Estimating The Fair Value Of Team17 Group plc (LON:TM17)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Team17 Group fair value estimate is UK£2.34

• With UK£2.50 share price, Team17 Group appears to be trading close to its estimated fair value

• Our fair value estimate is 36% lower than Team17 Group's analyst price target of UK£3.66

Today we will run through one way of estimating the intrinsic value of Team17 Group plc (LON:TM17) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. 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 Team17 Group

The Model

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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£27.6m	UK£32.2m	UK£24.0m	UK£23.0m	UK£22.5m	UK£22.2m	UK£22.1m	UK£22.1m	UK£22.3m	UK£22.5m
Growth Rate Estimate Source	Analyst x6	Analyst x5	Analyst x1	Est @ -4.08%	Est @ -2.40%	Est @ -1.22%	Est @ -0.40%	Est @ 0.18%	Est @ 0.58%	Est @ 0.86%
Present Value (£, Millions) Discounted @ 7.8%	UK£25.6	UK£27.7	UK£19.2	UK£17.0	UK£15.4	UK£14.1	UK£13.1	UK£12.1	UK£11.3	UK£10.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£166m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (1.5%) 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 7.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£22m× (1 + 1.5%) ÷ (7.8%– 1.5%) = UK£362m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£362m÷ ( 1 + 7.8%)¹⁰= UK£171m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£337m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£2.5, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The 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 Team17 Group 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 7.8%, which is based on a levered beta of 1.065. 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 Team17 Group

Strength

• Currently debt free.

Weakness

• Earnings declined over the past year.

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• Annual earnings are forecast to grow faster than the British market.

• Significant insider buying over the past 3 months.

Threat

• Annual revenue is forecast to grow slower than the British market.

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. 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. For Team17 Group, we've compiled three further elements you should further research:

1. Risks: Take risks, for example - Team17 Group has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for TM17'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM every day. If you want to find the calculation for other stocks just search here.

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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.