I've decided to dig a little deeper on the free cash flow to firm calculation. For this post I focus only on the last 2 years which is post ifrs-16. For 2020 and 2019 we have adjusted ebitda of $41,476 and $20,056 and operating income of $11,237 and $-5,314 respectively. When calculating the free cash flow to firm it is important to take into consideration the after tax operating income of the entity. The effective tax rate for 2020 and 2019 is ~ 25% and 26% but I will just keep it simple at 25%
after tax operating income :
2020: 11237(1-tax rate) = 11237*(1-0.25) = $8427.75
2019: -5314(*(1- tax rate) = -5314*(1-0.25) = $-3985.5
The net capital expenditures for owned assets includes both tangible and intangible assets. For net capital expenditures I look at the difference between capital expenditures and the cash proceeds received from assets sold. In addition to this we need to look at capital expenditures from leased assets as well as this is part of the firm.
capex from owned assets:
2020: $835
2019: $4,614
capex from leased assets:
2020: $846
2019: $8,367
The free cash flow to firm (fcff) is
Adjusted ebitda - operating income* tax rate - capex from owned and leased assets
2020 ffcf = $38,666.75 - $834 - $846 = $36,985.75
2019 ffcf= $ 21,384.5 - $4,614 - $8,367 = $8,403.5
For the last 2 years we have arrived at a free cash flow to the firm of approximately $ 37 million and $ 8.4 million. If we use a blended average of the last 2 years we get free cash flow of $22.7 million. In order to complete this exercise it is important to look at the weighted average cost of capital (wacc). In general, wacc is typically lower than cost of equity as the after tax cost of debt is cheaper than the after tax cost of equity. In most cases wacc may be as low as 6-7% while cost of equity may be as high as 9-10%. I will use a conservative assumption that Data Communication has a weighted average cost of capital of 10%( it is likely much lower) I will also make the assumption that the company will only grow at the rate of inflation at around 2%
If the company can maintain a free cash flow to firm of $22.7 million going forward and a 2% nominal growth rate then we have an Enterprise value of
EV = $22.7/ (10% - 2%) = $283.75
To arrive at a fair market value we need to subtract market value of debt, pension obligation and capital lease. I will instead use book value instead of market value which is
net debt of $37.5 million
pension of $9.3 million
capital lease $45.2
market value = $191.75 million
we have a fully diluted share count of 50 million shares and so the price per share would equate to $3.835
Keep in mind ive used a free cash flow average of the last 2 years which may or may not continue into the future. I've also made the assumption the business will only grow at the rate of inflation which is probably pessimistic. In addition I've used a higher weighted average cost of capital which lowers the fair value of capital.
I've come to the conclusion that there is significant margin of safety with this investment and if one holds over several years, they will do just fine!