EQUITY VALUE/ENTERPRISE VALUE Flashcards
Company issues $100 common stock & does nothing w/ it - what happens to EqV & TEV?
EqV: Increases by $100 (CSE increased by $100)
TEV: No change (the proceeds go to cash, which is non-operating & no operating liabilities change)
Co issues $100 common stock & uses proceeds to issue $50 of dividends
EqV: Increases by $50 (CSE changes by $50)
TEV: No change (the proceeds go to cash –> dividends come out of cash –> cash is non-operating)
Co issues $100 of Common Stock to fund a $100 Acquisition
EqV: Increases by $100 (CSE changes by $100)
TEV: Increases by $100 (Acquired assets were operational: increased by $100; no change to operating liabilities)
Co issues $100 of Debt and Does Nothing w/ the Proceeds
EqV: No change (Debt issuance does not affect CSE)
TEV: No change (Changes = Cash increases by $100 - where the proceeds go & Debt increases by $100; neither of these are operating As or Ls)
Co issues $100 of Debt to Fund $100 Common stock Repurchase
Eqv: Decreases by $100 (Common stock repurchase decreases CSE by $100)
TEV: No change (Changes to Cash, Debt, Equity –> nothing that changes here is an operating A or L)
Co issues $100 of Debt to Purchase $100 of Financial Instruments
EqV: no change
TEV: no change (changes to cash, debt, financial investments –> nothing that changes is an operating A or L)
Co issues $100 of Preferred Stock to Fund a $100 Common Stock Repurchase
EqV: Decreases by $100 (stock repurchase reduces CSE by $100)
TEV: no change (changes to cash, preferred stock, CSE –> no changes to operating A or L)
CapEx Increases by $100, Boosting Net PPE
EqV: No change (cash used to buy PPE –> no change in CSE).
TEV: Increases by $100. (Net PPE increases by 100 –> is a NOA; no NOLs change.)
Inventory Increases by $100
EqV: No change (cash used to buy inventory –> no change in CSE)
TEV: increases by $100 (inventory increases by $100 –> is a NOA; no NOLs change)
Inventory increases by $100. Co then sells $100 of Inv for $200 of finished Goods.
Eqv: Increases by $75 (Net income increases by $75, assuming 25% tax rate –> CSE increases by $75)
TEV: No change. (THE NET change to Inv (NOA) here is $0 b/c increased by $100, then sold & decreased by $100. Other changes = cash & CSE increased by $75 –> Non operating)
Deferred Revenue Increases by $100
EqV: No change. (DR not on IS b/c has not been recognized as revenue yet –> no change to Net Income –> no change to CSE; nothing else affects CSE either)
TEV: Increases by $100. (DR = Operating Liability; cash also increases, but that is not an operating asset
CEO picks up $100 on the Street
EqV: Increases by $75 (Net Income increases by $75 –> CSE increases by $75).
*recorded as a $100 Extraordinary Gain on the IS
TEV: No change (Cash & CSE increases –> non operating asset/liability)
*intuition: finding a non-operating asset on the st does not make a co’s core biz more valuable
Co records $100 Goodwill Impairment
EqV: Decreases by $75. (Net Income decreases by $75. –> CSE decreases by $75).
TEV: Decreases by $100 (Goodwill is an operating Asset –> falls by $100; no change in Operating Ls)
Preferred Dividends Increase by $10
EqV: Decreases by $10. (Preferred dividends taken out of CSE)
TEV: No change (cash & CSE changes –> non-operating)
Why does Concept of Enterprise Value being “capital structure-neutral” (not affected by financing changes) not hold up in real life?
- Concept of TEV: Not affected by financing changes; only affected by changes to operating assets/liabilities.
- Implied Enterprise Value (“Company Value”) = Unlevered FCF / (WACC - Unlevered FCF Growth Rate)
==> But, as a co raises additional debt/equity, repays debt, or repurchases stock –> it’s WACC changes:
1) %’s of cost of E&D changes -> so WACC Changes
2) Cost changes: At diff levels of Debt and Equity, the costs of those debt/equity also change.
