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Is There An Opportunity With Take-Two Interactive Software, Inc.'s (NASDAQ:TTWO) 38% Undervaluation?

Key Insights

  • Take-Two Interactive Software's estimated fair value is US$224 based on 2 Stage Free Cash Flow to Equity

  • Take-Two Interactive Software's US$138 share price signals that it might be 38% undervalued

  • Analyst price target for TTWO is US$157 which is 30% below our fair value estimate

In this article we are going to estimate the intrinsic value of Take-Two Interactive Software, Inc. (NASDAQ:TTWO) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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View our latest analysis for Take-Two Interactive Software

What's The Estimated Valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$89.5m

US$1.04b

US$1.41b

US$1.49b

US$1.88b

US$2.12b

US$2.33b

US$2.51b

US$2.66b

US$2.78b

Growth Rate Estimate Source

Analyst x10

Analyst x10

Analyst x8

Analyst x2

Analyst x1

Est @ 13.18%

Est @ 9.87%

Est @ 7.55%

Est @ 5.93%

Est @ 4.80%

Present Value ($, Millions) Discounted @ 7.4%

US$83.3

US$898

US$1.1k

US$1.1k

US$1.3k

US$1.4k

US$1.4k

US$1.4k

US$1.4k

US$1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$12b

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 (2.2%) 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 7.4%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$2.8b× (1 + 2.2%) ÷ (7.4%– 2.2%) = US$54b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$54b÷ ( 1 + 7.4%)10= US$27b

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$38b. 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$138, the company appears quite undervalued at a 38% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Take-Two Interactive Software 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 7.4%, which is based on a levered beta of 1.049. 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 Take-Two Interactive Software

Strength

  • Debt is well covered by earnings.

Weakness

  • No major weaknesses identified for TTWO.

Opportunity

  • Forecast to reduce losses next year.

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

  • Trading below our estimate of fair value by more than 20%.

Threat

  • Debt is not well covered by operating cash flow.

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. Can we work out why the company is trading at a discount to intrinsic value? For Take-Two Interactive Software, we've put together three further factors you should consider:

  1. Financial Health: Does TTWO have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

  2. Future Earnings: How does TTWO'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. 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.