Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Cloudflare fair value estimate is US$97.64
- Current share price of US$82.39 suggests Cloudflare is potentially trading close to its fair value
- The US$91.92 analyst price target for NET is 5.9% less than our estimate of fair value
How far off is Cloudflare, Inc. (NYSE:NET) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
See our latest analysis for Cloudflare
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF ($, Millions) | US$237.1m | US$377.3m | US$649.3m | US$989.7m | US$1.26b | US$1.51b | US$1.74b | US$1.93b | US$2.09b | US$2.23b |
Growth Rate Estimate Source | Analyst x20 | Analyst x11 | Analyst x3 | Analyst x2 | Est @ 27.44% | Est @ 19.96% | Est @ 14.72% | Est @ 11.06% | Est @ 8.49% | Est @ 6.69% |
Present Value ($, Millions) Discounted @ 7.1% | US$221 | US$329 | US$529 | US$753 | US$896 | US$1.0k | US$1.1k | US$1.1k | US$1.1k | US$1.1k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.2b
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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$2.2b× (1 + 2.5%) ÷ (7.1%– 2.5%) = US$50b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$50b÷ ( 1 + 7.1%)10= US$25b
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$33b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$82.4, the company appears about fair value at a 16% discount to where the stock price trades currently. 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.
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 Cloudflare 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 1.112. 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.
SWOT Analysis for Cloudflare
- Debt is not viewed as a risk.
- Shareholders have been diluted in the past year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Current share price is below our estimate of fair value.
- Not expected to become profitable over the next 3 years.
Looking Ahead:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For Cloudflare, we've put together three further aspects you should further examine:
- Risks: To that end, you should be aware of the 3 warning signs we've spotted with Cloudflare .
- Future Earnings: How does NET'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.
- 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.
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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About NYSE:NET
Cloudflare
Operates as a cloud services provider that delivers a range of services to businesses worldwide.
Excellent balance sheet with moderate growth potential.