==> More accurate: TEV is LESS affected by capital structure than Equity Value.
Formula for Implied Enterprise Value
Unlevered FCF / (WACC - Unlevered FCF Growth rate) = Implied TEV
What happens to cost of debt & equity as levels of Debt in a co rise?
1) As a Co takes on more Debt –> Cost of Debt rises b/c Co becomes riskier and riskier for new lenders
2) As Co takes on more Debt –> Cost of Equity rises too b/c Co becomes riskier for common SHs
What are Equity Investments? How are they dealt w/ in EqV to TEV “bridge”?
Assets; Represent a co’s MINORITY STAKE in another company –> financial statements are NOT consolidated
To get from EqV to TEV: SUBTRACT Equity Investments
Logic: 2 reasons –
1) Equity = non-operating asset –> not in TEV
2) Comparability: EqV already implicitly reflects the % of minority stake. BUT: b/c the financial statements are not consolidated –> the financial metric denom for multiple (EBIT, EBITA) reflects 0% of the stake. Easier to just subtract it from the EqV. ==> This way numerator/denominator are consistent
What are Noncontrolling Interests? How are dealt w/ in the EqV to TEV “bridge”?
Line item w/in Equity; Represents what a co DOES NOT OWN when it owns a MAJORITY (but less than 100%) stake of another co –> financial statements ARE consolidated
To get from EqV to TEV: ADD Noncontrolling Interests
Logic: 2 reasons –
1) Non-Controlling Interest = represents another investor group (other than common SH) –> add to TEV
2) Comparability: the financial statements are consolidated –> financial metric denom for multiple (EBIT, EBITA) reflects 100% of of the stake. So, have to add Noncontrolling Interest to reflect same % of the subsidiary co reflected in the multiple (100%). ==> This way numerator/denominator are consistent
In summary: why do we adjust Equity Investments and Noncontrolling Interests?
Ensure consistency in numerators and denominators of valuation multiples
Equity Value - what does it MEAN?
- value of EVERYTHING a co has (Net Assets) to only EQUITY investors (common SHs)
- Net Assets = Total Assets - Total Ls
==
*Intuition: equity linked w/ Net Assets b/c equity can be generated both internally & externally -> can use for BOTH operating & non-operating assets
Enterprise Value - what does it MEAN?
- value of a co’s CORE BUSINESS OPERATIONS (Net OPERATING Assets) to ALL investors (Equity, Debt, Preferred SHs, potentially others)
- Net Operating Assets = Operating Assets - Operating Ls
- formula: TEV = EqV + Debt + Pref Stock + Min Interest - Cash
==
*Intuition: TEV linked w/ operating assets b/c debt, preferred debt can only be raised externally -> unlikely to use it for assets not related to core biz
Why use both Equity Value & Enterprise Value?
Use both bc:
1) diff valuation methodologies may produce diff values: either implied eqv or implied tev. Need to be able to move between these diff values with a “bridge”
2) actions taken by one investor group affects everyone else
How do capital changes (co’s % of Eq vs. Debt allocation) affect EqV & TEV?
EqV: changes -> b/c: EqV depends on capital structure
TEV: will not change as much ->
Advantages of using TEV & TEV based multiples?
- don’t have to worry about co’s capital structures –> will not change (as much) as capital structure changes
How can a co generate equity internally? raise equity externally?
internal: from its Net Income –> flows into RE in CSE
external: from its outside investors, by issuing stock
Implied Value vs. Current (“Market”) Value? Why might they differ?
Implied (“Intrinsic”) Value - what SHOULD the co be worth according to your analysis & views?
Current Value - what is the co worth RIGHT NOW according to the market, its current owners, or current investors?
- may differ bc of disagreements re: co’s growth rate (future growth), discount rates, CFs; but most valuation differences is bc of disagreements about future growth rates
Current Equity Value - how to calculate?
