Stock Analysis

Does This Valuation Of LivePerson, Inc. (NASDAQ:LPSN) Imply Investors Are Overpaying?

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NasdaqGS:LPSN
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In this article we are going to estimate the intrinsic value of LivePerson, Inc. (NASDAQ:LPSN) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for LivePerson

Is LivePerson fairly valued?

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, 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$175.7k US$23.1m US$44.6m US$74.0m US$108.6m US$144.8m US$179.5m US$210.7m US$237.7m US$260.4m
Growth Rate Estimate Source Analyst x6 Analyst x5 Est @ 93.32% Est @ 65.93% Est @ 46.76% Est @ 33.35% Est @ 23.96% Est @ 17.38% Est @ 12.78% Est @ 9.56%
Present Value ($, Millions) Discounted @ 7.2% US$0.2 US$20.1 US$36.2 US$56.0 US$76.6 US$95.3 US$110 US$121 US$127 US$130

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$771m

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 7.2%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$260m× (1 + 2.0%) ÷ (7.2%– 2.0%) = US$5.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.1b÷ ( 1 + 7.2%)10= US$2.5b

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$3.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$63.5, the company appears slightly overvalued at the time of writing. 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
NasdaqGS:LPSN Discounted Cash Flow December 21st 2020

Important 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 LivePerson 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 7.2%, which is based on a levered beta of 0.992. 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:

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. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a premium to intrinsic value? For LivePerson, we've compiled three essential factors you should consider:

  1. Risks: To that end, you should be aware of the 3 warning signs we've spotted with LivePerson .
  2. Future Earnings: How does LPSN'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 NASDAQGS every day. If you want to find the calculation for other stocks just search here.

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