“Expectations Investing” by Michael Mauboussin in which he refers to a famous paper called “What does PE multiple mean” by Modigliani and Miller suggests a “Price Implied Expectations (PIE)” model of valuation where
Value of Firm = Steady State value + Future State value.
Steady state value assumes that current level of NOPAT will be sustainable indefinitely and that incremental investments neither add or destroy value. It’s very much like terminal value calculation in DCF model.
Steady State Value = (NOPAT / Cost of Capital) + Cash - Debt
I did some calculations last week based on this to understand market expections built into the current price -
The inputs based on March 24 figs:
- NOPAT (Ebit (1-t)) is 241 Cr.
- I have assumed CoC of 12%.
- Cash is 250 Crs
- Debt is around 41 Crs.
Using above figs and using the formula above, Steady State Value will be 2,214 Cr.
Future State Value refers to how much company invests, the spread between ROIC and CoC and for how long the company can find investible value creating opportunities or the competitive advantage period.
Future value creation = Investment * (return on capital – cost of capital) * competitive advantage period / Cost of capital * (1 + cost of capital)
Here, the inputs are (based on March 24 figs):
- Invested capital (Fixed Assets + Capital WIP – Dep + WC) = 796 Crs.
- RoIC (Ebit/Invested capital)(1-t) = 30% (tax adjusted)
- Competitive advantage period = 15 years (Given the large opportunity size and long runway for growth for Newgen, let’s say the market assumes a 15yrs of growth before decline to a phase where reinvestment earns no more than CoC.)
Using above formula and inputs, future state value comes to around 16,213 Cr.
Total value = 18,428 Cr.
Value per share = 18,428 Cr / No. of outstanding shares i.e. 14 Cr = 1314
The current market price is 1585. Clearly the stock is overvalued leaving absolutely no space of any margin of safety.
So the market is clearly betting on their ability to successfully build ecosystem to capture major GIS that will help them tap into the Fortune 2000 and large banks (for their platform sales, and increase the contribution of revenue from GIS from the current 5% to 30%. Market seems to trust in the management’s ambition targeting of reaching $500M in 5 years growing at CAGR of 27%.
Also, market thinks they can maintain their rate of acquiring 50-60 new logos each year and increase portion of Annuity based revenue from Saas, etc.
Big bets! Stock already up 120% in one year.