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An Intrinsic Calculation For Rovio Entertainment Oyj (HEL:ROVIO) Suggests It’s 21% Undervalued


In this article we are going to estimate the intrinsic value of Rovio Entertainment Oyj (HEL:ROVIO) by taking the expected future cash flows and discounting them to today’s value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward.

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.

Our analysis indicates that ROVIO is potentially undervalued!

The Calculation

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. 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (€, Millions) €43.3m €42.0m €36.0m €34.5m €33.6m €33.0m €32.6m €32.4m €32.2m €32.2m
Growth Rate Estimate Source Analyst x6 Analyst x4 Analyst x1 Analyst x1 Est @ -2.66% Est @ -1.78% Est @ -1.16% Est @ -0.73% Est @ -0.43% Est @ -0.21%
Present Value (€, Millions) Discounted @ 5.6% €40.9 €37.6 €30.5 €27.7 €25.5 €23.8 €22.2 €20.9 €19.7 €18.6

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €267m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.3%) 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 5.6%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = €32m× (1 + 0.3%) ÷ (5.6%– 0.3%) = €603m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €603m÷ ( 1 + 5.6%)10= €349m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €616m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €6.3, the company appears a touch undervalued at a 21% 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.

dcf
HLSE:ROVIO Discounted Cash Flow November 14th 2022

The 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 Rovio Entertainment Oyj 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 5.6%, which is based on a levered beta of 0.955. 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 Rovio Entertainment Oyj

Strength

  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness

  • Earnings growth over the past year underperformed the Entertainment industry.
  • Dividend is low compared to the top 25% of dividend payers in the Entertainment market.
  • Shareholders have been diluted in the past year.
Opportunity

  • Annual earnings are forecast to grow faster than the Finnish market.
  • Trading below our estimate of fair value by more than 20%.
Threat

  • Annual revenue is forecast to grow slower than the Finnish market.

Next Steps:

Whilst important, the DCF calculation shouldn’t be the only metric you look at when researching a company. It’s not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For Rovio Entertainment Oyj, we’ve compiled three further elements you should look at:

  1. Risks: We feel that you should assess the 1 warning sign for Rovio Entertainment Oyj we’ve flagged before making an investment in the company.
  2. Future Earnings: How does ROVIO’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.
  3. 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 HLSE 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 Rovio Entertainment Oyj 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.

View the Free Analysis

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.



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