Key Insights
- The projected fair value for MeridianLink is US$34.60 based on 2 Stage Free Cash Flow to Equity
- MeridianLink's US$21.37 share price signals that it might be 38% undervalued
- The US$22.17 analyst price target for MLNK is 36% less than our estimate of fair value
Does the October share price for MeridianLink, Inc. (NYSE:MLNK) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
The Calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
| 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
| Levered FCF ($, Millions) | US$83.0m | US$100.0m | US$112.4m | US$123.0m | US$132.0m | US$139.8m | US$146.6m | US$152.7m | US$158.3m | US$163.6m |
| Growth Rate Estimate Source | Analyst x3 | Analyst x1 | Est @ 12.39% | Est @ 9.42% | Est @ 7.35% | Est @ 5.89% | Est @ 4.88% | Est @ 4.16% | Est @ 3.66% | Est @ 3.31% |
| Present Value ($, Millions) Discounted @ 7.3% | US$77.4 | US$86.9 | US$91.0 | US$92.8 | US$92.8 | US$91.6 | US$89.5 | US$86.9 | US$84.0 | US$80.8 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$874m
The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$164m× (1 + 2.5%) ÷ (7.3%– 2.5%) = US$3.5b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.5b÷ ( 1 + 7.3%)10= US$1.7b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$2.6b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$21.4, the company appears quite good value at a 38% discount to where the stock price trades currently. 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.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 MeridianLink 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 7.3%, which is based on a levered beta of 1.165. 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 MeridianLink
- No major strengths identified for MLNK.
- Interest payments on debt are not well covered.
- 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 MLNK insiders been buying lately?
- Debt is not well covered by operating cash flow.
- Not expected to become profitable over the next 3 years.
- Is MLNK well equipped to handle threats?
Looking Ahead:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For MeridianLink, there are three additional aspects you should explore:
- Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with MeridianLink , and understanding them should be part of your investment process.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for MLNK's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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 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.
