings of $500,000, the capitalization rate for Malaysia’s power producer industry is to be at 10% and Malakoff owns tangible and intangible assets that net worth of $600,000. In the following, it is further illustrated by using the formula as follows:
+ Net asset worth
= + $600,000
= $ 5,000,000 + $600,000
= $ 5,600,000
Under the capitalization of earnings method, Malakoff is worth $5.6 million.
In sum, the information that it is needed to determine the value of Malakoff’s share can be obtained without difficulty for the investors not forgetting to mention that the valuation method, the outcome is reliable as it does not rely solely on the projections but to use the earnings that can be obtained from the past (The Business Management Institute of America, n.d.)
4.0 Capital Excess Earnings Method
One of the possible methods that may be used in valuing share price is the Capital Excess Earnings Method or at times, it is also known as the Treasury Method. In other words, this valuation method is also given the title of Appeals and Review Memorandum Number 34 or known as ARM 34 by the U.S Treasury Department in 1920 (Pratt & Niculita, 2008). It is a method that is often used to value many types of businesses be it small, medium or large sized (Pratt & Niculita, 2008).
Besides, this is a method that has dual function as it takes into consideration on the company’s asset and income based methods to reach a value that is able to reflect the company’s current performance (Palmiter, 2004; Institute of Business Appraisers, 2012; ValuAdder, 2017). Despite the fact that it is a valuation method that it is hard to assess on as it depends on the estimation of the goodwill’s sustainability or that the future value may be understated – be it the revenue or intangible assets, this method will be apt to put to use as it allows the company to have “…a sanity check against other valuation methods…” especially when the business operation is closely held (Business Professor Inc, n.d.; The Business Management Institute of America, n.d.; Pummel, 2013).
Thus, in order to implement this valuation method, there are four key variables that are needed to be emphasized on and to be applied to the ‘excess earnings’ namely the net tangible assets, earnings base to be capitalized, reasonable rate of return on net tangible assets and direct capitalization rate (Pratt & Niculita, 2008). To begin with, the analyst would first estimate the value of the net tangible asset of the company and this does not take into account on discrete intangible assets like leasehold interests, patents, trademarks and copyrights. The net tangible assets can be derived from the recast financial statements after having to subtract the adjusted liabilities and it should be appraised at a standard value where it is up to scratch as the asset accumulation method (Pratt & Niculita, 2008; ValuAdder, 2017). Then, the value that is derived has to be multiplied with the reasonable rate of return to obtain an estimation on the business earnings and in the following, the variation between the sum of the business earnings and net assets, as aforementioned will help to determine the excess earnings (MBASkool.com, 2017; ValuAdder, 2017). Ultimately, to have the “…fair market value of the intangibles…” be specified, the value that is measured – accordingly to the steps – needs to be capitalise by applying an apt capitalisation rate (MBASkool.com, 2017).
For instance, based on the Malakoff quarterly report on Appendix A and Appendix B, the company holds a pre-tax income of RM 175,533 and net tangible assets of RM 24,440,664 (RM 29,022,242 – RM 4,581,578) with the assumption that the rate of return for tangible and intangible assets hold a particular percentage for that through the steps, it becomes one of the factors that cause the analyst to arrive at a particular value on the share price for the company (Malakoff Corporation Berhad, 2015).
5.0 Book Value Method
By allowing the company’s liabilities value be subtracted from its assets value, the owners’ equity will be able to be determined through this method that are known as the Book Value Method (Institute of Business Appraisers, 2012). While it is not apt for small business to exercise on this method as it will deliver an inadequate information in valuing the company, it is a desirable approach to test valuations when the company particularly recorded a low profits and having to involve a significant assets in it namely, the “…equipment, receivables, inventory or property…” (BusinessTown, 2017; The Book Value Approach to Business Valuation, 2017). By way of illustration, Malakoff recorded a profit of $120,978 (Appendix A) along with a slow growth in their business and the book value that stands more than the financial gain. Accordingly, it shows that the company carries a large amount of valuable assets and the selling price of the company will be further determined by the book value rather than the profits made.
