In this article I am going to calculate the intrinsic value of VeriFone Systems Inc (NYSE:PAY) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will be using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for VeriFone Systems by following the link below. View out our latest analysis for VeriFone Systems
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To begin with we have to get estimates of the next five years of cash flows. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF ($, Millions)||$157.52||$177.46||$167.80||$170.54||$173.32|
|Source||Analyst x6||Analyst x6||Analyst x1||Extrapolated @ (1.63%)||Extrapolated @ (1.63%)|
|Present Value Discounted @ 10.67%||$142.34||$144.89||$123.80||$113.68||$104.40|
Present Value of 5-year Cash Flow (PVCF)= US$629.11m
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 10.7%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$173.32m × (1 + 2.9%) ÷ (10.7% – 2.9%) = US$2.31b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$2.31b ÷ ( 1 + 10.7%)5 = US$1.39b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$2.02b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $18.25. Relative to the current share price of $22.81, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at VeriFone Systems as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.7%, which is based on a levered beta of 1.095. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For PAY, there are three key aspects you should look at:
- Financial Health: Does PAY 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.
- Future Earnings: How does PAY’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of PAY? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.