Key Insights
- AudioCodes’ estimated fair value is US$19.03 based on 2 Stage Free Cash Flow to Equity
- Current share price of US$11.31 suggests AudioCodes is potentially 41% undervalued
- Our fair value estimate is 12% lower than AudioCodes’ analyst price target of US$21.60
Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of AudioCodes Ltd. (NASDAQ:AUDC) as an investment opportunity by projecting its future cash flows and then discounting them to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. There’s really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
See our latest analysis for AudioCodes
The Model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) estimate
| 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
| Levered FCF ($, Millions) | US$40.8m | US$43.0m | US$44.7m | US$46.2m | US$47.6m | US$48.9m | US$50.2m | US$51.4m | US$52.6m | US$53.7m |
| Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Est @ 4.00% | Est @ 3.42% | Est @ 3.01% | Est @ 2.73% | Est @ 2.53% | Est @ 2.39% | Est @ 2.30% | Est @ 2.23% |
| Present Value ($, Millions) Discounted @ 9.4% | US$37.3 | US$35.9 | US$34.2 | US$32.3 | US$30.4 | US$28.6 | US$26.8 | US$25.1 | US$23.5 | US$21.9 |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$296m
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 2.1%. We discount the terminal cash flows to today’s value at a cost of equity of 9.4%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$54m× (1 + 2.1%) ÷ (9.4%– 2.1%) = US$750m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$750m÷ ( 1 + 9.4%)10= US$306m
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$602m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$11.3, the company appears quite undervalued at a 41% 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.
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 AudioCodes 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 9.4%, which is based on a levered beta of 1.021. 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 AudioCodes
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Communications market.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Dividends are not covered by cash flow.
- Annual earnings are forecast to grow slower than the American market.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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. For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For AudioCodes, we’ve compiled three pertinent aspects you should explore:
- Risks: Every company has them, and we’ve spotted 1 warning sign for AudioCodes you should know about.
- Future Earnings: How does AUDC’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 NASDAQGS every day. If you want to find the calculation for other stocks just search here.
Valuation is complex, but we’re helping make it simple.
Find out whether AudioCodes is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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.
