Equity / Enterprise Value Flashcards
What is Company Value
Cash Flow / (Discount Rate - Cash Flow Growth Rate)
What is the main reason why Market and Intrinsic values often differ?
Often investors disagree on future growth prospects of the company based on historic analysis, as well as disagreeing on discount rate and cash flow.
What is Equity Value?
The value of everything (operating and financing - total assets) that is attributable to Equity Investors.
What is Enterprise Value?
The value of the company’s core business operations attributable to all investors in the company.
What does Enterprise Value exclude that equity value includes?
Non-operating Assets, such as Cash and Financial Investments, as well as Non-Operating Liabilities such as Debt.
What happens to Equity Value and Enterprise Value when a company changes its capital structure?
Equity value will change because equity value is dependent on capital structure (interest payments and debt repayments) whereas Enterprise value is capital structure independent.
Why pair equity value with Total Assets / Liabilities?
A company can generate equity internally from Net Income but also it can raise equity by issuing stock.
Similarly, a company cannot generate debt or preferred stock internally and must ask outside investors.
Moreover a company is unlikely to finance non-core operations using debt or preferred stock proceeds yet may be able to use internally generated proceeds for non-core operations.
What is another definition for Enterprise Value?
Enterprise Value =
Equity Value - non-operating Assets + Liability and Equity items that represent other investor groups
What are some examples of non-operating Assets?
An asset is non-operating if the company does not need it to sell product/services and deliver them to customers.
Financial Investments Owned Properties Side Businesses Assets Held For Sale / Discontinued Operations Equity Investments / Associate Companies Net Operating Losses
What are some examples of Liability and Equity items that represent other investors?
Capital Leases - debt-like obligations with interest payments (for PPE)
Non-controlling Interests - unowned portions of majority owned companies.
Unfunded Pensions - defined benefits pension - Pension Assets and Pension Liabilities accounts. If liabilities exceed assets, the pension is unfunded and only that portion should be added to the Enterprise Value bridge.
Potentially Operating Leases: 2019 brought new accounting rules for operating leases and on-Balance Sheet items.
How do you calculate valuations for Private Companies?
You have to rely on the valuation at which the company most recently raised money (or price it was acquired) or another external company to estimate its Current Equity Value.
How do Financing events affect enterprise value?
According to the Modigliani-Miller theorem, financing events don’t affect Enterprise value, such as:
Issuing debt: Cash and Debt both increase and offset each other
Repaying Debt: Cash and Debt both decrease and offset each other
Issuing Stock: Cash and Equity Value both increase and offset each other
Repurchasing Shares: Cash and Equity value both decrease and offset each other
Dividends: Cash and Equity both decrease and offset each other
What is a rule of thumb to see whether enterprise value changes?
Enterprise value only changes if a company’s Net Operating Assets (CORE BUSINESS OPERATIONS) change.
What are examples of Core Business Operations?
PPE increases: PPE is an operating asset so Net Operating Assets increases, Enterprise value increases
Inventory increases: Inventory is an operating asset so NOA increases, TEV increases
Accounts Receivables Decreases (Cash collection) so operating assets decrease so NOA decreases and TEV decreases
Deferred Revenue increases: this is an operating liability so Net Operating Assets decrease and Enterprise Value decreases.
How do we know if Equity Value changes?
Equity value changes only if Common Shareholder’s Equity Changes - both CSE and Equity Value change by the same amount.
Can a company’s current equity value or enterprise value be negative?
Market Equity value cannot be negative as it is share price x Share Count
Current Enterprise Value can be negative (Current Equity Value = $100, Debt = 0, Cash = $200)
Scenario is rare but it is common for pre-bankruptcy companies that are burning through cash at high rates and likely to die soon. It let’s one buy cash at discounts.
Can implied equity and enterprise value be negative?
Yes both can.
Consider a DCF where UFCF = -$100. Wacc is 3% and growth rate is 2%
Implied enterprise value is -$10,000.
If the company has $500 of cash and no debt, Equity Value will also be negative.
