RE:RE:Chris Thompson Price Target Raised $3.75: 230% Upside
vicario wrote: At the risk of throwing cold water on this:
1) this 'research' is paid for by DCM... this is buried in the fine print at the end of the report. Not ideal.
2) DCFs are great for predictable businesses. How anyone can predict the cash flows of DCM with any level of uncertainty is beyond me. Imagine someone tried to do this 5 years ago, 3 years ago or even 6 months ago.
3) I would argue one cannot and should not use a DCF to determine the value... but IF we are going to use it (and I do see this is but 1 of 3 methods used) then the discount rate should match the risk. 10% is a ridiculously low discount rate to use for a business that has yet to show us it deserves to even have us predict future cash flows. I would use 20-30% and that might even be conservative.
I'm not going to argue that DCM isn't undervalued here but I am simply pointing out my opinions of this 'research' and basis for valuation. The facts remain that IF DCM can stop the revenue bleed, increase margins, stop the parade of restructuring charges (they aren't non-recurring if they keep recurring', reduce debt, avoid temptation to acquire for the sake of acquiring and stop increasing the share count then we will be fine. This is a lot of IF's.
This sounds about right.
If one uses the traditional capital asset pricing model (Capm) we can determine an approximate cost of equity which uses "past data" inputs. If we look at the average "beta" for Data Communication over the last 5 months, I get ~ 4.32 (yahoo finance)
A typical equity risk premium for the markets today may be something like 5.5%
The cost of equity using the capital asset pricing model is simply the risk free rate plus beta multiplied by the equity risk premium. The current 10-year risk free rate is ~ 1.48%
cost of equity =~ 1.48% + 4.32*5.5% =~ 25.24%
A better approach to this may be to take the average beta for comparable companies and use that number instead. For instance, R.R Donnelley and Sons (RRD) has a 5 month beta of 2.65. It is interesting to note that DCM has a superior interest coverage ratio than RRD and so should theoretically be less risky with a lower beta. Supremex and Arc Document solutions have a beta of 1.34 exactly over the last 5 months. What is the correct beta to use? Future beta will likely decrease as the company begins to pay off its debt.
The average beta of the 4 companies mentioned is 2.41
cost of equity =~ 1.48% + 2.41*5.5% =~ 14.74%
I would say a cost of equity of anywhere between 15-25% may be more appropriate to use.