Equity Value, Enterprise Value, and Valuation Metrics and Multiples

Question 1

What is Enterprise Value? How is it impacted by changes in capital structure?

Answer 1

Value of the core cash flows that belongs to all providers of capital

BIWS: the value of a company’s core business operations (Net Operating Assets (Operating Assets - Operating Liabilities) to ALL the investors in the company

EV excludes non-operating assets such as cash and financial investments and non-operating liabilities such as debt

EV is will not change - or at least, not by as much - due to changes in capital structure.

Question 2

What is Net Debt?

Answer 2

Total Debt - Cash (because theoretically can use the cash to pay off debt)

Question 3

What is Equity Value? How is it impacted by changes in capital structure?

Answer 3

Residual (or leftover after company satisfies other obligations to debt holders, etc.) claim that equity investors have on the value of the business

BIWS: The value of everything a company has (Net Assets (Total Assets - Total Liabilities)) but only to Equity Investors (common shareholders).

aka Market Capitalization or Market Cap and = Current Share Price * Shares Outstanding

Equity Value changes with changes in capital structure (i.e.: changes in CSE).

Question 4

Walk through the formula to get to Enterprise Value from Equity Value/Explain the Eq Val to EV bridge.

Answer 4

Simple Answer: Eq Val minus cash plus debt = Enterprise Vale

Follow-Up Answer: Plus Preferred Stock and plus NCI

Advanced Answer: Less Equity Investments and Plus Capital Leases

BIWS: EV = Equity Value - Non-Operating Assets + Liabilities and Equity Items that Represent Other Investor Groups (i.e.: besides Common Shareholders)

Question 5

A CEO picks up $100 up off the street. How does this affect Equity Value and Enterprise Value?

Answer 5

Simple Answer: Equity Value: Increases by $100 and Enterprise Value: No Change (increase in Equity Value is offset by subtracting $100)

Follow-Up (i.e.: what about taxes): Eq Value increases by $75 ($100 recognized as Extraordinary Gain on Income Statement) and EV does not change (because no change in NOA)

Question 6

What are Enterprise Value Multiples?

Answer 6

Express the value of an entire enterprise - the value of all claims on a business - relative to a statistic that relates to the entire enterprise such as sales or EBITDA

Question 7

What are Equity Value Multiples?

Answer 7

Express the value of shareholders’ claims on the assets and cash flow of the business relative to a statistic that also applies to shareholders only such as earnings/Net Income (the residual left after payments to creditors, minority shareholders, and other non-equity claimants)

Question 8

A company’s EV/LTM EBITDA multiple is higher than the company’s EV/NTM EBITA Multiple. What does this mean?

Answer 8

This likely means that the company’s EBITDA is growing (because the numerator is static and the denominator is getting bigger which is reducing the EV/EBITDA multiple).

Question 9

You have a company with an EV/Revenue of 3x and an EV/EBITDA of 10x. What is the EBITDA margin?

Answer 9

EBITDA Margin = EBITDA / Revenue

Can plug in numbers to solve: Let EV = 30, then Revenue = 10 and if EV = 30, then EBITDA = 3 and so EBITDA / Revenue = 3 / 10 = 30%

Question 10

What is a multiple? What are the main drivers of a multiple? What does a higher multiple indicate?

Answer 10

Shorthand for a DCF or full valuation. Forward-looking and driven by investors’ expectations for the future.

Drivers include growth profile, cash conversion/profitability (the ability of the company to translate EBITDA into cash flow - efficiency), and return on capital/risk.

If a company has a higher expected growth rate than the other companies in the comparison set, then it should trade at higher multiples

Higher multiples indicate that you would be willing to pay more the company if its cash flows were growing more quickly

Question 11

If a company’s Eq Val > EV what does that mean?

Answer 11

The company has a lot of cash - Cash > Debt

Question 12

Can a company have negative Equity Value? Can a company have a negative Enterprise Value?

Answer 12

Yes. BV of Equity can be negative (i.e.: if liabilities are greater than assets, negative net assets, etc.)

But also no, because MV of Equity = # of shares outstanding * share price
^ neither of which will ever be negative

EV can be negative (for example, Equity Value = $100 million - cash of $200M and no debt)

Question 13

What is Market Value?