This is theoretically possible but unlikely unless you’re analyzing a highly distressed company or highly speculative company.
Is enterprise value the cost to acquire a company?
No, it is the value of the company’s core business operations to all investors.
At minimum, a buyer must pay for ALL shares outstanding. Then, most debt is refinanced (replaced or completely repaid) and then some debt-like items may not be included.
Lastly, acquirer may have to pay deal fees for the acquisition that isn’t reflected in the Enterprise value at all.
Is Enterprise value the true value of a company?
It depends to whom.
It is the true value to all investors in aggregate for any individual it is not. (Think having a mortgage - do you receive the whole selling price or do you have to repay your mortgage and only receive back the remaining equity stake)
Does Debt add to Enterprise Value or Cash subtract from it?
NO.
Debt does not add to Enterprise value. Debt is added from Equity Value when moving to Enterprise Value.
You similarly subtract cash from Equity Value to get to its Enterprise Value.
If a company has excess cash, why doesn’t it just repay its debt?
For two reasons:
First, debt interest acts as a tax shield and thus increases net income / bottom line.
Secondly, many forms of debt do not allow early repayment.
A company issues $100 in Common stock and does nothing with it.
1) Equity value increases by $100 since CSE increases
2) NOA does not change so TEV does not change
A company issues $100 in Common stock and issues $50 of dividends with it.
1) Equity value increases by $(100-50) = $50 since CSE increases by the delta
2) NOA does not change since only cash, non-operating asset increases by $50. TEV does not change
A company issues $100 in Common stock and acquires a $100 company
1) Equity value increases by $100 as you increase Common Shareholders Equity
2) TEV increases $100 as you add in an operating asset of $100 .
A company issues $100 in debt and does nothing with it.
1) No change to CSE - therefore no change to Equity Value.
2) No change to Net Operating Assets (neither debt cash or equity are operating assets) thus no change to TEV.
A company issues $100 in debt and purchases $100 of financial investments
1) No change to CSE so no change to equity value
2) No change to TEV since debt cash and financial investments are not operating assets.
A company issues $100 in preferred stock and repurchases $100 of shares.
1) Equity Value decreases $100 since you are repurchasing $100 of shares and reducing CSE by $100.
2) TEV stays the same since net operating assets do not change. Preferred stock is non-operating and thus does not affect TEV.
A company’s capex increases by $100 boosting net PPE.
1) No change to CSE thus no change to equity value
2) TEV increases by $100 as capex introduces further operating assets to the firm
Step 1: Inventory increases by $100 (cash)
Step 2: Company sells $100 of inventory for $200 of Finished Goods
Step 1:
a ) Equity value remains the same since there is no change to common shareholder’s equity (purchased through cash)
b) Enterprise value increases as there are additional operating assets available to all investors in the company
Step 2:
A) Common Shareholders’ Equity increases by the amount change in Net Income - if we have $100 margin on the sale, and a 25% tax rate, CSE increases by $75.
B) Since inventory decreases by $100, there are $100 less of operating assets available, so TEV decreases by $100 (back to its original value).
OVERALL:
Equity Value is up $75
TEV stays the same
Deferred Revenue increases $100
1) CSE does not change so Equity Value stays the same.
2) TEV decreases as Deferred Revenue increase is a net operating asset loss (operating Liability) so TEV decreases by $100.
A CEO picks up $100 of cash on the street
1) If we record this as an extraordinary gain on the income statement, our Net income is up $75 (25% tax) and so Equity Value increases $75.
2) There is no change to any operating assets so Enterprise Value stays the same
A company records $100 Goodwill impairment
1) A $100 goodwill impairment is recorded on the income statement so PreTax income is down $100. Net Income is down $75. So overall Equity Value decreases $75
2) Now, TEV decreases by $100 due to the goodwill impairment.
A preferred dividend increase of $10.
1) Preferred Dividends are deducted from Common Shareholders’ Equity so CSE is down $10 and so is Equity value
2) There are no changes to any operating assets in the company so Enterprise Value stays the same.
