Value investors who look exclusively at earnings multiples all too often lose sight of the fundamentals. In some occasions, companies merit high multiples due to solid growth potential. Even after factoring in aggressive risk discounting, Sirius XM (SIRI) is trading well below intrinsic value given its impressive momentum. In this article, I will run you through my DCF model and then triangulate the result against other media businesses, Netflix (NFLX) and Comcast (CMCSA).
First, let's begin with an assumption about the top-line. Sirius finished FY2011 with $3B in revenue, which represented a 7% gain off of the preceding year. I model 19.8% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold trending from 36.5% to 34% of revenue versus SG&A and R&D hovering at 30% and 9.5%, respectively. Capex is held constant at 8% of revenue. Taxes are estimated at between 7% - 12% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around 3% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $4.46, implying that the stock will double. The market seems to be factoring in an absurd WACC of 15%. None of this would be apparent if you only looked at the earnings multiple.
But, it gets better. You probably thought I assumed too high of a per annum growth rate at 19.8%. So, let's knock that figure down to 5%. Even with that egregiously low growth (more reasonable for a very mature firm like Wal-Mart) and a discount rate of 10%, the stock is only 11.5% above its justified level. Accordingly, I am not playing with growth and discount rates when I say that Sirius has a healthy margin of safety.
All of this falls within the context of strong performance:
"[T]his strong first quarter performance has made us comfortable in raising our full year net addition guidance from 1.3 million to 1.5 million. This increased guidance will put our paid subscriber base at 23.4 million by year end, an all-time record. And yes, we continue to be conservative, but are more optimistic than we were 3 months ago. We are also on track to meet our full year 2012 revenue guidance of $3.3 billion, adjusted EBITDA guidance of $875 million and free cash flow guidance of $700 million".
This 2012 free cash flow guidance of $700M is virtually in-line with my base case model that assumes 19.8% per annum growth over six years at a WACC of 15% (I got $696M). From a PE perspective, however, Netflix and Comcast come across as cheaper. Netflix trades at a respective 24.3x and 33.2x past and forward earnings versus 18.4x and 13.6x for Comcast.
Consensus estimates for Netflix's EPS forecast that it will plummet to $0.09 in 2012 and then rise to $4.25 by 2014. Assuming a multiple of 20x and a conservative 2014 EPS of $4.21, the stock would hit $84.20 for 16.3% upside. The company has largely been a rollercoaster, rising to a high of $304.79 in mid-2011, plummeting to a low of $62.37, rising rise back up to around $130, and then return to current levels. Much of this volatility is due to the speculative nature of the stock. Some bulls see a lot of fruit in how the company can monetize its streaming business while the bears emphasize poor customer relationship and relentless competition.
Consensus estimates for Comcast's EPS forecast that it will grow by 20.9% to $1.91 in 2012 and then by 15.2% and 16.4% in the following two years. Assuming a multiple of 17x and a conservative 2013 EPS of $2.17, the stock would hit $36.89 for 24.5% upside. According to NASDAQ, the Street rates the stock near a "strong buy". Over the last six months, the stock has risen by 33.7% and is currently near its 52-week high. With impressive fundamentals, strong execution, and a 2.2% dividend yield, Comcast represents a safe play on the media sector.
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