Is There An Opportunity With The Liberty SiriusXM Group's (NASDAQ:LSXM.K) 40% Undervaluation?

In this article we are going to estimate the intrinsic value of The Liberty SiriusXM Group (NASDAQ:LSXM.K) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

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 Liberty SiriusXM Group

Is Liberty SiriusXM Group fairly valued?

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF ($, Millions)	US$1.49b	US$1.49b	US$1.50b	US$1.52b	US$1.54b	US$1.56b	US$1.59b	US$1.62b	US$1.65b	US$1.68b
Growth Rate Estimate Source	Est @ -0.59%	Est @ 0.2%	Est @ 0.75%	Est @ 1.14%	Est @ 1.41%	Est @ 1.6%	Est @ 1.73%	Est @ 1.82%	Est @ 1.89%	Est @ 1.93%
Present Value ($, Millions) Discounted @ 8.3%	US$1.4k	US$1.3k	US$1.2k	US$1.1k	US$1.0k	US$968	US$909	US$855	US$804	US$757

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

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 8.3%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = US$1.7b× (1 + 2.0%) ÷ (8.3%– 2.0%) = US$27b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$27b÷ ( 1 + 8.3%)¹⁰= US$12b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$23b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$39.9, the company appears quite undervalued at a 40% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Liberty SiriusXM 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 8.3%, which is based on a levered beta of 1.198. 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:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. Can we work out why the company is trading at a discount to intrinsic value? For Liberty SiriusXM Group, there are three important aspects you should further research:

1. Risks: Case in point, we've spotted 4 warning signs for Liberty SiriusXM Group you should be aware of, and 1 of them is potentially serious.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for LSXM.K's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 NASDAQGS 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. 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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