Key Insights
- Using the 2 Stage Free Cash Flow to Equity, PROS Holdings fair value estimate is US$30.29
- With US$36.28 share price, PROS Holdings appears to be trading close to its estimated fair value
- The US$40.71 analyst price target for PRO is 34% more than our estimate of fair value
In this article we are going to estimate the intrinsic value of PROS Holdings, Inc. (NYSE:PRO) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for PROS Holdings
What's The Estimated Valuation?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
| 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
| Levered FCF ($, Millions) | US$16.0m | US$30.8m | US$43.5m | US$56.3m | US$68.4m | US$79.0m | US$88.1m | US$95.8m | US$102.3m | US$107.8m |
| Growth Rate Estimate Source | Analyst x5 | Analyst x2 | Est @ 41.28% | Est @ 29.54% | Est @ 21.32% | Est @ 15.57% | Est @ 11.55% | Est @ 8.73% | Est @ 6.75% | Est @ 5.37% |
| Present Value ($, Millions) Discounted @ 7.6% | US$14.9 | US$26.6 | US$34.9 | US$42.0 | US$47.4 | US$50.9 | US$52.8 | US$53.3 | US$52.9 | US$51.8 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$428m
The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$108m× (1 + 2.2%) ÷ (7.6%– 2.2%) = US$2.0b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.0b÷ ( 1 + 7.6%)10= US$972m
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. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$36.3, the company appears around fair value at the time of writing. 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.
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 PROS 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 7.6%, which is based on a levered beta of 1.089. 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 PROS Holdings
- Debt is well covered by earnings.
- Expensive based on P/S ratio and estimated fair value.
- Forecast to reduce losses next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Debt is not well covered by operating cash flow.
- Total liabilities exceed total assets, which raises the risk of financial distress.
- Not expected to become profitable over the next 3 years.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For PROS Holdings, we've put together three additional elements you should consider:
- Risks: Every company has them, and we've spotted 2 warning signs for PROS Holdings (of which 1 is potentially serious!) you should know about.
- Future Earnings: How does PRO'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:PRO
PROS Holdings
Provides software solutions that optimize the processes of selling and shopping in the digital economy in Europe, the Asia Pacific, the Middle East, Africa, and internationally.
Good value low.
