Stock Analysis

Are A10 Networks, Inc. (NYSE:ATEN) Investors Paying Above The Intrinsic Value?

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NYSE:ATEN
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Today we will run through one way of estimating the intrinsic value of A10 Networks, Inc. (NYSE:ATEN) by taking the expected future cash flows and discounting them 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.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Our analysis indicates that ATEN is potentially undervalued!

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

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$71.3m US$64.2m US$60.3m US$58.1m US$57.0m US$56.5m US$56.5m US$56.9m US$57.5m US$58.2m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -6.09% Est @ -3.67% Est @ -1.98% Est @ -0.79% Est @ 0.04% Est @ 0.62% Est @ 1.03% Est @ 1.32%
Present Value ($, Millions) Discounted @ 7.1% US$66.6 US$56.0 US$49.1 US$44.2 US$40.5 US$37.5 US$35.0 US$32.9 US$31.1 US$29.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$422m

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. 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 7.1%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$58m× (1 + 2.0%) ÷ (7.1%– 2.0%) = US$1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.2b÷ ( 1 + 7.1%)10= US$587m

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$1.0b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$17.9, the company appears potentially overvalued at the time of writing. 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
NYSE:ATEN Discounted Cash Flow November 22nd 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. 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 A10 Networks 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 7.1%, which is based on a levered beta of 0.994. 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. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. Why is the intrinsic value lower than the current share price? For A10 Networks, there are three further elements you should further examine:

  1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with A10 Networks .
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ATEN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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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