Enterprise Value & Equity Value Flashcards
Enterprise Value Formula
Equity Value + Debt - Cash + Preferred Stock + Non Controlling Interest
What is a dilutive effect?
Potential to create additional shares in the future
What is a Call Option?
The right for someone (usually an employee) to pay the company money and get a newly created share in return.
In-the-Money
Share Price > Conversion Price
What is the Treasury Stock Method?
Used to calculate diluted shares and assumes that new shares get created when the options are exercised and that the company buys back some of those shares with the funds it receives.
Dilutive Securities
Options
Convertible Bonds
Warrants
Convertible Preferred Stock
Restricted Stock Units
Performance Shares
What are Convertible Bonds?
Corporate bonds that can be exchanged for common stock by the issuing company.
Issued to lower the coupon rate on debt and delay dilution
Why bother including dilutive equity value?
Usually when one company purchases another, any in-the-money dilutive securities get cashed out or get converted into equivalent number of the buyers securities
Why do we subtract cash when calculating Enterprise Value?
When it saves you money or potentially gives you extra cash in the medium or long term
Why do you add an item when calculating Enterprise Value?
1) Represents something that must be paid immediately upon acquiring a company
2) Something that must be repaid in the future
3) when you’re adding it back for comparability purposes
What are some items other than cash that we might subtract from Enterprise Value?
Short-Term, Long-Term, and Equity Investments (potentially) - can be sold in the future to get extra cash (taken out based on liquidity)
Net Operating Losses - could potentially save you cash as future tax deductions
Why do you add Non-Controlling Interest (AKA Minority Interest) to Enterprise Value?
When you own over 50% of a company, you must consolidate 100% of its financial statements (example 70%). However, the equity value will only reflect 70% of the company that you own. We need to add the minority interest (30%) to the Enterprise Value so that we’re including 100% of the other company’s value in Enterprise Value.
Therefore, ratios involving Enterprise Value will be accurately reflecting the full value of the company (EV/EBITDA) would be apples to apples.
Examples of common multiples
EV/EBITDA
EV/EBIT
EV/Revenue
P/E (Equity Value/Net Income)
Enterprise Value/FCFF
Equity Value/FCFE
Why do we add Preferred Stock to get Enterprise Value?
Preferred stock is more similar to debt because it pays out a fixed dividend and preferred stockholders have a higher claim to a company’s assets than investors do.
How do we factor in convertible bonds into the Enterprise Value calculation?
“In the Money” - count 100% as additional shares (NO TREASURY STOCK METHOD)
“Out of the Money” - counted as debt
Equity Value v Shareholder’s Equity
Equity Value = Market Value
Shareholders Equity = Book Value
Why use levered FCF when calculating Equity Value?
Levered FCF includes the affect of interest income and interest expense and therefore only equity investors are entitled to that cash flow
What are some additional items that may be considered as debt-like items (and added) in the Enterprise Value formula?
Capital Leases - have interest payments that may need to be repaid
Unfunded Pension Obligations - usually paid with something other than a company’s normal cash flow
Why wouldn’t you include Accounts Payable in the Enterprise Value formula but include items such as Unfunded Pension Obligations?
Magnitude and Source of Funds are critical - 99% of the time AP is paid back via the company’s cash flow from its normal business operations and it tends to be relatively small
Is there a rule for “too much” equity dilution?
There is no rule but typically over 10% equity dilution would be odd
What are Restricted Stock Units (RSUs)?
RSUs are a form of stock-based compensation but are restricted during a vesting period that may last several years. Once vested, RSUs can be sold or kept like any other shares of common stick?
How are RSUs and Performance Based Shares factored in when calculating dilutive equity value?
RSUs are added to the common stock share count
Performance Shares are similar to Convertible Bonds, however if the share price is below the performance share price target (out of the money), they are not counted as debt, they are ignored altogether. If they are in the money then they are treated as common shares.
When would you use an LBO Analysis as part of a valuation?
To set a floor on a company’s value and to determine the minimum amount that a PE firm could pay to achieve its target returns
How do you calculate EBIT
Revenue - COGS - Operating Expenses (SG&A, R&D, and including Non-Cash Expenses like D&A) = Operating Income (EBIT)
How do you Calculate EBITDA
Revenue - COGS - Operating Expenses (SG&A, R&D, Non-Cash Expense)
EBIT + D&A
Walk me through the Equity Value to Enterprise Value bridge
Equity Value + Debt - Cash + Preferred Stock + Minority Interest
What are some additional components of the Equity Value to Enterprise Value Bridge?