What happens to the WACC if a company raises additional Debt Equity, or repays debt, repurchases stock?
The wacc will change as the company juggles its financings.
If a company switches the proportions of debt, equity, and preferred stock, the percentage of each in the company will change and so too will the discount rate.
Why is Debt cheaper than Equity?
1) Debt investors require lower returns than equity investors due to fixed interest rates
2) Interest expenses are tax deductible to the company, making it less expensive to pay.
What happens to WACC if the company issues more debt ?
Up to a certain point, WACC will decrease however after that:
1) The cost of debt will keep rising as the company becomes more risky and the cost of financial distress increases
2) The cost of equity will also rise as the risk is more tangible for common shareholders’ too.
How does capital structure impact Discount Rate and Implied Enterprise Value?
1) TAXES: since interest is tax deductible, it makes cost of debt less expensive than cost of equity / preferred stock
2) BANKRUPTCY RISK: Debt and some types of preferred stock increase chances of bankruptcy (Mandatory repayments) whereas additional equity does not add to bankruptcy risk (optional dividends)
3) AGENCY COSTS: Debt investors want to earn their interest and receive money in the end so they prefer companies to be more conservative and focus on repayments. Equity investors may want the company to grow as they have unlimited upside.
What is the formula for enterprise value?
Enterprise Value = Equity Value - Non-Operating Assets + Liability and Equity Items that represent other investor groups
What are some Non-Operating Assets?
Cash and Cash Equivalents Financial Investments Rental Properties Side Businesses Assets Held for Sale Discontinued Operations Equity Investments NOLs
What are some liability and equity items that represent other investor groups?
Debt Preferred Stock Unfunded Pension Obligations (tax deductible) Capital Leases Noncontrolling Interests Some operating Leases
When a company has negative EBIT/EBITDA, what metrics can we use to compare them?
Revenue can be used when a company has negative EBIT/EBITDA/Net Income.
When would you use EBIT mutliples?
CapEx is important and or the company is spending a lot to grow quickly and you want to include the partial impact of CapEx
When would you use EBITDA multiples?
When capex is a smaller % of revenue and you want to normalize companies with different CapEx and D&A
When would you use EBITDAR multiples?
You want to normalize between different lease accounting treatments or you’re comparing companies that use US GAAP and IFRS
What is Free Cash Flow?
Cash Flow from Operations - CapEx (may need to be adjusted to remove Interest, Tax, Lease Expenses)
What multiples to use in FIG?
Enterprise Value is invalid because Operating Assets/Liabilities are difficult to distinguish.
Use P/E, P/BV, P/TBV (Tangible Book Value), the Dividend Discount Model (DDM) rather than a DCF, and the Embedded value methodology for Insurance.
How do pensions work?
Defined-benefit Pension - company promises to pay retired employees specific amounts in the future (and company is responsible for setting aside these funds and investing appropriately). These DO NOT factor into Enterprise Value because they are not balance sheet items.
Do we add pensions?
Add unfunded or underfunded pensions (as these are also investors in the company and represent another investor group)
What are capital leases?
Capital leases are debt like items that companies use to acquire equipment property factories and other PPE, and include interest expenses and depreciation expenses.
How does Enterprise Value change with Capital Leases?
Capital leases are added to Equity Value to arrive at Enterprise Value as they are debt-like items.
How do Operating Leases affect Enterprise Value?
1) If you include Operating Leases in Enterprise Value calculations, you need to include them in EBITDA (full expense)
2) In US GAAP, you do not count Operating Leases in Enterprise Value and so you may use EBIT, EBITDA multiples. If you count Operating Leases you must use EBITDAR multiples.
3) Under IFRS, when you use EBITDA, you must use TEV including Operating Leases. EBITDA EBITDAR are now the same. EBIT is problematic since it only deducts part of the full lease expense so EBIT multiples are invalid unless adjusted.
What are Net Operating Losses?
Net Operating Losses accumulate when a company records negative Pre-tax Income.
