Are Investors Undervaluing Paya Holdings Inc. (NASDAQ:PAYA) By 46%?

By
Simply Wall St
Published
January 24, 2022
NasdaqCM:PAYA
Source: Shutterstock

Does the January share price for Paya Holdings Inc. (NASDAQ:PAYA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 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 Paya Holdings

The model

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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$43.9m US$55.0m US$63.3m US$70.4m US$76.3m US$81.3m US$85.4m US$89.0m US$92.1m US$94.9m
Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ 15.12% Est @ 11.18% Est @ 8.41% Est @ 6.48% Est @ 5.12% Est @ 4.17% Est @ 3.51% Est @ 3.04%
Present Value ($, Millions) Discounted @ 7.2% US$40.9 US$47.9 US$51.4 US$53.3 US$54.0 US$53.6 US$52.6 US$51.1 US$49.4 US$47.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$501m

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 (2.0%) 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)= FCF2031 × (1 + g) ÷ (r – g) = US$95m× (1 + 2.0%) ÷ (7.2%– 2.0%) = US$1.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.9b÷ ( 1 + 7.2%)10= US$927m

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$1.4b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$5.8, the company appears quite good value at a 46% 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.

dcf
NasdaqCM:PAYA Discounted Cash Flow January 24th 2022

Important 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. 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 Paya Holdings 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 1.191. 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.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Paya Holdings, we've compiled three relevant items you should explore:

  1. Risks: Every company has them, and we've spotted 2 warning signs for Paya Holdings you should know about.
  2. Future Earnings: How does PAYA'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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