Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Lions Gate Entertainment fair value estimate is US$15.75
- Lions Gate Entertainment's US$8.34 share price signals that it might be 47% undervalued
- Our fair value estimate is 51% higher than Lions Gate Entertainment's analyst price target of US$10.42
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Lions Gate Entertainment Corp. (NYSE:LGF.A) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Is Lions Gate Entertainment Fairly Valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
| 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
| Levered FCF ($, Millions) | US$37.4m | US$278.4m | US$312.0m | US$337.4m | US$359.2m | US$378.3m | US$395.4m | US$411.0m | US$425.6m | US$439.5m |
| Growth Rate Estimate Source | Analyst x5 | Analyst x5 | Analyst x3 | Est @ 8.13% | Est @ 6.47% | Est @ 5.32% | Est @ 4.51% | Est @ 3.94% | Est @ 3.55% | Est @ 3.27% |
| Present Value ($, Millions) Discounted @ 11% | US$33.7 | US$227 | US$229 | US$223 | US$215 | US$204 | US$192 | US$180 | US$168 | US$157 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.8b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.6%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 11%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$439m× (1 + 2.6%) ÷ (11%– 2.6%) = US$5.5b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.5b÷ ( 1 + 11%)10= US$2.0b
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$3.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$8.3, the company appears quite good value at a 47% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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. 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 Lions Gate Entertainment 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 11%, which is based on a levered beta of 2.000. 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 Lions Gate Entertainment
- Debt is well covered by .
- Balance sheet summary for LGF.A.
- Interest payments on debt are not well covered.
- Shareholders have been diluted in the past year.
- Forecast to reduce losses next year.
- Good value based on P/S ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Has less than 3 years of cash runway based on current free 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 LGF.A well equipped to handle threats?
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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. 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. What is the reason for the share price sitting below the intrinsic value? For Lions Gate Entertainment, there are three relevant aspects you should assess:
- Risks: To that end, you should learn about the 4 warning signs we've spotted with Lions Gate Entertainment (including 1 which is concerning) .
- Future Earnings: How does LGF.A'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 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.
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.