This method is often used as a cross-test in “…applying multiples to EBITDA, cash flow, or net earnings…” (BusinessTown, 2017). It is common for book value to be the primary method in estimation especially when the company is suffering losses in operational activities for that there are no earnings to be applied to what was previously mentioned and hence, the fair market value of total assets after subtracting the total liabilities will be used to evaluate (BusinessTown, 2017). Indeed, most of the assets may be inscribed at historical cost for that when it comes to a buying or selling agreements, it is utmost important to take into consideration if the assets carries a significant value, where it is recast to exhibit its fair market value for the buildings, equipment, machinery and land (BusinessTown, 2017). Moreover, it may also be altered upon request as to have the current values be reflected to the anticipated condition and to determine if the assets are making profit for the business.
6.0 Asset Accumulation Method
Being a method where the company organise its spreadsheet and to have both of its tangible and intangible assets be compared to its liabilities, the variance between is known as the company’s value. Asset Accumulation Method identifies the business’ economic value and the productivity of the assets that it has as it sets apart the identification, the individual valuation of the assets and liabilities (Pratt & Niculita, 2008). On a simple note, it identifies which assets are partly responsible in the contribution to the company’s economic value and how much economic value each is contributing. This is because it is vital to have the both apply on a standard of value and a premise of value that matches with the purpose of the business’ valuation (Pratt & Niculita, 2008). As much as it is conceptually incorrect to jump into conclusion that the value of a business is based only on the value of its tangible assets, it also applies the same to not have it be finalised that the business’ value is equivalent to its accounting book value without the use of generally accepted valuation procedures and proper fundamental analysis (Pratt & Niculita, 2008).
In particular, this method uses the total of tangible assets valued at RM 14,761,224 (RM 14,332,966 + RM 428,258) and liabilities of RM 24,870,046 that are listed on the Malakoff’s balance sheet (Appendix B) with the aim of achieving “…a total value based on the value of individual assets…” (Wojcik, 2017). The following procedure for this method would be to have a discount applied to dispose of the cost in order to achieve a comparable assets “…in current market conditions…” while before having the final value be assigned to the company, the intangible assets and liabilities needs to be considered (Wojcik, 2017). Briefly, the asset accumulation method would require an analyst to be an expertise, to have an adequate experience and qualifications in identifying and evaluating both tangible and intangible assets in order to fill the void for particular asset type (Pratt & Niculita, 2008).
7.0 Conclusion
In essence, as much as we can see how important an electric power can bring an influence to one’s daily life, Malakoff will have to step up its game by improving and meeting the needs of the end-users as well as to gain the ability to sustain in the long run and to obtain a competitive advantage through increasing the installed capacity and adding capacity for new plants that it is needed. This will further help the analysts to evaluate on the performance of the company as to derive on a value on the share price with a particular method that will reflect on the security for purchasing a defined number of shares or the timing of entry to purchase, to hold or to sell the shares for the investors. With the five different methods that are being discussed, book value and asset accumulation has its own advantages that it could bring to the company, the flaws may cause a serious impact as the assets in book value method are mostly recorded at historical cost, does not accurately reflect the true value and when the assets constantly wear and tear, it will sink the company’s profits in the long run. On the other hand, if Malakoff were to assess on the company’s value through the asset accumulation method, it may consume the time more than it was supposed and that may increases the costs because of the need to have an expertise in valuing the company as well as not taking into consideration on the external factors like the current economy’s condition (National Association of Realtors, 2017).
As the Corporate Treasury Head for Malakoff Corporation Berhad, it is advisable for the Chairman to assess on the company’s value and the given ratings by addressing itself to the discounted cash flow, capitalisation of cash flow and capital excess earnings method. This is because the income approach namely, DCF and Capitalization of Cash Flow are considered to be the most reliable and widely recognized valuation method, the ability to stimulate the market price as well as the Capital Excess Earnings that allows the investors to know how the actual company is being valued – their ability in generating earnings at an average level of risk, to further invest and see if it is worth to continue (Simple409A, 2012). It will act as an assistance for Malakoff as to comprehend and to evaluate on the company’s worth – if the share price should be underprice, overprice or fairly priced.