In this article we are going to estimate the intrinsic value of Tencent Music Entertainment Group (NYSE:TME) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. 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.
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 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (CN¥, Millions)
CN¥8.43b
CN¥9.52b
CN¥12.5b
CN¥14.1b
CN¥15.2b
CN¥16.2b
CN¥17.1b
CN¥17.9b
CN¥18.6b
CN¥19.2b
Growth Rate Estimate Source
Analyst x5
Analyst x5
Analyst x1
Analyst x1
Est @ 8.34%
Est @ 6.59%
Est @ 5.36%
Est @ 4.50%
Est @ 3.90%
Est @ 3.48%
Present Value (CN¥, Millions) Discounted @ 8.0%
CN¥7.8k
CN¥8.2k
CN¥9.9k
CN¥10.3k
CN¥10.4k
CN¥10.2k
CN¥10.0k
CN¥9.7k
CN¥9.3k
CN¥8.9k
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CN¥95b
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 (2.5%) 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 8.0%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥359b÷ ( 1 + 8.0%)10= CN¥166b
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 CN¥261b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$13.5, the company appears quite undervalued at a 42% 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.
NYSE:TME Discounted Cash Flow October 7th 2024
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Tencent Music Entertainment Group 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 8.0%, which is based on a levered beta of 1.104. 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 Tencent Music Entertainment Group
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Entertainment market.
Opportunity
Annual revenue is forecast to grow faster than the American market.
Trading below our estimate of fair value by more than 20%.
Threat
Annual earnings are forecast to grow slower than the American market.
Moving On:
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. 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 Tencent Music Entertainment Group, there are three additional elements you should further examine:
Future Earnings: How does TME'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.
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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.