3 methods:
1) (Public Cos) Shares Outstanding * Current Share Price
2) MV of Total Assets - MV of Total Ls
3) (Private Cos) Valuation in last round of funding or in an an outside appraisal
*method 2 = v time consuming! so, usually stick w/ 1 if public co, and 3 if private co
Current Enterprise Value - how to calculate for public cos?
1) Start w/ calculating Current Equity Value
2) TEV “Bridge” it to move to Current TEV: SUBTRACT non-operating assets & ADD L&E items that represent other investor groups
Non-Operating Assets - what is it? examples?
Co does not need the asset to sell products/deliver them to customers
Examples:
- cash
- financial investments (stocks, bonds)
- rental properties (owned properties from which co earns rental income)
- side businesses (that earn income for the co)
- assets held for sale and assets associated w/ discontinued operations
- equity investments or associate cos (minority stakes in other cos)
- net operating losses (a component of the deferred tax asset)
–
*SUBTRACTED in TEV bridge
Liability & Equity items that represent other investor groups - examples?
- debt
- preferred stock
- capital leases
- non-controlling interests
- unfunded pensions
- (potentially) operating leases: under IFRA, normally add them in the bridge; but under GAAP - could go other way as long as you’re consistent w/ the valuation multiples
–
*ADDED in TEV bridge
Noncontrolling Interests - what is it?
- represents portion of a co, that this co owns a majority of, that is not owned by you
- counted as “other investor group”
*intuition: if you own majority of a co -> have effective control
Capital Leases - what is it?
- Debt-like obligations
- w/ interest payments
- used to acq PP&E
–
*ADDED in TEV bridge
Unfunded Pensions - what is it
Portion of the pension where pension Ls exceed pension assets (in cases where a co has a defined-benefit pension)
- defined-benefit pension = co is required to pay retired employees a fixed amount each year
-> if co has a defined-benefit pension –> will have Pension Assets & Pension liabilities - Pension Assets = investments set aside for those retirement payment
- Pension Ls = PV of expected future obligations
==> IF Pension Ls > Pension Assets –> pension is UNFUNDED
–
*ADDED in TEV bridge - only the unfunded portion
- intuition: employees = “another investor group” here - exchanged lower salaries/benefits presently for future promised payments in retirement
- similar to debt, but over much longer time frame
Operating Leases - treatment in TEV bridge?
IFRS: normally added - b/c of how lease expense is represented on the IS
US GAAP: could go either way as long as you’re consistent w/ the valuation multiples
Private companies - how to calculate current TEV & current EqV?
- Current EqV: look at external sources - most recent valuation when co raised money, price acquired at, etc
*b/c: no publicly traded shares ==> can’t use current share price * shares outstanding - Current TEV: no straight-forward way to calculate
–> In practice: often skip current EqV & TEV calculations for private cos & just est IMPLIED values
==> bankers advising private co’s: may skip comparison b/t co current vs. implied values & just tell client IMPLIED value - what you think it should be worth
CURRENT EqV & TEV - can they be negative?
Current EqV: never;
- for public cos: can’t have negative share count nor negative share price
- for private cos: also can’t be negative
Current TEV: yes, but rare.
- co that has cash that exceeds it current Eqv & no debt
-ex: pre-bankruptcy co’s burning through cash at high rates & likely to die soon
IMPLIED EqV & TEV - can they be negative?
- theoretically yes:
–> unlike CURRENT EqV, implied EqV is calculated based on your own views & assumptions. can back into it from a negative or $0 implied TEV (ex: if a co has more debt than cash) - but IRL: v unlikely - UNLESS: distressed or highly speculative co’s (ex: tech, biotech startup)
Enterprise Value - when does it change?
- changes ONLY when net operating assets (core biz operations) change
–> both NOA & TEV change by same amount - financing event? -> NO EFFECT
ex: paying Dividends? -> changes (reduces) Cash & CSE ==> neither are operating assets or liabilities
ex: debt issuance? -> changes (increases) Cash & Debt ==> neither are operating assets or liabilities
Equity Value - when does it change?
