A Look At The Fair Value Of Freelancer Limited (ASX:FLN)

Simply Wall St

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Freelancer Limited (ASX:FLN) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. This is done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Freelancer

Crunching the numbers

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, 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

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
Levered FCF (A$, Millions) AU$2.59m AU$3.83m AU$5.12m AU$6.35m AU$7.43m AU$8.34m AU$9.08m AU$9.68m AU$10.2m AU$10.5m
Growth Rate Estimate Source Est @ 67.64% Est @ 47.67% Est @ 33.69% Est @ 23.91% Est @ 17.06% Est @ 12.27% Est @ 8.91% Est @ 6.56% Est @ 4.92% Est @ 3.77%
Present Value (A$, Millions) Discounted @ 6.0% AU$2.4 AU$3.4 AU$4.3 AU$5.0 AU$5.5 AU$5.9 AU$6.0 AU$6.1 AU$6.0 AU$5.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$50m

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 10-year government bond rate of 1.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.0%.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = AU$11m× (1 + 1.1%) ÷ 6.0%– 1.1%) = AU$215m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$215m÷ ( 1 + 6.0%)10= AU$119m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$169m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$0.3, the company appears about fair value at a 17% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

ASX:FLN Intrinsic value April 5th 2020

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 Freelancer 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 6.0%, which is based on a levered beta of 0.913. 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.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching 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?" 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 Freelancer, We've compiled three fundamental factors you should further examine:

  1. Risks: Be aware that Freelancer is showing 3 warning signs in our investment analysis , you should know about...
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for FLN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks just search here.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.