In this article, we’ll estimate the intrinsic value of Mimecast Limited (NASDAQ: MIME) by taking expected future cash flows and discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to do, although it might seem quite complex.
We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. Anyone interested in knowing a little more about intrinsic value should read the Simply Wall St analysis model.
See our latest review for Mimecast
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. In the first step, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||US $ 85.7 million||US $ 124.3 million||US $ 149.3 million||US $ 191.3 million||210.0 million US dollars||US $ 237.0 million||$ 256.9 million||US $ 273.5 million||US $ 287.5 million||US $ 299.5 million|
|Source of growth rate estimate||Analyst x11||Analyst x11||Analyst x10||Analyst x3||Analyst x2||Analyst x2||Est @ 8.38%||Est @ 6.46%||Est @ 5.12%||Est @ 4.18%|
|Present value (in millions of dollars) discounted at 7.2%||$ 79.9||108 USD||US $ 121||145 USD||US $ 148||$ 156||US $ 158||157 USD||US $ 154||US $ 149|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 1.4 billion
The second stage is also known as terminal value, this is the cash flow of the business after the first stage. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 7.2%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US $ 299 million × (1 + 2.0%) ÷ (7.2% to 2.0%) = US $ 5.9 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 5.9b (1 + 7.2%)ten= US $ 2.9 billion
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is $ 4.3 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. From the current share price of $ 53.2, the company appears to be roughly at fair value with a 19% discount from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
We would like to stress that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Mimecast as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation, we used 7.2%, which is based on a leveraged beta of 0.982. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While important, calculating DCF is just one of the many factors you need to assess for a business. The DCF model is not a perfect equity valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Mimecast, there are three relevant factors that you should research further:
- Risks: We think you should evaluate the 3 warning signs for Mimecast we reported before making an investment in the business.
- Management: Have insiders increased their shares to take advantage of market sentiment about MIME’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you might not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQGS share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St does not have any position in the mentioned stocks.
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