- changes ONLY if CSE changes
–> both CSE & EqV change by same amount
Financing Events - examples
- issuing debt
- repaying debt
- issuing debt
- repurchasing shares
- issuing dividends
Operating Assets (and Liabilities) - examples
- PP&E
- inventory
- accounts receivable
- deferred revenue (liability)
How events impact Current EqV & TEV (changes to co’s BS)
1) Does CSE change?
- If yes -> EqV changes. If no -> EqV doesn’t change.
- items that affect CSE: Net Income; Dividends; Stock Issuances; Stock Repurchases
2) Does Net Operating Assets (change)?
- If yes -> TEV changes. If no -> TEV doesn’t change.
Impact of financing changes on TEV IRL
- IRL: TEV is LESS affected by financing changes. as capital structure changes, WACC changes
1) % of each cap structure changes
2) cost of debt & equity rises as co takes on more and more debt => decreases implied TEV
(b/c w/ more debt - co becomes riskier for all investors)
*this applies more to IMPLIED TEV. IRL: CURRENT TEV prob won’t change overnight. But if it’s expected to have more Debt going forward: CURRENT TEV will also start to change.
Why is Debt cheaper than Equity?
1) LOWER RETURNS: debt investors (lenders) expect lower returns than equity investors -> get fixed interest rate (so don’t benefit even if co doubles its CFs)
2) TAXES: interest expense is tax-deductible -> less expensive to pay
Public Co’s: Current EqV calculation
Common Shares Outsanding * Current Share Price
*need to account for dilutive securities
Dilutive securities - effect; examples; method to calculate dilution
- could potentially create more shares -> shrinks a current SHs ownership
- examples: stock options; convertible bonds; restricted stock units (RSUs)
- calculate dilution using Treasury Stock Method (TSM)
Treasury Stock Method calculation
- use for stock options & warrants
- used to calculate total diluted shares outstanding
1) Compare current stock price to the exercise price
-> If “in-the-money” (current price is above exercise price) -> assume options are exercised => # of new shares created
2) Net proceeds = exercise price * # of options
3) Co uses net proceeds to repurchase some of the newly created shares @ current share price:
cash proceeds / current price = # of shares repurchased
4) Net dilution = # of options (new shares) - shares repurchased
5) Total diluted shares = shares outstanding + net dilution
Restricted stock vs. Restricted stock units
Restricted Stock = usually already included in co’s common share count -> ignore in diluted share count
Restricted Stock Units = not included in common share count -> ADD to diluted share count
Convertible bonds - definition; treatment in EqV/TEV calculation
- alternate form of debt: co pays lower interest rates in exchange for giving bond holders option to “convert” bond into new shares in the future (rather than get cash)
- to measure dilution:
- compare current share price vs. conversion price:
–> if current price > conversion -> assume all convert into shares ==> count as DILUTION to EqV
–> if current price < conversion -> count them all as bonds instead ==> ADD as DEBT in TEV bridge, using FMV amount
*if big discrepancy b/t diluted shares & disclosed shares related to senior convertible notes –> may be b/c of “capped call” or “note hedge” transaction
Convertible bond issuance - in a “capped call” or “note hedge” transactions
- “capped called”/”note hedge” transaction: 1) co buys call option on its own stock at conversion price –> 2) then, sells warrants on its own stock @ higher price
- effect: 1) cancels out dilution and 2) if shares climb to warrant exercise price -> some dilution from new shares created, but less than original
–> to calculate this dilution effect from warrants: apply TSM, but ONLY to the warrants
EqV to TEV “bridge”
- SUBTRACT Non-Operating Assets
- ADD Liability & Equity Items that represent other investors, beyond common SHs
==> Commonly:
-SUBTRACT CASH (ex of non-operating asset)
(can also include: equity investments, assets held for sale, assets associated w/ discontinued operations)
& ADD DEBT & PREFERRED STOCK (ex of other investor groups)
(can also include: underfunded pensions, capital leases, non-controlling interests)
- value to use: fair market value, but if not avail, use book value (on BS)
==
*intuition:
- TEV reflects only Net Operating Assets –> subtract out non-operating assets
- TEV reflects ALL investor groups –> add back lines items that represent other investor groups
EqV & TEV - when is it useful? When is it not useful?
