Stock Analysis

A Look At The Intrinsic Value Of Cogent Communications Holdings, Inc. (NASDAQ:CCOI)

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NasdaqGS:CCOI
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Does the March share price for Cogent Communications Holdings, Inc. (NASDAQ:CCOI) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Cogent Communications Holdings

The calculation

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 begin with, we have to get estimates of 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$108.3m US$118.0m US$106.5m US$117.7m US$136.1m US$142.1m US$147.4m US$152.2m US$156.5m US$160.6m
Growth Rate Estimate Source Analyst x8 Analyst x8 Analyst x3 Analyst x1 Analyst x1 Est @ 4.44% Est @ 3.72% Est @ 3.22% Est @ 2.86% Est @ 2.62%
Present Value ($, Millions) Discounted @ 6.2% US$102 US$105 US$88.9 US$92.5 US$101 US$98.9 US$96.6 US$93.9 US$90.9 US$87.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$956m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.2%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$161m× (1 + 2.0%) ÷ (6.2%– 2.0%) = US$3.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.9b÷ ( 1 + 6.2%)10= US$2.1b

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$3.1b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$63.7, the company appears about fair value at a 4.9% 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.

dcf
NasdaqGS:CCOI Discounted Cash Flow March 25th 2021

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Cogent Communications 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 6.2%, which is based on a levered beta of 0.800. 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.

Moving On:

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. DCF models are not the be-all and end-all of investment valuation. 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. For Cogent Communications Holdings, we've put together three fundamental factors you should explore:

  1. Risks: For example, we've discovered 5 warning signs for Cogent Communications Holdings (3 are concerning!) that you should be aware of before investing here.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CCOI'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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About NasdaqGS:CCOI

Cogent Communications Holdings

Cogent Communications Holdings, Inc., through its subsidiaries, provides high-speed Internet access, private network, and data center colocation space services in North America, Europe, Asia, South America, Australia, and Africa.

Moderate growth potential second-rate dividend payer.