Is There An Opportunity With Ten Square Games S.A.'s (WSE:TEN) 29% Undervaluation?

Today we will run through one way of estimating the intrinsic value of Ten Square Games S.A. (WSE:TEN) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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 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.

Check out the opportunities and risks within the PL Entertainment industry.

The Method

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 start off with, we need to estimate 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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (PLN, Millions)	zł80.3m	zł84.5m	zł71.3m	zł74.0m	zł72.5m	zł72.0m	zł72.3m	zł73.1m	zł74.3m	zł75.8m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Analyst x2	Est @ -2.05%	Est @ -0.6%	Est @ 0.41%	Est @ 1.12%	Est @ 1.62%	Est @ 1.97%
Present Value (PLN, Millions) Discounted @ 8.6%	zł73.9	zł71.6	zł55.6	zł53.2	zł47.9	zł43.9	zł40.5	zł37.7	zł35.3	zł33.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł492m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.6%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = zł76m× (1 + 2.8%) ÷ (8.6%– 2.8%) = zł1.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł1.3b÷ ( 1 + 8.6%)¹⁰= zł583m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł1.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of zł105, the company appears a touch undervalued at a 29% 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.

The 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Ten Square Games 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 8.6%, which is based on a levered beta of 0.952. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For Ten Square Games, we've compiled three pertinent factors you should consider:

1. Risks: Take risks, for example - Ten Square Games has 2 warning signs we think you should be aware of.
2. Future Earnings: How does TEN'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the WSE 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.