- useful for: comparing co’s IMPLIED value to its CURRENT value
- NOT useful for comparing diff co’s to each other
- b/c: co’s can differ in size
Multiples - what is it? why is it useful?
- values each co on a per-unit basis
- useful to compare co’s against each other (accounts for the fact that co’s differ in size)
-> compare diff co’s multiples to each other
==> allows you to see how expensive/cheap a co is, relative to similar co’s - BUT: for multiples to be meaningful, co’s must be similar
Examples of common valuation multiples?
- TEV / Revenue
- TEV / EBIT
- TEV / EBITDA
- P/E
TEV / REVENUE - measures? when is it useful?
-measures price in relation to co’s sales
- useful: when co has negative #s for EBIT & EBITDA and negative CFs –> no other way to value co
*revenue = measures sales
*includes net interest expense (& preferred dividends) —-> avail to all SHs –> pair w/ TEV
Multiples that measure profitability?
- TEV / EBIT
- TEV / EBITDA
- TEV / EBITDAR
- P/E (based on Net Income)
–> Denom metrics all measure profitability -> corresponding multiples measure co’s price in relation to its profits
Implied Enterprise Value - what is it & how to calculate?
- implied enterprise value = what YOU think core-business operations are worth based on YOUR own views & analysis
- use valuation methodologies: DCF, comparable public companies, precedent transactions
Differences in Current Enterprise Value vs. Implied Enterprise Value - why?
- you & the market make have diff views on a co’s cash flow growth rate or discount rate; you may view co’s CF to grow at a faster or slower rate than the market
- goes back to formula for co value = cf / (discount rate - CF growth rate), where discount rate > growth rate
- co’s CURRENT CASH FLOW = part of equation that everyone agrees on
Free Cash Flows - what is it? diff types?
- answer: “how much discretionary CFs does a co have”?
- FCF (general) = CFO - CapEx (possibly w/ adjustments)
- CFs AFTER co pays what it needs to run core business & avoid being shut down by external parties & govt => tells you how much a co’s CORE BIZ is generating on a recurring, predictable basis
- 3 types:
1) Unlevered FCF
2) FCF
3) Levered FCF
*differ based on: 1) which investor group is CF avail to? & 2) treatment of debt - is it deducted or ignored?
Unlevered FCFs - what is it? how to calculate? when is it used/why?
- CFs avail to all investor groups - as if co hasn’t paid interest on debt or preferred dividends
- includes ONLY CORE biz revenues & expenses
- to calculate:
1) start w/ NOPAT (= EBIT * (1-Tax Rate)*)
(components = Revenue - COGS / Operating Expenses - Taxes)
2) ADD BACK: D&A (sometimes non-cash adj.)
3) ADD/DEDUCT Change in Working Capital
4) DEDUCT CapEX - used in DCF b/c lets you eval a co while ignoring its capital structure
Levered FCFs
- CFS avail only to Eq investors
- to calculate:
1) start w/ NET INCOME TO COMMON
2) ADD BACK: D&A
3) ADD/DEDUCT Change in Working Capital
4) DEDUCT CapEX
5) ADD BACK Debt issuances - not useful b/c ppl disagree about definition
- can use in levered FCF & may better represent the net change in cash
Discount rate - TEV vs. EqV?
- TEV = WACC
- EqV = Cost of Equity
Diff btw SH equity vs. EqV?
- EqV = market value
- SH equity = book value
Examples of industry specific multiples?
