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# Calculating The Intrinsic Value Of BAIOO Family Interactive Limited (HKG:2100)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of BAIOO Family Interactive Limited (HKG:2100) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. I will be using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for BAIOO Family Interactive

### The method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

#### 10-year free cash flow (FCF) forecast

 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 Levered FCF (CNÂ¥, Millions) CNÂ¥41.8m CNÂ¥61.7m CNÂ¥82.6m CNÂ¥102.8m CNÂ¥121.0m CNÂ¥136.7m CNÂ¥149.9m CNÂ¥161.0m CNÂ¥170.2m CNÂ¥178.1m Growth Rate Estimate Source Est @ 67.29% Est @ 47.7% Est @ 33.99% Est @ 24.4% Est @ 17.68% Est @ 12.98% Est @ 9.68% Est @ 7.38% Est @ 5.77% Est @ 4.64% Present Value (CNÂ¥, Millions) Discounted @ 7.8% CNÂ¥38.7 CNÂ¥53.1 CNÂ¥66.0 CNÂ¥76.1 CNÂ¥83.1 CNÂ¥87.1 CNÂ¥88.6 CNÂ¥88.3 CNÂ¥86.6 CNÂ¥84.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CNÂ¥751m

After calculating the present value of future cash flows in the intial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 10-year government bond rate (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.8%.

Terminal Value (TV)= FCF2029 Ã— (1 + g) Ã· (r â€“ g) = CNÂ¥178mÃ— (1 + 2.0%) Ã· 7.8%â€“ 2.0%) = CNÂ¥3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CNÂ¥3.1bÃ· ( 1 + 7.8%)10= CNÂ¥1.5b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CNÂ¥2.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK\$0.8, the company appears about fair value at a 8.4% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

### The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at BAIOO Family Interactive 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 accounts for debt. In this calculation we've used 7.8%, which is based on a levered beta of 0.973. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

### Next Steps:

Whilst important, DCF calculation shouldnâ€™t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For BAIOO Family Interactive, There are three fundamental aspects you should further examine:

1. Financial Health: Does 2100 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 2100? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every HK stock every day, so if you want to find the intrinsic value of any other stock just search here.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.