How does NOL change?
off-Balance Sheet NOL increases by -1*Pre-Tax Income
The Deferred Tax Asset increases by -1Pre-Tax IncomeTax Rate
How do you adjust Enterprise Value for NOLs?
You subtract Deferred Tax Assets (the on-Balance Sheet NOL) from Equity Value to arrive at Enterprise Value.
How do you account for Goodwill and Other Intangible Assets in Enterprise Value Bridge?
Goodwill should not affect Enterprise Value calculation (since they are operating assets).
How do you account for Industry-Specific Assets in Enterprise Value Bridge?
Mostly these are content assets (Netflix) and thus are not included in the calculation (operating assets)
How do you account for Provisions / Other Liabilities?
If these items are debt/interest bearing then include in the bridge. If they are related to timing differences and uncertain future expenses, do not add them.
How do you account for Legal and Restructuring Liabilities?
Not included in TEV bridge usually.
How do you account for Deferred Tax Liabilities?
You do not include these in the bridge as these are a result of timing differences that will reverse in the future. They also do not represent an investor group.
A company is currently trading at 10X TEV/EBITDA. It wants to sell an operating asset for 2x its EBITDA. What happens to Enterprise Value and TEV/EBITDA?
First, the sale will reduce Enterprise value because you are trading an operating asset for cash which reduces the net operating assets available for all investors. So TEV will decrease by the amount of the Asset.
Secondly, the TEV/EBITDA multiple will increase since the Asset’s multiple was lower than the entire company’s multiple.
eg. EBITDA = $100, Asset = $20 of the EBITDA. TEV = $1000.
Asset sells for 2x its EBITDA = $40. TEV is down $40 = $960. EBITDA is down $20 = $80.
TEV/EBITDA = 960/80 = 12X
Two companies have the same amount of debt but one has convertible and one has traditional. If OpInc, Tax, Equity Value are all the same, which has a higher P/E multiple?
So if we are looking for P/E we must highlight it being Equity / Net Income. Since both have the same Equity Value, we need to understand whose net income is going to be larger or smaller.
This will be as a result of interest expense. Since convertible bonds typically have lower rates than traditional debt, the interest expense will therefore be lower for the firm trading with convertible debt meaning the Net Income will be higher and P/E will resultingly be lower.
Notes, we could technically also include amortization of convertible debt in the income statement too meaning that the P/E will be more close.
When you create forward multiples for metrics such as revenue and ebitda, how do you adjust Enterprise Value?
You don’t project it EVER.
You always use the company’s current Enterprise or Equity Value and divide them by historical metrics and the projected metrics.
This is because current Enterprise and Equity value represent past performance and future market expectation.
Why do you not subtract Goodwill when moving from Equity to Enterprise Value?
Goodwill reflects the premiums paid for previous acquisitions, if it were removed it would be saying that the acquisitions are not part of the core business.
Why do you subtract only part of a company’s DTA when calculating Enterprise Value?
DTAs are created through timing differences or tax credits for operational items. You should subtract the NOLs in the DTA because those are considered non-operational and less related to operations than the rest of the DTAs.
How do you factor in (operating) Working Capital when moving from Equity Value to Enterprise Value?
You don’t need to account for working capital since it is available to both Equity and Debt (and other investors). Equity value represents the Net Assets to Common shareholders and Enterprise Value represents the Net Operating Assets to all investors. Each working Capital items counts in both so you don’t need to include the full value.
Why do you subtract Equity Investments when moving from Equity to Enterprise Value?
Firstly, they are non-operating assets since the parent company has only a minority stake in the companies and thus does not control them.
Secondly, you subtract for comparability purposes for metrics such as EBIT(DA), Revenue since the income statements are not consolidated and we want to match the numerator and denominator.
Why do we add Noncontrolling Interests when moving from Equity to Enterprise Value?
Firstly, these noncontrolling interests represent another investor group beyond common shareholders (minority shareholders of Other Company).
Secondly, since the financial statements are consolidated (revenue, EBIT, EBITDA showing 100% consolidation), we want to include the noncontrolling interests into the numerator since Equity Value only includes the value the actual parent owns (for example 70%).
