Why do we look at both Enterprise Value and Equity Value?
- Enterprise Value represents the value of the company that is attributable to all investors; Equity Value only represents the portion available to shareholders (equity investors)
- You look at both b/c Equity Value is the number the public-at-large sees (“the sticker price”) while Enterprise Value represents its true value (what it would really cost to acquire)
How do you use Equity Value and Enterprise Value differently?
- Equity Value gives you a general idea of how much a company is worth; Enterprise Value tells you more specifically how much it would cost to acquire.
- You use them differently depending on the valuation multiple you’re calculating. If the denominator of the multiple includes interest income and expense (e.g. Net Income) you use Equity Value; otherwise if it does not (e.g. EBITDA) you use Enterprise Value
What’s the formula for Enterprise Value?
Simple Formula:
• Enterprise Value = Equity Value + Debt + Preferred Stock + Non-controlling Interests - Cash
Advanced Formula:
• Enterprise Value = Equity Value + Debt + Preferred Stock + Non-controlling Interests + Capital Leases + Unfunded Pension Obligations and Other Liabilities - Cash - NOLs - Investments - Equity Investments
Why do you need to add Noncontrolling Interests to Enterprise Value?
- Whenever a company owns over 50% of another company‚ it is required to report 100% of the financial performance of the other company as part of its own performance. Even if it doesn’t own 100%‚ it reports 100% of the majority-owned subsidiary’s financial performance.
- You must add the Noncontrolling Interest to get to Enterprise Value so that your numerator and denominator both reflect 100% of the majority-owned subsidiary.
How do you calculated diluted shares and Diluted Equity Value?
- You take the basic share count and add in the dilutive effect of stock options and any other dilutive securities‚ such as warrants‚ convertible debt‚ and convertible preferred stock.
- To calculate the dilutive effect of options and warrants‚ you use the Treasury Stock Method.
Why do we bother calculating share dilution? Does it even make much of a difference?
- We do it for the same reason that we calculate Enterprise Value: to more accurately determine the cost of acquiring a company.
- Normally in an acquisition scenario‚ in-the-money securities (ones that will cause additional shares to be created) are 1) cashed out and paid by the buyer (raising the purchase price)‚ or 2) are converted into equivalent securities for the buyer (also raising the effective price for the buyer)
- Dilution doesn’t always make a big difference‚ but it can be as high as 5-10% (or more) so you definitely want to capture this effect.
Why do you subtract Cash in the formula for Enterprise Value? Is that always accurate?
- In an acquisition‚ the buyer would “get” the cash of the seller‚ so it effectively pays less for the company based on how large its cash balance is. Remember‚ Enterprise Value tells us how much you’d effectively have to “pay” to acquire another company.
- It’s not always accurate b/c technically you should subtract only excess cash (the amount of cash a company has above the minimum cash required to operate)
- In practice‚ the minimum cash required by a company is difficult to determine; also‚ you want the Enterprise Value calculation to be relatively standardized among different companies‚ so you normally just subtract the entire cash balance.
Is always accurate to add Debt to Equity Value when calculating Enterprise Value?
- In most cases‚ yes‚ b/c the terms of a Debt issuance usually state that Debt must be repaid in an acquisition. And a buyer usually pays off a seller’s Debt‚ so it is accurate to say that Debt “adds” to the purchase price.
- Adding Debt is also partially a matter of standardizing the Enterprise Value calculation among different companies: if you added it for some and didn’t add it for others‚ EV would no longer mean the same thing and valuation multiples would be off.
Could a company have a negative Enterprise Value? What does that mean?
- Yes. It means that the company has an extremely large cash balance‚ or an extremely low market capitalization (or both).
- You often see it w/ companies on the brink of bankruptcy‚ and sometimes also with companies that have enormous cash balances.
Could a company have a negative Equity Value? What would that mean?
No. This is not possible b/c you cannot have a negative share count or a negative share price.
Why do we add Preferred Stock to get to Enterprise Value?
- Preferred Stock pays out a fixed dividend‚ and Preferred Shareholders also have a higher claim to a company’s assets than equity investors do. As a result‚ it is more similar to Debt than common stock.
- Also‚ just like Debt‚ typically Preferred Stock must be repaid in an acquisition scenario.
How do you factor in Convertible Bonds into the Enterprise Value calculation?
- If the convertible bonds are in-the-money‚ meaning that the conversion price of the bonds is below the current share price‚ then you count them as additional dilution to the Equity Value (no Treasury Stock Method required - just add all the shares that would be created as a result of the bonds).
- If the Convertible Bonds are out-of-the-money‚ then you count the face value of the convertibles as part of the company’s debt.
What’s the difference between Equity Value and Shareholder’s Equity?
- Equity Value is the market value and Shareholder’s Equity is the book value.
- Equity Value could never be negative b/c shares outstanding and share prices can never be negative‚ whereas Shareholder’s Equity can be positive‚ negative or zero.
- For healthy companies‚ Equity Value usually far exceeds Shareholder’s Equity b/c the market value of a company’s stock is worth far more than its paper value. In some industries (e.g. financial institutions)‚ Equity Value and Shareholder’s Equity tend to be very close.
Should you use Enterprise Value or Equity Value with Net Income when calculating valuation multiples?
Since Net Income includes the impact of interest income and interest expense‚ you always use Equity Value.
Why do you use Enterprise Value for Unlevered Free Cash Flow multiples but Equity Value for Levered Free Cash Flow multiples? Don’t they both just measure cash flow?
- They both measure cash flow‚ but Unlevered FCF (FCF to firm) excludes interest income and interest expense (and mandatory debt repayments)‚ whereas Levered FCF includes interest income and interest expense (and mandatory debt repayments)‚ meaning that only Equity Investors are entitled to that cash flow.
- Therefore‚ you use Equity Value for Levered FCF and Enterprise Value for Unlevered FCF.
Let’s say we create a brand new operating metric for a company that approximates its cash flow. Should we use Enterprise Value or Equity Value in the numerator when creating a valuation multiple based on this metric?
- It depends on whether or not this new metric includes the impact of interest income and interest expense.
- If it does‚ you use Equity Value. If it doesn’t‚ you use Enterprise Value.
