Key Takeaways:
- The fair value estimate of Betr Entertainment Limited (ASX:BBT) is AU$0.22, indicating a potential overvaluation of 20% based on the current share price of AU$0.26.
- The analyst price target for BBT is AU$0.45, which is 106% above the estimated fair value.
- The Discounted Cash Flow (DCF) model is used to estimate the intrinsic value of the company.
- The DCF model has limitations and should be used in conjunction with other valuation metrics.
- The company’s growth rate, discount rate, and terminal value are key inputs in the DCF model.
Introduction to Discounted Cash Flow
The Discounted Cash Flow (DCF) model is a valuation technique used to estimate the intrinsic value of a company by discounting its future cash flows to their present value. This model is based on the idea that a dollar in the future is less valuable than a dollar today. The DCF model is a widely used tool in equity analysis, but it is not without its limitations. In this article, we will use the DCF model to estimate the fair value of Betr Entertainment Limited (ASX:BBT) and compare it to the current share price.
Estimating Future Cash Flows
To estimate the future cash flows of Betr Entertainment, we use a two-stage DCF model. The first stage is a higher growth period that levels off heading towards the terminal value, captured in the second ‘steady growth’ period. We estimate the next ten years of cash flows, using analyst estimates where possible, and extrapolating the previous free cash flow (FCF) from the last estimate or reported value. We assume that 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.
Calculating the Present Value of Cash Flows
The present value of the future cash flows is calculated by discounting the cash flows to today’s value using a discount rate of 8.2%. The discount rate is based on a levered beta of 1.164, which is a measure of the stock’s volatility compared to the market as a whole. The present value of the 10-year cash flow (PVCF) is estimated to be AU$82m.
Terminal Value and Equity Value
The second stage of the DCF model is the terminal value, which is the business’s cash flow after the first stage. We use a conservative growth rate of 3.3%, which is the 5-year average of the 10-year government bond yield. The terminal value is estimated to be AU$316m, and the present value of the terminal value (PVTV) is estimated to be AU$144m. The total value, or equity value, is the sum of the present value of the future cash flows, which is AU$226m.
Comparison to Current Share Price
The estimated fair value of Betr Entertainment is AU$0.22, which is lower than the current share price of AU$0.26. This indicates that the company may be overvalued by 20%. However, it is essential to note that the DCF model has limitations and should be used in conjunction with other valuation metrics. The analyst price target for BBT is AU$0.45, which is 106% above the estimated fair value.
Limitations of the DCF Model
The DCF model is not a perfect stock valuation tool, and it has several limitations. The model 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. The assumptions used in the calculation, such as the discount rate and growth rate, can significantly impact the valuation. Therefore, it is essential to view the estimated fair value as a rough estimate, not precise down to the last cent.
Conclusion
In conclusion, the DCF model estimates the fair value of Betr Entertainment Limited (ASX:BBT) to be AU$0.22, indicating a potential overvaluation of 20% based on the current share price of AU$0.26. However, it is essential to consider the limitations of the DCF model and use it in conjunction with other valuation metrics. The company’s growth rate, discount rate, and terminal value are key inputs in the DCF model, and small changes to these assumptions can significantly impact the valuation. As with any investment, it is crucial to do your own research and consider multiple factors before making a decision.
