Paysafe Limited (NYSE:PSFE), the profitable online payments company, reported excellent second-quarter results on Aug. 16. But someone forgot to give the market the memo, as PSFE stock had been falling up until the news release. In fact, on Aug. 19, the stock reached a trough of $8.06 per share. Since then, it has been trending upward and closed at $9.24 as of Friday, Sept. 3.
So far this year, the stock has dropped like a rock from $15.10 where it closed on Dec. 31. That is a decline of 38.8% year-to-date.
However, as I wrote on July 13, I still think PSFE stock is worth more than its present price. At the time PSFE stock was at $11.50 and I argued that, based on free cash flow projections, the stock could be worth as much as $14.41.
However, I have lowered my price target to $10.76 now, as I have adjusted it based on the company’s latest earnings.
Where Things Stand
On Aug. 16, Paysafe reported that its total payment volume (TPV) increased 41% and its net revenue rose 13% year-over-year (YoY). Moreover, its net income turned positive at $6.6 million from losses last year, and its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) grew 8% to $118.8 million. However, its adjusted EBITDA margin fell a bit from 32.4% to 30.9%.
The problem is, though, that Paysafe’s Q2 performance was significantly lower than Q1 2021. For example, page 30 of its slide deck shows that Q2 free cash flow (FCF) was $54.6 million. This was lower than the $96.2 million in FCF last year. Moreover, page 19 of its Q1 slide deck shows that Q1 FCF was $84.387 million.
Any way you look at it, FCF was much lower. For example, in Q2 its FCF margin was 14.2% (i.e., $54.6m/$384.3m in sales). But last quarter, the company had a much higher FCF margin, even though sales were lower than in Q2. It produced $84.387m in FCF on sales of $377.4m). That means its Q1 FCF margin was 22.36%, much higher than the Q2 14.2% margin. The average for both quarters is 18.3%.
So going forward, my forecast for FCF needs to be lower, assuming an average FCF margin of 18.3%. This will lower my price target for PSFE stock.
What Paysafe Stock Is Worth
As I wrote in my last article, one way to value PSFE stock is to forecast its FCF using an FCF margin against a future sales estimate. Then, using an FCF yield metric, we can estimate its market value and compare that with today’s market cap.
For example, analysts now estimate that 2022 sales will reach $1.75 billion. That is slightly higher than the previous $1.71 billion average forecasts in my last article. However, now the FCF margin, at 18.3%, is lower than the prior FCF margin. The net result is an estimate of $320 million in FCF, vs. $490 million last time.
Now, if we divide this FCF estimate by 4.7%, the peer estimate that I used in my last article, the projected target market value is $6.814 billion. This is only slightly higher than the current market value of $6.687 billion market cap (according to Yahoo! Finance, which typically has the most accurate calculation). So it implies that PSFE stock is worth 1.9% higher than Friday’s close, or $9.42 per share.
However, I also now believe that a more realistic FCF yield metric is closer to 4% rather than 4.7%. This is because the average price/cash flow ratio of four other stocks is about 30 times, which works out to a cash flow yield of 3.33%. Given that free cash flow is, by definition, a lower absolute number than cash flow (after deducting capex spending), a more appropriate FCF yield rate would be 4%.
Therefore, dividing $320 million by 4% produces a target market value of $8 billion. This represents a potential gain of 16.5% (i.e., $8.0b/$6.687b) to or $10.76 per share.
What to Do With PSFE Stock
I’ve lowered my price target to $10.76 from $14.41 earlier, based on the company’s lower FCF margins this quarter, despite its higher sales. If Paysafe produces better-than-expected results in Q3, I could end up raising my target price again. In fact, Paysafe is still maintaining its previous sales guidance for 2021, so there is a good likelihood this could happen.
Investors might like to take a small toe-hold stake now that PSFE stock is near the bottom of a trough. If its FCF margins grow going forward, the leverage to PSFE stock’s value is quite significant.
On the date of publication, Mark R. Hake did not hold any position, directly or indirectly, in any of the securities mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.