The projected fair value for PROS Holdings is US$34.78 based on 2 Stage Free Cash Flow to Equity
PROS Holdings' US$26.52 share price signals that it might be 24% undervalued
Analyst price target for PRO is US$41.86, which is 20% above our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of PROS Holdings, Inc. (NYSE:PRO) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
What's The Estimated Valuation?
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$39.7m
US$52.0m
US$63.7m
US$74.2m
US$83.3m
US$91.0m
US$97.6m
US$103.2m
US$108.1m
US$112.4m
Growth Rate Estimate Source
Analyst x4
Est @ 31.09%
Est @ 22.48%
Est @ 16.45%
Est @ 12.23%
Est @ 9.27%
Est @ 7.21%
Est @ 5.76%
Est @ 4.74%
Est @ 4.04%
Present Value ($, Millions) Discounted @ 7.5%
US$36.9
US$45.0
US$51.3
US$55.6
US$58.1
US$59.1
US$58.9
US$58.0
US$56.5
US$54.7
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$534m
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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.3b÷ ( 1 + 7.5%)10= US$1.1b
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$1.6b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$26.5, the company appears a touch undervalued at a 24% 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.
NYSE:PRO Discounted Cash Flow July 2nd 2024
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 PROS 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 7.5%, which is based on a levered beta of 1.106. 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 PROS Holdings
Strength
No major strengths identified for PRO.
Weakness
Shareholders have been diluted in the past year.
Opportunity
Forecast to reduce losses next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Trading below our estimate of fair value by more than 20%.
Have PRO insiders been buying lately?
Threat
Debt is not well covered by operating cash flow.
Total liabilities exceed total assets, which raises the risk of financial distress.
Not expected to become profitable over the next 3 years.
Is PRO well equipped to handle threats?
Moving On:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a discount to intrinsic value? For PROS Holdings, we've put together three fundamental items you should look at:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with PROS Holdings (at least 1 which is significant) , and understanding them should be part of your investment process.
Future Earnings: How does PRO'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.
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 NYSE every day. If you want to find the calculation for other stocks just search here.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
