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- NasdaqGS:LNW
An Intrinsic Calculation For Light & Wonder, Inc. (NASDAQ:LNW) Suggests It's 30% Undervalued
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Light & Wonder fair value estimate is US$143
- Light & Wonder is estimated to be 30% undervalued based on current share price of US$101
- Our fair value estimate is 25% higher than Light & Wonder's analyst price target of US$115
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Light & Wonder, Inc. (NASDAQ:LNW) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for Light & Wonder
What's The Estimated Valuation?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$526.8m | US$645.4m | US$739.4m | US$808.1m | US$862.9m | US$905.2m | US$942.5m | US$976.2m | US$1.01b | US$1.04b |
Growth Rate Estimate Source | Analyst x8 | Analyst x8 | Analyst x3 | Analyst x2 | Analyst x2 | Est @ 4.91% | Est @ 4.12% | Est @ 3.57% | Est @ 3.19% | Est @ 2.92% |
Present Value ($, Millions) Discounted @ 8.5% | US$486 | US$548 | US$579 | US$583 | US$574 | US$555 | US$533 | US$509 | US$484 | US$459 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$5.3b
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 (2.3%) 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 8.5%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$1.0b× (1 + 2.3%) ÷ (8.5%– 2.3%) = US$17b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$17b÷ ( 1 + 8.5%)10= US$7.6b
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 US$13b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$101, the company appears a touch undervalued at a 30% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
The Assumptions
Now 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 Light & Wonder 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 8.5%, which is based on a levered beta of 1.347. 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 Light & Wonder
- No major strengths identified for LNW.
- Interest payments on debt are not well covered.
- Annual earnings are forecast to grow faster than the American market.
- Trading below our estimate of fair value by more than 20%.
- Debt is not well covered by operating cash flow.
- Annual revenue is forecast to grow slower than the American market.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Light & Wonder, we've compiled three additional items you should explore:
- Risks: Every company has them, and we've spotted 2 warning signs for Light & Wonder (of which 1 makes us a bit uncomfortable!) you should know about.
- Future Earnings: How does LNW'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: 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 NASDAQGS every day. If you want to find the calculation for other stocks just search here.
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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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 NasdaqGS:LNW
Light & Wonder
Operates as a cross-platform games company in the United States and internationally.
Proven track record with moderate growth potential.