Stock Analysis

Calculating The Intrinsic Value Of Tencent Music Entertainment Group (NYSE:TME)

NYSE:TME
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Key Insights

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Tencent Music Entertainment Group (NYSE:TME) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

See our latest analysis for Tencent Music Entertainment Group

The Model

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.

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) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF (CN¥, Millions) CN¥6.51b CN¥8.03b CN¥9.59b CN¥11.1b CN¥11.4b CN¥11.8b CN¥12.1b CN¥12.4b CN¥12.7b CN¥13.0b
Growth Rate Estimate Source Analyst x7 Analyst x7 Analyst x6 Analyst x3 Analyst x2 Est @ 2.88% Est @ 2.73% Est @ 2.62% Est @ 2.55% Est @ 2.50%
Present Value (CN¥, Millions) Discounted @ 8.4% CN¥6.0k CN¥6.8k CN¥7.5k CN¥8.0k CN¥7.6k CN¥7.2k CN¥6.9k CN¥6.5k CN¥6.1k CN¥5.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥69b

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 (2.4%) 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 8.4%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥13b× (1 + 2.4%) ÷ (8.4%– 2.4%) = CN¥221b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥221b÷ ( 1 + 8.4%)10= CN¥98b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥167b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$14.5, the company appears about fair value at a 1.9% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
NYSE:TME Discounted Cash Flow May 24th 2024

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Tencent Music Entertainment 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 8.4%, which is based on a levered beta of 1.074. 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 Tencent Music Entertainment Group

Strength
  • Earnings growth over the past year exceeded its 5-year average.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings growth over the past year underperformed the Entertainment industry.
  • Dividend is low compared to the top 25% of dividend payers in the Entertainment market.
Opportunity
  • Annual earnings are forecast to grow faster than the American market.
  • Current share price is below our estimate of fair value.
Threat
  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

Whilst important, the DCF calculation 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Tencent Music Entertainment Group, there are three relevant elements you should further examine:

  1. Financial Health: Does TME 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.
  2. Future Earnings: How does TME'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 NYSE 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.