+ Unfunded Pension Obligations + Capital Leases + Restructuring/Environmental Liabilities
Why do we add in Unfunded Pension Obligations when calculating Enterprise Value?
There is not nearly enough cash flow from normal business operations to pay for these, they’ll need to get the money from somewhere…which means that the buyer is paying or has to raise debt to pay for them
Market Value v Intrinsic Value
Market Value - what company is worth right now according to current owners and investors
Implied (Intrinsic Value) - what the company should be worth according to your analysis and views
Three different ways of calculating Equity Value?
1) Shares Outstanding * Current Share Price
2) Market Value of Total Assets - Market Value Total Liabilities
3) Company’s last round of funding - its valuation in the last round of funding (Used for private companies)
Enterprise Value Formulas
EV = Equity Value - Non-Operating Assets + Debt - Cash + Preferred Stock + Minority Interest + Unfunded Pension Obligations + Capital Leases
EV = Equity Value - Non-Operating Assets + Liability and Equity Items That Represent Other Investor Groups
Examples of Non-Operating Assets
Non-Operating if the company doesn’t need the asset to sell products/services and deliver them to customers
Cash
Financial Investments (stocks, bonds)
Owned Properties
Side Businesses
Assets Held for Sale
Equity Investments or Associated Companies
Net Operating Losses (NOLs)
How do you calculate Enterprise Value for Private Companies?
Calculations are similar but can’t get equity value so you need to rely on the most recent valuation of the company
Can Implied Equity Value be negative?
Yes, implied Equity Value can be negative but…
If implied equity is 0, we would typically assume the share price is 0 and say the company is worthless
Do financing events affect Enterprise Value?
Financing events don’t affect Enterprise Value; Only changes in the company’s core business (Net Operating Assets) affect Enterprise Value
They do not affect enterprise value because the changes to the financing item and cash cancel each other out
Ex: Debt up 100 and Cash up 100
What are some examples of Financing Events?
Note: These have no affect on Enterprise Value
Issuing Debt
Repaying Debt
Issuing Stock
Repurchasing Shares
Issuing Dividends
What are some examples of Net Operating Assets?
Note: Enterprise Value changes ONLY if Net Operating Assets change!
PPE Increases –> Enterprise Value Increases
Inventory Increases –> Enterprise Value Increases
Accounts Receivable Decreases (due to cash collection –> Enterprise Value Decreases
Deferred Revenue Increases –> Enterprise Value decreases
*Assuming cash is other impacted line item on B/S
What are Net Operating Assets defined as?
Net Operating Assets = Operating Assets - Operating Liabilities
Is Enterprise Value the “Cost to Acquire a Company”?
No!
Enterprise Value is the value of a company’s core business operations to all investors in the company
Why not?
- Buyer replaces the seller’s debt with new debt (refinances)
- Acquirer doesn’t necessarily “get” all the seller’s cash
- Acquirer may have to pay additional fees
What is the Cost to Acquire a Company?
The target’s Equity Value + Premium
Is the Enterprise Value the “True Value” of a company?
Depends on who this is for? It may be the true value to all investors in aggregate but if you are a common shareholder, it will not be the true value to you.
Does debt “add” and cash “subtract” from Enterprise Value?
No!
You add debt when you move from a company’s Equity Value to its Enterprise Value
You subtract cash when you move from a company’s Equity Value to its Enterprise Value
*Only changes to the company’s core business affect its Enterprise Value
Do you subtract cash when calculating Enterprise Value because It’s “the opposite” of debt?
No, you subtract cash because it’s a non-operating asset (the company doesn’t need its full cash balance to continue selling/delivering products and services to customers
What is the two-step process for determining how events impact Enterprise Value and Equity Value?
2 Step Process:
1) Does Common Shareholder Equity Change? If so, the equity value changes by the amount the CSE changes
Items that affect CSE: NI, Dividends, Stock Issuances, and Stock Repurchases
2) Do Net Operating Assets (NOA) Change? If so, Enterprise Value will change by the amount the NOA changes
Why doesn’t the concept of Enterprise Value hold up in real life?
