Estimating The Intrinsic Value Of Frontier Digital Ventures Limited (ASX:FDV)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Frontier Digital Ventures Limited (ASX:FDV) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Frontier Digital Ventures

Crunching the numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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, 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

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (A$, Millions)	-AU$2.60m	AU$2.70m	AU$8.40m	AU$14.0m	AU$20.6m	AU$27.6m	AU$34.3m	AU$40.3m	AU$45.5m	AU$49.9m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 66.78%	Est @ 47.35%	Est @ 33.75%	Est @ 24.23%	Est @ 17.56%	Est @ 12.9%	Est @ 9.63%
Present Value (A$, Millions) Discounted @ 9.4%	-AU$2.4	AU$2.3	AU$6.4	AU$9.8	AU$13.2	AU$16.1	AU$18.3	AU$19.7	AU$20.3	AU$20.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$124m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate 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 today's value at a cost of equity of 9.4%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = AU$50m× (1 + 2.0%) ÷ (9.4%– 2.0%) = AU$691m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$691m÷ ( 1 + 9.4%)¹⁰= AU$282m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$406m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$1.4, the company appears around fair value at the time of writing. 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Frontier Digital Ventures 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 9.4%, which is based on a levered beta of 1.054. 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.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Frontier Digital Ventures, we've compiled three additional aspects you should look at:

1. Risks: We feel that you should assess the 4 warning signs for Frontier Digital Ventures (2 are significant!) we've flagged before making an investment in the company.
2. Future Earnings: How does FDV'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.
3. Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!

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

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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