- Tech: TEV/Unique Visitors, TEV/Pageviews
- Retail/Airlines: TEV/EBITDAR (Earnings before int, taxes, D&A, rent)
*use enterprise value: b/c metric is avail to all investors in a co
Factors that impact TEV:
- Capital structure ==> WACC
==> %s - discount rate (WACC)
==> costs ==> discount rate (WACC)
ex:
- going from no debt to small amount of debt –> may initially reduce WACC b/c debt is cheaper than equity. but, past a certain point, additional debt will increase WACC b/c risk to all investors starts increasing
Impact of debt on WACC
- increasing debt will initially reduce WACC (b/c debt is cheaper than equity
- but, past a certain point, additional debt will increase WACC b/c risk to all investors starts increasing
Impact of ACQ on TEV?
- if increases NOA –> increases TEV
- goodwill?
Debt Issuance to fund asset acq? - impact on TEV/EqV?
- debt issuance = does not change CSE -> no impact on TeV
- asset acq only impacts TEV if it’s an NOA
What changes CSE?
- net income generation
- dividends
- stock issuances
- stock repurchases
Preferred Stock Issuances? - impact on TEV/EqV
- NO impact to EqV
*Pref Stock issuances affects preferred stock w/in equity, not CSE - NO impact to TEV
Stock repurchases - impact on TEV/EqV?
- decreases eqV
generating net income & letting it sit in cash
intuition: does not make core biz more valuable –> TEV doesn’t change
Changes to Operational line items – impact on TEV/EqV?
- can affect both TEV/eqVal but the impact on EqV may be “reduced” if co also changes its cap structure at the same time
Projected Revenue change - impact on TEV/EqV?
- increase expected revenue growth (sales growth) –> changes expected future FCFs ==> impacts implied eqV/TEV
- current eqV/TEV: can increase if co’s share price jumps in reaction to this news (market)
How to calculate EBITDA & EBIT? (public co)
EBIT = Operating Income + non-recurring charges that have reduced Operating Income
- Operating Income = Revenue - COGS & Other operating expenses
EBITDA = EBIT + D&A
- take D&A from the CFS
(*to get the all-inclusive #. D&A from IS is often embedded fully or partially in other line items)
EBITDA & EBIT calculations/multiples ==> diffs under GAAP & IFRS?
- GAAP: both EBIT/EBITDA fully deduct Lease or Rental Expense
- IFRS: do not deduct Lease or Rental Expense
–> Lease Expense = split into Int & Depreciation elements
==> under IFRS: EBIT deducts PART OF Lease expense, while ebitda ADDS BACK OR EXCLUDES entire lease expense
FCFs - how to calculate? what does it mean? when do you use it?
= CF from Operations - CapEx
(assuming that CFO deducts net int expense, taxes, and full lease expense)
- tells you how much debt principal co could repay, how much it could spend on acqs, dividends, stock repurchases
- use in: standalone co analysis & determining co’s ability to repay debt
FCF Valuation metrics - drawbacks? why use EBIT/EBITDA metrics instead of FCF?
1) convenience and 2) comparability
(+) FCF / UFCF: measure co’s CFs more accurately
(-) take more time to calculate (need to review full CFS & possibly make adjustments)
(-) items w/in FCF can differ b/t co’s, regions, industries, accounting systems ==> would need to normalize
P/E multiple - why use Net Income to Common rather than Net Income?
- don’t create multiples that are based on metrics in BETWEEN Eqv & TEV
- If you use net income, rather than net income to common, would have to use eqV + pref stock in the numerator (halfway to TEV, but missing adjustments for debt, cash, etc.)
FCF multiple - pair w/ TEV or EqV?
- If FCF metric DEDUCTS Net Interest Expense (ex: FCF or Levered FCF) –> eqV
- If FCF does NOT deduct Net Interest Expense (ex: Unlevered FCF) –> TEV
Advantages/disadvantages of these multiples:
1) P/E
2) TEV/EBITDA
3) TEV/EBIT
TEV/EBITDA & TEV/EBIT =
(+) capital structure neutral. Won’t change when co’s capital structure changes.
EBITDA: (-) doesn’t account for capex. (+) closest to free cash flow proxy.
–> better in cases when you want to exclude Capex/cap structure completely.
==> more about normalizing companies. better in industries where capex is not a huge value driver.
