Zix Corporation (NASDAQ: ZIXI) Shares May Be 36% Below Their Embedded Value Estimate
Today we are going to review a valuation method used to estimate the attractiveness of Zix Corporation (NASDAQ: ZIXI) as an investment opportunity by estimating the company’s future cash flows and determining them. discounting to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it’s not too hard to follow, as you will see in our example!
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
The calculation
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF ($, Millions) | US $ 28.7 million | US $ 32.0 million | US $ 34.9 million | US $ 37.3 million | US $ 39.3 million | US $ 41.0 million | US $ 42.5 million | US $ 43.8 million | US $ 45.0 million | US $ 46.2 million |
Source of growth rate estimate | Analyst x2 | Est @ 11.85% | Est @ 8.89% | Est @ 6.82% | East @ 5.37% | Est @ 4.36% | East @ 3.65% | Is @ 3.15% | Is 2.8% | Is 2.56% |
Present value (in millions of dollars) discounted at 7.7% | US $ 26.6 | US $ 27.6 | US $ 27.9 | US $ 27.7 | US $ 27.1 | US $ 26.2 | US $ 25.2 | US $ 24.2 | US $ 23.1 | $ 22.0 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 257 million
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 7.7%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = US $ 46 million × (1 + 2.0%) ÷ (7.7% to 2.0%) = US $ 823 million
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 823 million ÷ (1 + 7.7%)^{ten}= US $ 391 million
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is $ 648 million. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 7.4, the company appears to be quite undervalued with a 36% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
NasdaqGS: ZIXI Discounted Cash Flow September 16, 2021
Important assumptions
We draw your attention to the fact 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 entries, I recommend that you redo the calculations yourself and play with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Zix 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 takes into account debt. In this calculation, we used 7.7%, which is based on a leveraged beta of 1.213. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Looking forward:
While a business valuation is important, ideally it won’t be the only analysis you review for a business. The DCF model is not a perfect equity valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. What is the reason why the stock price is below intrinsic value? For Zix, we’ve compiled three additional factors to consider:
- Risks: You should be aware of the 1 warning sign for Zix we found out before considering an investment in the business.
- Future benefits: How does ZIXI’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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