Error Log EV & Equity Value IBV Flashcards
How does ____ affect Enterprise Value?
Raise $200m in Debt, use cash to buy a new piece of equipment.
Go through each item in the equity bridge.
EV up by 200
Enterprise Value = Equity Value + Debt + Preferred Stock + Non controlling interests - Cash and Cash Equivalents
+200m Debt
-200m Cash from Debt
+200m Cash from Purchase (subtract a negative amount = add)
So plugging that into the Enterprise Value equation, Enterprise Value would go up by 200m (since cash is subtracted)
How does ____ affect Enterprise Value?
Issue $200m in Equity for an IPO.
Go through each item in the equity bridge.
Enterprise Value = Equity Value + Debt + Preferred Stock + Non controlling interests - Cash and Cash Equivalents
+200 Equity Value
-200 Cash (increase in cash is subtracted from EV)
EV unchanged
Would you rather buy a company with a high or low P/E multiple?
What does the P/E ratio indicate?
Generally, would rather buy low and sell high, so would want to buy one with a low P / E multiple that increases over time.
Remember, P / E signifies how much investors are willing to pay per $1 of earnings.
What characteristics of a company would generate a higher valuation multiple?
This premium in valuation corresponds to a greater interest in the company’s stock, suggesting that the company has a competitive advantage over its peers. The most common characteristics that lead to this presumed competitive advantage / a higher valuation multiple include:
● Higher growth projections than peers
● Market leadership / economic moat
● Access to proprietary information or key patents
● Geographic superiority or access to geographically limited resources
● Key personnel such as talented upper management
Why do you subtract cash in the formula for Enterprise Value? Is that always accurate?
The “Official” reason:
Cash is subtracted from Enterprise Value because it is considered a non-operating asset and because Equity Value implicitly accounts for it.
Alternative way to think about it:
- 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 would really have to “pay” to acquire another company.
- It’s not always accurate because technically you should be subtracting only excess cash - the amount of cash a company has above the minimum cash it requires to operate.
Is it always accurate to add Debt to the Equity Value when calculating Enterprise Value?
In most cases you should add debt to the Equity Value when calculating Enterprise value because the terms of a debt agreement usually say that debt must be refinanced in an acquisition.
In most cases a buyer will pay off a seller’s debt so it is accurate to say that any debt “adds” to the purchase price.
However there could always be exceptions where the buyer does not pay off the debt but they are super rare.
Could a company have negative Enterprise Value? What would that mean? And where could you see it?
Yes, a company can have negative Enterprise Value.
This can mean that the company has an extremely large cash balance, or an extremely low market capitalization (or both). You see it with:
1) Companies on the brink of bankruptcy
2) Financial institutions, such as banks, that
have large cash balances.
Why do we add Preferred Stock to get to Enterprise Value?
Preferred Stock is added to get to Enterprise Value because:
1) Preferred Stock pays out a fixed dividend; and
2)preferred stock holders 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.
Can you describe a few of the additional items that might be a part of Enterprise Value, beyond Cash, Debt, Preferred Stock, and Noncontrolling Interests, and explain whether you add or subtract each one?
Everyone agrees that Cash should be subtracted and Debt should be added when calculating Enterprise Value, but when you get to more advanced items, treatment varies greatly between different banks and different groups.
A more “complete” formula might be: Enterprise Value = Equity Value - Cash + Debt + Preferred Stock + Noncontrolling Interests - NOLs - Investments - Equity Investments + Capital Leases + Unfunded Pension Obligations and Other Liabilities.
Wait a second, why might you add back Unfunded Pension Obligations but not something like Accounts Payable? Don’t they both need to be repaid?
The distinctions are magnitude and source of funds. Accounts Payable, 99% of the time, is paid back via the company’s cash flow from its normal business operations. And it tends to be relatively small.
Items like Unfunded Pension Obligations, by contrast, usually require additional funding (e.g. the company raises Debt) to be repaid. These types of Liabilities also tend to be much bigger than Working Capital / Operational Asset and Liability items.
Are there any exceptions to the rules about subtracting Equity Interests and adding Noncontrolling Interests when calculating Enterprise Value?
You pretty much always add Noncontrolling Interests because the financial statements are always consolidated when you own over 50% of another company.
But with Equity Interests, you only subtract them if the metric you’re looking at does not include Net Income from Equity Interests (which only appears toward the bottom of the Income Statement).
For example, Revenue, EBIT, and EBITDA all exclude revenue and profit from Equity Interests, so you subtract Equity Interests.
But with Levered Free Cash Flow (Free Cash Flow to Equity), typically you’re starting with Net Income Attributable to Parent… which already includes Net Income from Equity Interests.
Normally you subtract that out in the CFO section of the Cash Flow Statement so you would still subtract Equity Interests if you calculate Free Cash Flow by going through all the items in that section.
But if you have not subtracted out Net Income from Equity Interests (if you’ve used some other formula to calculate FCF), you should not subtract it in the Enterprise Value calculation - you want to show its impact in that case.
How do you factor in Convertible Preferred Stock in the Enterprise Value calculation?
The same way you factor in normal Convertible Bonds: if it’s in-the-money, you assume that new shares get created, and if it’s not in the money, you count it as Debt.
