Atlassian Corporation's (NASDAQ:TEAM) Intrinsic Value Is Potentially 45% Above Its Share Price

Key Insights

• Atlassian's estimated fair value is US$280 based on 2 Stage Free Cash Flow to Equity
• Atlassian is estimated to be 31% undervalued based on current share price of US$193
• The US$259 analyst price target for TEAM is 7.2% less than our estimate of fair value

How far off is Atlassian Corporation ( NASDAQ:TEAM ) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. This will be done using 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 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Atlassian

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 start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$1.06b	US$1.35b	US$1.80b	US$2.17b	US$2.85b	US$3.34b	US$3.77b	US$4.14b	US$4.45b	US$4.71b
Growth Rate Estimate Source	Analyst x17	Analyst x17	Analyst x11	Analyst x3	Analyst x2	Est @ 17.38%	Est @ 12.85%	Est @ 9.68%	Est @ 7.47%	Est @ 5.91%
Present Value ($, Millions) Discounted @ 6.9%	US$992	US$1.2k	US$1.5k	US$1.7k	US$2.0k	US$2.2k	US$2.4k	US$2.4k	US$2.4k	US$2.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$19b

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.

Terminal Value (TV) = FCF ₂₀₃₃ × (1 + g) ÷ (r – g) = US$4.7b× (1 + 2.3%) ÷ (6.9%– 2.3%) = US$104b

Present Value of Terminal Value (PVTV) = TV / (1 + r) ¹⁰ = US$104b÷ ( 1 + 6.9%) ¹⁰ = US$53b

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$73b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$193, the company appears quite undervalued at a 31% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Atlassian 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 6.9%, which is based on a levered beta of 1.006. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a discount to intrinsic value? For Atlassian, we've compiled three fundamental elements you should further examine:

1. Risks : Case in point, we've spotted 1 warning sign for Atlassian you should be aware of.
2. Future Earnings : How does TEAM'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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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.