EBIT: (+) accounts for capex. (-) further than FCF than EBITDA
–> better when you want to ignore cap structure, but partially factor in capex
==> better when you want to link capex to co’s value (ex: industrials company)
P/E =
(-): affected by cap structures, diff tax rates, non-core biz activities => not useful in most cases.
(+): SHs care about this.
TEV/EBITDAR - how to adjust TEV?
- TEV: add back co’s balance sheet operating leases
*rationale: if denom EXCLUDES OR ADDS BACK an expense on the IS, then numerator should ADD BS item corresponding to that expense
EBITDAR = EBITDA + Rental Expense ==> so, adds back rental expense
–> TEV: add back on-BS Operating Leases
If ebitda decreases, how do unlevered FCF & levered fcf change?
- both would decrease. the operating income that flows into both of them will be lower
- if ebitda decreased: would mean either revenue has decreased or cogs/opex have increased
technically: fcf could stay the same if changes in d&a, change in WC or capex offset drop in operating income
–> but decrease in op income will also reduce ufcf and lfcf, assuming everything else stays the same
Diff ways to calculate Unlevered fcf?
STARTING W REVENUE:
REVENUE
- cogs & other operating expenses
= ebit
*(1-tax rate)
+ d&a (& possibly other non-cash adj)
+/- change in WC
- capex
= Unlevered FCF
STARTING W EBITDA:
(EBITDA-D&A)
* (1-tax rate)
+ d&a (& possibly other non-cash ad)
=- change in WC
- capex
Starting w/ CFO:
CFO
- (Net Interest Expense & Other Items b/t Op Income and Pre-Tax Income)
*
(1-Tax Rate)
- Capex
EBIT * (1-Tax Rate) to calculate unlevered FCF - intuition?
- ignoring the tax shield from the interest expense
- b/c: if you’re ignoring the co’s cap structure (UNLEVERED FCF) –> have to ignore everything RELATED TO CAP STRUCTURE (so, have to also ignore tax benefits from interest if you’re going to exclude interest)
Forward multiples
- based on projections for metrics
- DO NOT project TEV/EqV; rather use each co’s CURRENT eqV/TEV and divide them by the metrics (both historical and projected)
Why do you never project TEV/EqV?
current eqV/TEV represent past performance AND market’s future expectations for that co
Cash - portion of cash balance as an “operating asset”
-there is a portion of any co’s cash balance is an “operating asset” b/c co needs a min amount of cash to continue running its business
- so, technically should only subtract EXCESS cash (above this min amount) when moving from eqV to TEV. but since co’s don’t really disclose this #, and it varies widely bt diff industries, everyone subtracts the whole cash balance
Goodwill - EqV to TEV bridge
- is NOT subtracted when moving from EqV to TEV
- Goodwill is considered an operating asset ==> considered part of co’s “core biz” -
*intuition: goodwill reflects premiums paid for previous acqs –> if subtracted, would be saying previous acqs are NOT part of co’s core biz anymore
- would only subtract, then, if co has shut down or sold those companies ==> have to remove all As & Ls associated
DTAs (Deferred Tax Assets) - do you subtract when calculating TEV?
- only subtract NOLs - considered non-operating asset. less related to ops than rest of items in a DTA (Ex: diffs in timing; tax credits for operational items)
Working Capital - EqV to TEV bridge?
- not factored into eqV to TEV bridge
EqV = net assets
TEV = net operating assets
All WC items = both net asset & net operating assets –> DON’T adjust anything. Both eqV & TEV include full value of TEV
Equity Investments (ex: Associate Companies) - EqV to TEV?
Subtracted when moving from EqV to TEV.
(Added when moving from TEV to EqV)
- 1) Equity Investments are NON-operating Assets: the parent co only has a minority stake, not a controlling stake, in these co’s.
- 2) Comparability - to match denom metrics that exclude equity investments: denominator financial metrics (ex: EBITDA, EBIT, Revenue) do not include any of these co’s financial contributes. –> do not include in a TEV multiple. But, EqV implicitly includes value of this stake.