This concept more applies to Implied Enterprise Vale rather than Current Enterprise Value
Enterprise Value will be affected by financing changes in real life (it is not really capital structure neutral as some sources claim)
Think: Company Value = CF / (Discount Rate - Growth Rate) …
So… Implied Enterprise Value = Unlevered FCF / (WACC - Unlevered FCF Growth Rate)
Raising debt impacts the WACC by reducing it (since debt is cheaper than equity) but it reduces it up to a certain point…
- The cost of debt increases as a company takes on more debt (company becomes riskier)
- Cost of equity will rise for the same reason (more debt means more risk to common shareholders)
If Debt increases…Cost of Debt increases and Cost of Equity increases
Why does capital structure affect the discount rate (which in turn affects Implied Enterprise Value?
1) Taxes - Interest paid on Debt is Tax Deductible
2) Bankruptcy Costs - Debt and some types of Preferred Stock increase the chances of a company going bankrupt because of the interest expense
3) Agency Costs - Debt investors cannot earn more than the interest rate. Equity investors want the company to grow because they have unlimited upside (conflicting agendas mean debt is not equivalent to equity)
4) Efficiency Markets - debt, equity, and preferred stock are not equivalent for lesser-known companies in obscure markets
What are 3 ways a company’s share count can increase (dilutive effect)?
1) Stock Options - Employees can exercise call options when strike price > share price
2) Convertible Bonds - investor can convert bonds to shares when strike price > share price
3) RSUs - like normal shares in a company but have restrictions when employees can receive them and sell them (due to time they have spent at the firm)
Walk through the steps in the Treasury Stock Method (TSM)
1) Shares Get Created (Strike Price > Share Price)
2) Company gets Cash Proceeds from Sale of the Stock
3) Company uses Cash Proceeds to Repurchase Shares
4) Net Dilution = Newly Created Shares - Repurchased Shares
If a company has negative net income, will it list its dilutive shares in its filing?
No because they will be anti-dilutive to EPS
EPS = NI / Shares Outstanding
-10/5 = -2 ; -10/7.5 = -1.5
What are performance shares and do they add to dilution effect?
Performance Shares - restriction to exercise is tied to a performance goal
Companies do not disclose these performance goals so you usually add them all to the dilutive effect
Explain the concept of convertible bonds and how they add to the dilutive effect
Convertible Bonds give bondholders the option to convert bonds into equity at a predetermined conversion price.
What is a “capped call?”
When a company purchases Call Options on its own stock at the conversion price and then it sells warrants on its own stock at a higher price
What does the diluted share count represent?
Basic Shares + the potential shares from options, warrants, convertible bonds, RSUs, performance shares, and other sources
What are 4 Common Valuation Multiples?
1) TEV/Revenue
2) TEV/EBIT
3) TEV/EBITDA
4) P/E
What are the 3 Major Types of Free Cash Flow?
1) Free Cash Flow: CFO - CapEx
2) Unlevered FCF: NOPAT + D&A +/- Change in Working Capital - CapEx
3) Levered Free Cash Flow: NI + D&A +/- Changes in WC - CapEx - Debt Repayments + Debt Issuances
Why are forward multiples useful?
They represent consensus expectations for a company and company valuation based on expectations of future performance
How do you select companies to compare multiples?
Based on Industry, Financial Metrics, and Geography
What does a higher multiple indicate?
Indicates that you’ll be willing to pay more for the company if its cash flows are growing quickly
Why does Enterprise Value NOT necessarily represent the “true cost” to acquire a company?
1) The treatment of the seller’s existing Debt and Cash differs based on the terms of the deal. Buyer may not necessarily repay the seller’s debt - it could instead refinance it and replace it with new debt - and it may not “get” all the seller’s cash
2) Buyer has to pay additional fees for the M&A advisory, accounting, and legal services and the financing to acquire another company, and those are not reflected in the Enterprise Value
What IS valuation multiple?
A company’s value based on its Cash Flow
Used to compare company to company
Why are valuation multiples and growth rates not as correlated as you may think?
Difficult to find 100% comparable companies so there will be differences in discount rates because the risk and potential returns will differ
Current events always affect the multiples, even if they don’t change a company’s long term performance. These include legal troubles, a recently announced product, or a new executive.
Why do we use metrics like EBIT and EBITDA in valuation rather than FCF or UFCF?
Comparability purposes
FCF takes more time to calculate and the items within FCF and UFCF vary quite a bit between different companies
How do we decide whether to use Equity Value or Enterprise Value when creating valuation multiples?
If metric in the denominator deducts interest expense then it pairs with Equity Value - debt investors can no longer be paid after they earn their interest. This represents only the value available to equity holders
If metric in the denominator does not deduct net interest expense, then it pairs with Enterprise Value. This applies to both financial metrics (EBIT and EBITDA) and non-financial metrics (Unique Users, Subscribers)
