Equity value is
- otherwise known as market cap
Share price of company x total number of shares
Basically asks - how much is this company worth
What is enterprise value
Enterprise value is the TRUE price to buy the company, not the sticker price.
What factors may make enterprise value different to equity value
- debt to repay on acquisition
- company may have excess cash we can claim
- company may have unfunded pension obligations and other liabilities we’ll have to repay at some point
So what do we really add and subtract to find enterprise value
Add anything we’re going to have to set aside funds to pay off in the future.
Subtract anything that can save us money in the future.
Enterprise value formula
= equity value + debt + preferred stock + NCI - cash+cash equivalents
Why can calculating exact number of shares be tricky
Due to dilutive securities
A security is dilutive if it could potentially create more shares.
What is a call option
Gives someone ability to pay the company money and get a newly created share in return
Call option example
Stock worth 10, exercise prices 5.
Out of the money means exercise price> stock price
In the money means exercise price < stock price
- but may wait to exercise in the money options due to expectations of future value
So how to calculate the impact of diluted shares
Use the treasury stock method - TSM
You assume that the new shares greater when options are exercised and that the company then buys back some of those new shares with the funds it receives
Assumption with TSM
Assume all the in the money options contribute to the dilution
Other types of common dilutive securities
Warrants - use TSM
Convertible bonds - treatment is either: they count as debt, or count 100% as additional shares
Convertible preferred stock - same as convertible bonds
Restricted stock units - straight addition
Performance shares - above a certain level, additional shares.
Why use diluted equity value
- to see what it would really cost to acquire a company
When you buy another company, the purchase agreement normally states that any in-the-money dilutive securities get cashed out or converted into an equivalent number of buyer’s securities.
Either scenarios would cost buyer when it acquires the company.
When do you subtract an item
- Normally when it saves you money or potentially gives you extra cash, either immediately or in the long-term
E.g - cash, ST, LT and equity investments (could sell and get extra cash), net operating losses
When do you add an item
- When it represents some thing that must be paid immediately upon acquiring the company.
- When its something that must be repaid in the future, but wouldn’t come from the company’s normal cash flows e.g. unfunded pension obligations
- When you’re adding it back for comparability purposes, e.g. NCI
E.g. - unfunded pension obligations, capital leases, restructuring liabilities
Why add back NCI
You add these because when you own over 50% of another company, you consolidate 100% of its financial statements with your own, equity value only reflects the value of the % you own not 100%.
So you need to reflect 100% of that other company in entreposé value, if you didn’t add NCI, only be reflecting 60, 70% or however much you own
NCI example
Revenue is £100, and you own 70% of a company worth 50£ in revenue.
- statement shows £150 in revenue because you consolidate 100% of the statements.
- equity value, by itself, only reflects the 70% of the other company that you own
Enterprise value would be wrong because we would have 100% of the other company’s revenue, but only 70% of its value so numerator and denominator wouldn’t match - enterprise value/revenue
When to use equity or enterprise value
If the denominator includes interest income and expenses, use equity value
If denominator does not include interest income and expense, use enterprise value
Enterprise value /
Revenue
EBITDA
EBIT
Free cash flow to firm
Equity value/
Net income
Free cash flow to equity
