Is VeriSign, Inc. (NASDAQ:VRSN) Expensive For A Reason? A Look At Its Intrinsic Value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of VeriSign, Inc. (NASDAQ:VRSN) as an investment opportunity 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. There's really not all that much to it, even though it might appear quite complex.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for VeriSign

What's the estimated valuation?

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, 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

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF ($, Millions)	US$859.8m	US$942.3m	US$1.05b	US$1.17b	US$1.26b	US$1.33b	US$1.40b	US$1.45b	US$1.51b	US$1.55b
Growth Rate Estimate Source	Analyst x4	Analyst x3	Analyst x2	Analyst x2	Est @ 7.59%	Est @ 5.98%	Est @ 4.85%	Est @ 4.06%	Est @ 3.51%	Est @ 3.12%
Present Value ($, Millions) Discounted @ 8.7%	US$791	US$798	US$818	US$838	US$830	US$809	US$781	US$748	US$712	US$676

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$7.8b

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. 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 8.7%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = US$1.6b× (1 + 2.2%) ÷ (8.7%– 2.2%) = US$25b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$25b÷ ( 1 + 8.7%)¹⁰= US$11b

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$19b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$206, the company appears slightly overvalued 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.

dcf

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 VeriSign 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 8.7%, which is based on a levered beta of 1.073. 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. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For VeriSign, there are three further elements you should look at:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with VeriSign , and understanding them should be part of your investment process.

2. Future Earnings: How does VRSN'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.

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.

This article by Simply Wall St is general in nature. 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.

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