Enterprise Value & Equity Value

Question 1

Enterprise Value Formula

Answer 1

Equity Value + Debt - Cash + Preferred Stock + Non Controlling Interest

Question 2

What is a dilutive effect?

Answer 2

Potential to create additional shares in the future

Question 3

What is a Call Option?

Answer 3

The right for someone (usually an employee) to pay the company money and get a newly created share in return.

Question 4

In-the-Money

Answer 4

Share Price > Conversion Price

Question 5

What is the Treasury Stock Method?

Answer 5

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.

Question 6

Dilutive Securities

Answer 6

Options
Convertible Bonds
Warrants
Convertible Preferred Stock
Restricted Stock Units
Performance Shares

Question 7

What are Convertible Bonds?

Answer 7

Corporate bonds that can be exchanged for common stock by the issuing company.
Issued to lower the coupon rate on debt and delay dilution

Question 8

Why bother including dilutive equity value?

Answer 8

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

Question 9

Why do we subtract cash when calculating Enterprise Value?

Answer 9

When it saves you money or potentially gives you extra cash in the medium or long term

Question 10

Why do you add an item when calculating Enterprise Value?

Answer 10

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

Question 11

What are some items other than cash that we might subtract from Enterprise Value?

Answer 11

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

Question 12

Why do you add Non-Controlling Interest (AKA Minority Interest) to Enterprise Value?

Answer 12

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.

Question 13

Examples of common multiples

Answer 13

EV/EBITDA
EV/EBIT
EV/Revenue
P/E (Equity Value/Net Income)
Enterprise Value/FCFF
Equity Value/FCFE

Question 14

Why do we add Preferred Stock to get Enterprise Value?

Answer 14

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.

Question 15

How do we factor in convertible bonds into the Enterprise Value calculation?

Answer 15

“In the Money” - count 100% as additional shares (NO TREASURY STOCK METHOD)
“Out of the Money” - counted as debt

Question 16

Equity Value v Shareholder’s Equity

Answer 16

Equity Value = Market Value
Shareholders Equity = Book Value

Question 17

Why use levered FCF when calculating Equity Value?

Answer 17

Levered FCF includes the affect of interest income and interest expense and therefore only equity investors are entitled to that cash flow

Question 18

What are some additional items that may be considered as debt-like items (and added) in the Enterprise Value formula?

Answer 18

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

Question 19

Why wouldn’t you include Accounts Payable in the Enterprise Value formula but include items such as Unfunded Pension Obligations?

Answer 19

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

Question 20

Is there a rule for “too much” equity dilution?

Answer 20

There is no rule but typically over 10% equity dilution would be odd

Question 21

What are Restricted Stock Units (RSUs)?

Answer 21

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?

Question 22

How are RSUs and Performance Based Shares factored in when calculating dilutive equity value?

Answer 22

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.

Question 23

When would you use an LBO Analysis as part of a valuation?

Answer 23

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

Question 24

How do you calculate EBIT

Answer 24

Revenue - COGS - Operating Expenses (SG&A, R&D, and including Non-Cash Expenses like D&A) = Operating Income (EBIT)

Question 25

How do you Calculate EBITDA

Answer 25

Revenue - COGS - Operating Expenses (SG&A, R&D, Non-Cash Expense)
EBIT + D&A

Question 26

Walk me through the Equity Value to Enterprise Value bridge

Answer 26

Equity Value + Debt - Cash + Preferred Stock + Minority Interest

Question 27

What are some additional components of the Equity Value to Enterprise Value Bridge?

Answer 27

+ Unfunded Pension Obligations + Capital Leases + Restructuring/Environmental Liabilities

Question 28

Why do we add in Unfunded Pension Obligations when calculating Enterprise Value?

Answer 28

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

Question 29

Market Value v Intrinsic Value

Answer 29

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

Question 30

Three different ways of calculating Equity Value?

Answer 30

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)

Question 31

Enterprise Value Formulas

Answer 31

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

Question 32

Examples of Non-Operating Assets

Answer 32

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)

Question 33

How do you calculate Enterprise Value for Private Companies?

Answer 33

Calculations are similar but can’t get equity value so you need to rely on the most recent valuation of the company

Question 34

Can Implied Equity Value be negative?

Answer 34

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

Question 35

Do financing events affect Enterprise Value?

Answer 35

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

Question 36

What are some examples of Financing Events?

Answer 36

Note: These have no affect on Enterprise Value

Issuing Debt
Repaying Debt
Issuing Stock
Repurchasing Shares
Issuing Dividends

Question 37

What are some examples of Net Operating Assets?

Answer 37

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

Question 38

What are Net Operating Assets defined as?

Answer 38

Net Operating Assets = Operating Assets - Operating Liabilities

Question 39

Is Enterprise Value the “Cost to Acquire a Company”?

Answer 39

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

Question 40

What is the Cost to Acquire a Company?

Answer 40

The target’s Equity Value + Premium

Question 41

Is the Enterprise Value the “True Value” of a company?

Answer 41

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.

Question 41

Does debt “add” and cash “subtract” from Enterprise Value?

Answer 41

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

Question 42

Do you subtract cash when calculating Enterprise Value because It’s “the opposite” of debt?

Answer 42

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

Question 43

What is the two-step process for determining how events impact Enterprise Value and Equity Value?

Answer 43

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

Question 44

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

Answer 44

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

Question 45

Why does capital structure affect the discount rate (which in turn affects Implied Enterprise Value?

Answer 45

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

Question 46

What are 3 ways a company’s share count can increase (dilutive effect)?

Answer 46

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)

Question 47

Walk through the steps in the Treasury Stock Method (TSM)

Answer 47

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

Question 48

If a company has negative net income, will it list its dilutive shares in its filing?

Answer 48

No because they will be anti-dilutive to EPS

EPS = NI / Shares Outstanding
-10/5 = -2 ; -10/7.5 = -1.5

Question 49

What are performance shares and do they add to dilution effect?

Answer 49

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

Question 50

Explain the concept of convertible bonds and how they add to the dilutive effect

Answer 50

Convertible Bonds give bondholders the option to convert bonds into equity at a predetermined conversion price.

Question 51

What is a “capped call?”

Answer 51

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

Question 52

What does the diluted share count represent?

Answer 52

Basic Shares + the potential shares from options, warrants, convertible bonds, RSUs, performance shares, and other sources

Question 53

What are 4 Common Valuation Multiples?

Answer 53

1) TEV/Revenue
2) TEV/EBIT
3) TEV/EBITDA
4) P/E

Question 54

What are the 3 Major Types of Free Cash Flow?

Answer 54

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

Question 55

Why are forward multiples useful?

Answer 55

They represent consensus expectations for a company and company valuation based on expectations of future performance

Question 56

How do you select companies to compare multiples?

Answer 56

Based on Industry, Financial Metrics, and Geography

Question 57

What does a higher multiple indicate?

Answer 57

Indicates that you’ll be willing to pay more for the company if its cash flows are growing quickly

Question 58

Why does Enterprise Value NOT necessarily represent the “true cost” to acquire a company?

Answer 58

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

Question 59

What IS valuation multiple?

Answer 59

A company’s value based on its Cash Flow

Used to compare company to company

Question 60

Why are valuation multiples and growth rates not as correlated as you may think?

Answer 60

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.

Question 61

Why do we use metrics like EBIT and EBITDA in valuation rather than FCF or UFCF?

Answer 61

Comparability purposes

FCF takes more time to calculate and the items within FCF and UFCF vary quite a bit between different companies

Question 62

How do we decide whether to use Equity Value or Enterprise Value when creating valuation multiples?

Answer 62

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)