Answer 13

What the company is worth right now according to the stock market, its current owners, or its current investors.

Question 14

What is Implied or Intrinsic Value?

Answer 14

What the company should be worth according to a certain set of views and analysis.

Question 15

Why does Market Value often differ from Intrinsic or Implied Value?

Answer 15

Primary Reason: Differences in beliefs re: the company’s future growth - future growth rate expectations.

Secondary Reason: Disagreement on discount rate, company’s cash flows, etc.

Question 16

What are the three main methods for calculating Equity Value?

Answer 16

1. For Publicly Traded Companies: Shares Outstanding * Current Share Price
2. MV of Total Assets - MV of Total Liabilities (technically everything on the L&E side except for CSE)
3. For Private Companies: Company’s valuation in its last round of funding or its valuation in an outside appraisal (or its most recent acquisition price, etc.)

Question 17

Cash is a Non-Operating Asset. What is a Non-Operating Asset and what some examples of other Non-Operating Assets?

Answer 17

Non-Operating Assets are assets that the company does not need in order to sell/deliver products/services to the customer. Examples include:

Financial Investments such as bonds and stocks

Owned/Rental properties from which the company generates rental income (vs. using the properties internally and generating no income from them)

Side Businesses (that earn income for the company)

Assets Held for Sale and Assets from Discountinued Operations

Equity Investments or Associate Companies (which are assets that represent minority stakes in other companies; these assets are non-core because own less than 50% and therefore cannot control them)

NOLs (which are a component of DTAs; considered non-operating because not required to run the business/sell and deliver products/services)

Question 18

Debt and Preferred Stock are both “Liability and Equity Line Items That Represent Other Investor Groups”. What other items are included in this category?

Answer 18

Capital Leases (which are debt-like obligations with interest payments that are used to acquire PPE)

Noncontrolling Interests (which represent the unowned portions of majoirty-owned companies)

Unfunded Pensions (which equals Pension Liabilities - Pension Assets)

(Potentially) Operating Leases

Question 19

What are Noncontrolling Interests and why are they considered another investor group?

Answer 19

NCI represents the unowned portions of majority-owned companies.

If Company A owns 80% of Company B, it will consolidate Company B’s financials with its own but also record a NCI for the 20% of Company B that it does not own (on the L&E side of the B/S under Equity).

If a company owns more than 50% of another company, it has effective control of that other company and can draw on all of its resources, including those linked to the minority shareholders of this company. The minority shareholders in that other company effectively become an investor group.

Question 20

True or False: Financing Events do not impact Enterprise Value.

Answer 20

True.

Issuing Debt: No impact on EV because cash and debt both increase and offset each other

Repaying Debt: No impact on EV because cash and debt both decrease and offset each other

Issuing Stock: No impact on EV because cash and equity value both increase and offset each other

Repurchasing Stock: No impact on EV because cash and equity value both decrease and offset each other

Issuing Dividends: No impact on EV because cash and equity value both decrease and offset each other

NOA do not change in any of the above examples. Cash, Debt, and common stock are all non-operating. EV only changes if a company’s NOA changes (i.e.: increase in PPE, Inventory, Deferred Revenue, etc.).

Question 21

What items affect CSE?

Answer 21

Dividends, Net Income, Stock Issuances and Repurchases

Question 22

What is Unlevered Free Cash Flow?

Answer 22

Cash Flow available to ALL investors in the firm.

aka Free Cash Flow to Firm

Question 23

What is WACC?

Answer 23

WACC is equal to the cost of each part of a company’s capital structure times the percentage of capital in that part

If a company raises additional debt or equity, repays debt, or repurchases stock, its WACC will change

Question 24

Why is Debt cheaper than Equity?

Answer 24

Debt holders expect lower returns than equity holders (because they earn only a fixed interest rate and there’s no upside potential).

Interest Expense is also tax-deductible, making it less expensive to pay.

Question 25

True or False: If a company continues to take on more and more debt, both the cost of equity and the cost of debt will increase.

Answer 25

True.

Question 26

What are dilutive securities?

Answer 26

Securities that could potentially create more shares if a company’s share price reaches certain levels

Question 27

What are Convertible Bonds?

Answer 27

An alternative form of debt where the company pays much lower interest rates in exchange for giving the bondholders the option to “convert” their bonds into new shares in the future - if the company’s Share Price reaches a certain level (the “Conversion Price”).