Should you add on-Balance Sheet Operating Leases in the Equity Value calculation to Enterprise Value bridge?
Under US GAAP you can or you can ignore. If you add them, you have to pair TEV including Operating Leases with EBITDAR (since you have to include Rental Expenses)
Under IFRS you must use Operating Leases with TEV and use the EBITDA multiple since EBITDA already exclude the Interest and depreciation element of Lease expenses.
How do pensions factor into Enterprise Value?
Only defined-benefits pension plans factor in since defined-contribution plans are not balance sheet.
You have to add un/underfunded pensions portion in the TEV bridge since employees now represent another investor group in the firm (they agree to lower pay and benefits today for fixed payments on retirement).
If the pension contributions are tax deductible, you must multiply by (1-tax).
What is the difference between Basic Equity Value and Diluted Equity Value?
Basic = Common Shares Outstanding * Current Share Price
Diluted = Basic + impact of dilutive securities such as options, warrants, RSUs, convertible bonds,
Diluted Shares Outstanding * Current Share price.
Why do companies use dilutive securities?
2 reasons:
1) To incentivise employees to stay at the firm
2) To raise funds (convertible bonds)
A company has 100 shares outstanding at $10 per share. 10 options at $5 per share. What is diluted equity value?
First we note that the options are all in the money so they are exercisable at the current stock price.
Next, we create 10 new shares on exercised options, receiving $50 in cash from this transaction, bringing our share count to 110. We can now use this cash to repurchase 5 shares (at $10 each) so our diluted shares outstanding actually becomes 105 shares. At $10 per share, our diluted equity value is $1050.
A company has 1 million shares outstanding and current share price is $100. The company has $10M in convertible bonds at $1000 par value and a conversion price of $50.
First, we note that the convertible bonds are in the money, so they are exercisable. Next, we define how many bonds we currently have.
If each bond has a $1000 par value and we have $10M outstanding, we have 10,000 bonds exercisable. Each bond can be exercised for $1000/$50 shares, so that is 20 shares per bond.
Now, we increase our share count by 20*10,000 = 200,000 shares so our diluted share count increases to 1.2M shares @ $100/share.
Equity value is $120M
A company has 10,000 shares outstanding and a current share price of $20. It has 100 options at an exercise price of $10. It has 50 restricted stock units and 100 convertible bonds at $10 conversion and par value of $100. What is the diluted equity value?
Best way to solve this is to break it into its component parts: options, RSUs, and convertibles.
First with options, we note that they are in the money so the 100 options can be exercised creating 100 new shares for which we receive $1000. With this 1000 we can repurchase 50 shares so overall the options exercised result in a net +50 shares.
Next our RSUs, we add these as if they were common shares, so we increase our share count by 50 shares.
Lastly our convertible bonds - we first see that these are also exercisable. We have a par value of $100 and a conversion price of $10, so each of the 100 bonds can be converted for 10 shares, so this is an additional 1000 shares.
So overall, our diluted shares outstanding increases to 11,100 and our share price of $20 each means that our Diluted Equity Value is $222,000
The same company (EQUITY = 222000) has cash of 10,000 debt of 30,000 and Noncontrolling interest of 15,000. What is the Enterprise Value?
Enterprise Value = Equity Value - non-operating assets + equity and liability that represent other investor groups.
TEV = 222,000 - 10,000 + 30,000 + 15,000 = $257,000
A company issued a convertible bond in a capped call transaction where it purchased call options on its own stock at an exercise price equal to the conversion price and sold warrants on its stock at a higher price. Can you estimate the dilution in this case?
In capped call transactions, the call options typically offset all the initial dilution from the convertible bond. New shares get created, but then the company exercises its call options to repurchase them.
Then you apply the TSM to the warrants sold at the higher price, such as $100 if the conversion price is $70
So if the company’s current share price is $40, there will be no dilution until it reaches $100, at which point you will use the TSM to calculate the dilution from the warrants.
