Key Insights
- Cloud Music's estimated fair value is HK$96.38 based on 2 Stage Free Cash Flow to Equity
- Current share price of HK$95.10 suggests Cloud Music is potentially trading close to its fair value
- The CN¥116 analyst price target for 9899 is 20% more than our estimate of fair value
Today we will run through one way of estimating the intrinsic value of Cloud Music Inc. (HKG:9899) by taking the forecast future cash flows of the company and discounting them back to today's 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!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Cloud Music
The Calculation
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 discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (CN¥, Millions) | CN¥725.3m | CN¥1.12b | CN¥1.30b | CN¥1.24b | CN¥1.26b | CN¥1.28b | CN¥1.31b | CN¥1.33b | CN¥1.36b | CN¥1.38b |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Analyst x3 | Analyst x1 | Analyst x1 | Est @ 1.69% | Est @ 1.80% | Est @ 1.87% | Est @ 1.92% | Est @ 1.96% |
Present Value (CN¥, Millions) Discounted @ 7.9% | CN¥672 | CN¥958 | CN¥1.0k | CN¥914 | CN¥861 | CN¥811 | CN¥765 | CN¥722 | CN¥681 | CN¥644 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥8.1b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (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 7.9%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥1.4b× (1 + 2.0%) ÷ (7.9%– 2.0%) = CN¥24b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥24b÷ ( 1 + 7.9%)10= CN¥11b
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 CN¥19b. 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$95.1, the company appears about fair value at a 1.3% 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
We would point out that 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 Cloud Music 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 7.9%, which is based on a levered beta of 1.050. 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 Cloud Music
- Currently debt free.
- No major weaknesses identified for 9899.
- Annual earnings are forecast to grow faster than the Hong Kong market.
- Current share price is below our estimate of fair value.
- Revenue is forecast to grow slower than 20% per year.
Next Steps:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Cloud Music, there are three important factors you should look at:
- Financial Health: Does 9899 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 9899'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 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 Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.
Valuation is complex, but we're here to simplify it.
Discover if NetEase Cloud Music might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
About SEHK:9899
NetEase Cloud Music
An investment holding company, engages in the operation of online platforms to provide music and social entertainment services in the People’s Republic of China.
Flawless balance sheet with solid track record.