A Look At The Intrinsic Value Of Team17 Group plc (LON:TM17)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Team17 Group fair value estimate is UK£3.76
• Team17 Group's UK£3.45 share price indicates it is trading at similar levels as its fair value estimate
• The UK£5.76 analyst price target for TM17 is 53% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Team17 Group plc (LON:TM17) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Team17 Group

Crunching The Numbers

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 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	UK£32.4m	UK£36.1m	UK£37.4m	UK£38.4m	UK£39.2m	UK£40.0m	UK£40.6m	UK£41.2m	UK£41.8m	UK£42.4m
Growth Rate Estimate Source	Analyst x7	Analyst x7	Analyst x4	Est @ 2.63%	Est @ 2.18%	Est @ 1.87%	Est @ 1.66%	Est @ 1.50%	Est @ 1.40%	Est @ 1.32%
Present Value (£, Millions) Discounted @ 8.1%	UK£30.0	UK£30.9	UK£29.6	UK£28.1	UK£26.6	UK£25.1	UK£23.6	UK£22.1	UK£20.8	UK£19.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£256m

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 a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.2%) 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 8.1%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£42m× (1 + 1.2%) ÷ (8.1%– 1.2%) = UK£618m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£618m÷ ( 1 + 8.1%)¹⁰= UK£284m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£541m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£3.5, the company appears about fair value at a 8.2% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important 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 Team17 Group 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 8.1%, which is based on a levered beta of 0.994. 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.

SWOT Analysis for Team17 Group

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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 Team17 Group, there are three essential aspects you should further examine:

1. Risks: We feel that you should assess the 1 warning sign for Team17 Group we've flagged before making an investment in the company.
2. Future Earnings: How does TM17'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM every day. If you want to find the calculation for other stocks just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.