THE DCF METHOD OF VALUATION IN THE YUKOS ARBITRATION

In most investment arbitrations, the Discounted Cash Flow method of valuation (DCF method of valuation) is becoming the norm used by Tribunals to do the valuation of ongoing profitable companies, but is it the right way?

The DCF valuation method has become very popular and is almost the default approach in many investment arbitrations because it is viewed as very transparent and provides very detailed calculations. However, from a valuer’s perspective, some of the calculations may be of spurious precision and can be manipulated to reach pre-determined numbers. It is important to determine when DCF works and when it is not appropriate. In any event, whenever DCF is used, it must always be subject to a cross-check.

Claimants’ Use of a Weighted Approach Including the DCF Method of Valuation

In order to help the Tribunal reach an accurate valuation for Yukos, Claimants’ experts used three classic valuation technics:

1. DCF method of valuation – estimated future cash flows (based on operational and financial data published by Rosneft and Gazprom Neft, from 2007 to 2015, using a terminal value in 2015) and discounting back to the valuation date (Final Award, para. 1714).

2. Comparable companies – Claimants used Russian and international oil companies (Final Award, para. 1715).

3. Comparable transactions – based on public purchase transactions of comparable companies – as there were no transactions similar to the expropriation of Yukos, Claimants used a sum of the parts valuation (Final Award, para. 1716). This approach is a useful cross-check which can often bring the experts back to reality.

The unusual aspect of the Claimants’ valuation is that Claimants synthesized the enterprise value of Yukos based on the results of the three approaches, weighed them (attributing 50% to DCF, 40% to Comparable companies and 10% to Comparable Transactions (Final Award, para. 1717)), deducted the debt (to get from Enterprise to Equity value) and multiplied it by Claimants’ share in Yukos (53% or 70.5% depending on the scenario chosen) (Final Award, para. 1718).

Although each of these techniques is commonly used on their own, M. MacGregor of BDO (London) asserts having never seen in practice such a synthesized or weighted approach.

Criticism of the use of the DCF method of valuation

DCF is not the most common valuation method in practice, but it is often used for audit and transactional matters. The most commonly used method in tax is that of Comparable Companies.

Not only did Claimants base 50% of their Yukos valuation on DCF, they also used DCF to identify comparable companies, to determine whether there were any similar transactions and because all the sense checks (based for example on the market capitalization of Rosneft, the RTS Oil and Gas Index and YNG shares), done to ensure that the valuation makes sense, were based on the underlying DCF (Final Award 1719, 1720, 1721).

In Yukos, because of the lack of information, the DCF was a reconstruction of accounts using data from a variety of sources (including benchmark data) which raises issues of credibility and accuracy. Moreover, Claimants’ expert’s admitted that his DCF analysis was ‘influenced by his own “pre-determined” notions as to what would be an appropriate result’ (Final Award, 1785)

Although the Tribunal stated to have been persuaded by Respondent’s expert’s analysis that “little weight” should be given to the DCF method of valuation, the Tribunal must have taken into account DCF because it forms the basis of both the valuation of shares and the lost dividends.

– Olivier Marquais