When it comes to unprofitable companies, guidance and ARR (Annual Recurring Income) are more important to investors than surprise at a short-term profit.
UiPath Inc. (PATH.US), an automated process robotization software and development company, is no stranger to this model. After its latest results, a new low sank even though the surprise of its results was positive. This is because the stock's market price is above its current intrinsic value based on the discounted cash flow (DCF) model.
Companies can be valued in many ways, and none of them are perfect, but for a company that is not yet profitable, DCF is a good valuation method. Its latest results are as follows:
Q2 Results
- EPS: 0,01$ (exceeded by US $ 0.07)
- Normalized EPS: -0,19$ (exceeded by 0,01$)
- Revenue: 195,52$ million (surpassed by 8,8$ million)
Despite outperforming results, the market was spooked by sustained declines for the second consecutive quarter, especially in one of the most favored metrics: ARR.
In addition, the expiration of the blocking of the shares for those who attended the IPO, and the strong sale of shares of one of the main executives (insider selling) of the listed company continues to scare some investors.
However, some analysis houses estimate the target value of UiPath above 80$.
Valuation
Using the two-phase DCF model, which, as the name implies, considers two stages of growth. The first stage is generally a period of higher growth, heading towards the terminal value, captured in the second period of "constant growth".
For the first phase it is necessary to estimate the next ten years of cash flows. If possible, analysts estimates are used (as they save us a lot of time), but when they are not available, we extrapolate the previous free cash flow (FCF) from the last estimate published in the earnings report. It is assumed that companies with increasingly slow free cash flow will reduce their rate of contraction and that companies with increasing free cash flow will see their growth rate slow down during this period. This is done to reflect that growth tends to slow more in the early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so the sum of these future cash flows is discounted to the present value:
In the case of UiPath, the Present Value of the FCF from 2031 in 2021 according to the source are (PVCF) = $ 3.3 billion
Therefore, we now need to calculate the terminal value, which represents all future cash flows from the 10th year onwards. The Gordon Growth formula (Gordon-Saphiro) is used to calculate the terminal value at a future annual growth rate that is equal to the 5-year average of the 10-year government bond yield (g), which is 2.0 %. We discount terminal cash flows to present value at cost of equity (r) of 6.5% and round FCF 2031 to facilitate calculations.
- Terminal value (TV) = FCF2031 × (1 + g) ÷ (r- g) = $ 1.2 billion × (1 + 2.0%) ÷ (6.5% -2.0%) = $ 27 billion
- Present value of terminal value (PVTV) = TV ÷ (1 + r) ^ 10 = $ 27 billion ÷ (1 + 6.5%) ^ 10 = $ 14 billion
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is $ 18 billion rounding off. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Which gives us an intrinsic price per share of $ 41.75.
Relative to the current stock price of $ 51.85 (9/20/21), the company appears potentially overvalued, so the big question is: why is this stock so expensive? Note that the ratings are not perfect, as a small adjustment in the inputs can make a big difference at the end. Let's keep this in mind.
Assumptions
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. DCF does not consider the potential cyclicality of an industry or the future capital requirements of a company, so it does not provide a complete picture of its potential performance. Since we are considering UiPath as a potential, the cost of equity is used as the discount rate rather than the cost of equity (or weighted average cost of equity, WACC), which represents debt.
What will the stock do in the short term?
While a business valuation is important, it shouldn't be the only metric to consider when researching a business. The DCF model is not a perfect tool for stock valuation. Rather, it should be seen as a guide to "what assumptions must be true for this stock to be undervalued or overvalued?" For example, if the growth rate of the terminal value is adjusted slightly, it can drastically alter the overall result.
Is it the high growth potential if the company has virtually no debt?
We must mainly assess the weaknesses of UiPath to get an idea of why its price has fallen so much, even below the price of the IPO.
- It is an unprofitable company that also has no forecast of making any profit in at least 3 years.
- There have been strong insider sales by UiPath's own executives, something that investors do not like and that calls into question the alignment of interests between executives and company.
- With practically no debt, that is, leverage, it is very difficult for the company to boost its growth, especially when it does not make any profit and a good negotiation could obtain favorable financing with a low cost of debt.
Technical Analysis
Broadly speaking, the evolution of UiPath shows the overvaluation of the price in its debut on the stock market, which unleashed a strong upward momentum to 89,9$. And with the analysis discussed above, it appears that investors are looking for it to at least reach intrinsic value, which is an additional 10% drop over the current price.
This level is around 161.8% fibo of the last correction, which could help to project the target that investors are looking for, that the price reaches its fair value.
Darío García, EFA
XTB Spain
