Stock Analysis

Is Upland Software, Inc. (NASDAQ:UPLD) Trading At A 33% Discount?

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NasdaqGM:UPLD
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Upland Software, Inc. (NASDAQ:UPLD) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 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.

Check out our latest analysis for Upland Software

The calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$34.3m US$54.5m US$70.8m US$86.1m US$99.6m US$111.2m US$120.9m US$129.0m US$135.8m US$141.6m
Growth Rate Estimate Source Analyst x2 Analyst x3 Est @ 29.98% Est @ 21.58% Est @ 15.71% Est @ 11.59% Est @ 8.71% Est @ 6.69% Est @ 5.28% Est @ 4.3%
Present Value ($, Millions) Discounted @ 7.3% US$31.9 US$47.3 US$57.3 US$65.0 US$70.1 US$72.9 US$73.8 US$73.4 US$72.0 US$70.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$633m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 7.3%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$142m× (1 + 2.0%) ÷ (7.3%– 2.0%) = US$2.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.7b÷ ( 1 + 7.3%)10= US$1.3b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$2.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$44.2, the company appears quite undervalued at a 33% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NasdaqGM:UPLD Discounted Cash Flow May 10th 2021

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 Upland Software 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 7.3%, which is based on a levered beta of 1.125. 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:

Although the valuation of a company is important, it is only one of many factors that you need to assess for 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. What is the reason for the share price sitting below the intrinsic value? For Upland Software, we've compiled three further factors you should consider:

  1. Risks: You should be aware of the 3 warning signs for Upland Software we've uncovered before considering an investment in the company.
  2. Future Earnings: How does UPLD'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 NASDAQGM every day. If you want to find the calculation for other stocks just search here.

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