Non-controlling Interests - EqV to TEV?
Added when moving from EqV to TEV
(Subtracted when moving from TEV to EqV)
1) non-controlling Interests represent another investor group beyond the common SHs: the min SHs of the other co in which parent co owns a majority stake in.
- Parent co effectively controls this other co now ==> counts these min owners as an investor group
2) add NCI for comparability reasons:
- when parent co owns majority take in other co –> financial statements are 100% consolidated.
- so, financial metrics paired w TEV (EBITDA, Revenue, EBIT) represent 100% of financials from both co’s
- corresponding numerator metric (TEV) should then add the stake NOT owned by parent co (NCI) so that TEV reflects 100% of other co’s value
==> ensures multiples include 100% of other co in both num & denom
BS Operating Leases - eqV to TEV bridge?
- GAAP: can either add or ignore. but if added, have to pair TEV including Op Leases w/ EBITDAR. CAN’T use EBIT & EBITDA anymore b/c these deduct the full rental expense
- IFRS: Add op leases in TEV bridge b/c EBITDA already exclude I&D elements of Lease Expese
Pensions - effect on TEV calculation?
*ADDED in TEV bridge - only the unfunded portion
- intuition: employees = “another investor group” here - exchanged lower salaries/benefits presently for future promised payments in retirement
- similar to debt, but over much longer time frame
Basic EqV vs. Diluted EqV
- basic eqV = shares oustanding * market value
- diluted eqV = includes the effect of dilutive securities (ex: options, warrants, RSUs, convertible bonds) in the share count –> larger # of shares
==> diluted shares outstanding * market value - means that existing SHs ownership stake in the co is “diluted” or gets smaller, as # of shares increases
–> more accurate measure of what co’s net assets are worth to common SHs
Convertible bonds - do you use TSM?
No, b/c investors don’t pay the co to convert the bonds into shares. they paid for the bonds upon first issuance.
Q:
Why cant we use Equity Value/EBITDA multiple but use Enterprise Value/EBITDA multiple?
Q:
How do you get to share price from your enterprise value?
Q:
Rank EV/Rev, EV/EBITDA, EV/EBIT from largest to smallest
Q:
Why would two similar companies be trading at different multiples?
Q:
What is NOL? How does it affect Enterprise/Equity value?
Net Operating Losses are a non-operating asset. It is included in EqV, but is not included in TEV, which only reflects operating assets. So, when moving from eqV to TEV, should subtract NOLs.
EBIT/EBITDA margins
EBITDA margin = EBITDA/sales
EBIT margin = EBIT/sales
- Both are net income margins: measure co’s OVERALL profitability (rather than operating profitability)
- does not include interest expense, so is not affected by capital structure
A company issues $200 of Debt to fund a $200 Equity Purchase Price acquisition of a company with $150 in Common Shareholders’ Equity. How do Equity Value and Enterprise Value change, considering that the acquirer must create Goodwill?
The $50 of Goodwill here does not affect anything because Goodwill is an Operating Asset. $200 of Acquired Company Assets vs. $150 of Acquired Company Assets and $50 of Goodwill make the same impact on both Eq Val and TEV. This $200 Debt Issuance does not affect CSE, so Eq Val stays the same. TEV increases by $200 because NOA increases by $200 (Operating Assets increase by $200, and no Operating Liabilities change).
If EBITDA decreases, how do Unlevered FCF and Levered FCF change?
EBITDA = Revenue – COGS – Operating Expenses Excluding D&A.
If EBITDA decreases, it means that Revenue has dropped, or that COGS or Operating Expenses have increased.
Unlevered FCF and Levered FCF also add and subtract all these items, plus more. As a result, both Levered FCF and Unlevered FCF will also decrease since the Operating Income that flows into both of them will be lower.
Technically, the FCF figures might stay the same if changes in D&A, the Change in Working Capital, or CapEx offset the drop in Operating Income. But that’s not the main point of the question; the point is that a decrease in Operating Income will also reduce UFCF and LFCF, assuming everything else stays the same.
