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Hello vo2macs,
Jan 03 01:11 am
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All Comments by Gino Verza »ClickSoftware Technologies: Smallcap Value Investment [View article]
Thank you for the message.
The growth rate (g) in the PV formula is the growth rate in free cash flow (FCF). The computations cover different assumptions in g and in WACC. This model focuses on FCF. It does not address accrual earnings.
PV is the value of perpetual stream of FCF growing at g and discounted by (WACC – g). Both, g and WACC, apply in perpetuity.
It could be argued that g should be higher than 8% in view of the historical rapid growth in revenues. This argument is supported by the recent reselling agreement with SAP and the likelihood of continuing (or accelerating) rapid revenue growth.
An opposing view would say that in real life rapid revenue growth does not happen either in a straight line or in perpetuity, and that revenue growth does not always result in increased FCF. In fact, revenue growth connotes investments in Operating Fixed Assets, which drain FCF.
One could also argue that WACC should be lower than 10%, given the cash surplus in CKSW’s balance sheet and low beta. Again, arguments can also be made in opposition to this view.
A more optimistic scenario than the three quantified in the article would represent a fourth alternative ---Compute the PV based on $3.2 million FCF, 9% growth, and 10% WACC (and other inputs remaining unchanged). This results in $13.09, stock value.
The set of four alternatives provides a context to consider the attractiveness of CKSW as an investment relative to the market price of the stock. The current stock price ($1.99) would entail a set of assumptions (accepted by the market) that are at the pessimistic end of our four alternatives. If we believe that the market assumptions (and stock price) are too pessimistic, then there is a basis for an investment decision.
Importantly, the article discussed the reasonable level of risk inherent in CKSW’s business model. Implicit in such view is durability and staying power. Both, value and risk are important in the evaluation.
Best wishes in 2009.
Disclosure: I hold a long position in CKSW
Gino Verza