The Conversion Price is usually a modest premium to the company’s current share price such as 20-30%

For companies, convertible bonds are cheaper debt and for investors, convertible bonds are hedged equity (i.e.: if a company’s share price falls or stagnates, the investors will probably get their principal back, creating some downside protection)

Question 28

What are Restrictued Stock Units (RSUs)?

Answer 28

RSUs are like normal shares of the company, but they have restrictions on when employees can receive them and when they can sale them

“Incentive compensation” granted to employees, usually with requirements that employees stay for a certain number of years before they can receive or sell the shares

Varies from Restricted Stock because RS is usually included in the company’s Common Share Count (therefore you can ignore normal Restricted Stock); there are also legal and tax differences

Question 29

What is the Treasury Stock Method (TSM)?

Answer 29

If current share price exceeds exercise price, employees pay the company exercise price * # of options to exercise the options and receive one new share per option

Company then uses proceeds to repurchase some of the newly created shares at the same current share price

Question 30

A company’s current share price is $20. It has 10M shares and 1M option with an exercise price of $10. What is its Diluted Equity Value?

Answer 30

Assume that 1M new shares get created (because in the money - $20 > $10).

The company receives $10M in proceeds (1M * $10)

The company buys back 500,000 shares ($10M / $20)

So 500,000 newly shares outstanding

Diluted Equity Value = 10M + 50,000 = 10.5M * $20 = $210M

Question 31

What are Performance Shares or Stock Appreciation Rights?

Answer 31

Another class of restricted securities that may create dilution but the restriction here is a “performance goal” rather than time

Question 32

What is Diluted Equity Value?

Answer 32

Current Share Price * Diluted Shares Outstanding

Diluted Eq Value doesn’t “mean” anything specific it is just a more accurate calculation.

Question 33

What are some common valuation multiples?

Answer 33

TEV / Revenue

TEV / EBIT

TEV / EBITDA

P / E (which is Equity Value / Net Income or Price per share / Earnings per share)

Question 34

True or False: EBIT, EBITDA, EBITDAR, and Net Income all measure a company’s profitability, and the corresponding valuation multiples measure the company’s price in relation to its profits

Answer 34

True

Question 35

What does TEV / Revenue measure?

Answer 35

The company’s price in relation to its sales

Question 36

True or False: When you use EBITDAR, you must add Operating Leases to Enterprise Value and count them as another investor group.

Answer 36

True

Question 37

What are the 5 aspects by which EBIT, EBITDA, EBITDAR and Net Income vary?

Answer 37

1. To whom the money is available
2. OpEx vs. CapEx
3. Rent/Lease Expense
4. Interest, Taxes, and Non-Core Business Activities
5. When They’re Useful (i.e.: want to reflect the impact of CapEx vs. not, etc.)

Question 38

When is a revenue-based multiple most useful?

Answer 38

When the company has negative EBIT or EBITDA

Question 39

When is EBIT most useful?

Answer 39

If CapEx is very important for the company or CapEx drives value in the sector.

EBIT is sometimes closer to FCF (CFO - CapEx)

Question 40

When is EBITDA most useful?

Answer 40

When CapEx is less significant or you want to normalize otherwise similar companies that have different CapEx and D&A policies

EBITDA is sometimes closer to CFO because both metrics completely exclude CapEx

Question 41

When is EBITDAR most useful?

Answer 41

To normalize companies with different types of leases (and also companies using IFRS vs. US GAAP)

Question 42

When is Net Income most useful?

Answer 42

NI is not great for comparing companies and it’s also not great for approximating their cash flows, so its useful mostly as a very quick metric that requires no calculation

Question 43

What is EBIT a proxy for?

Answer 43

Core, recurring business profitability before the impact of capital structure and taxes

Ultimately an approximation for a company’s discretionary cash flow

Question 44

What is EBITDA a proxy for?

Answer 44

Core, recurring business CFO before the impact of capital structure and taxes

Ultimately an approximation for a company’s discretionary cash flow

Question 45

What is Net Income a proxy for?

Answer 45

Profit after taxes, the impact of capital structure (interest), and non-core business activities

Question 46

What is discretionary cash flow?

Answer 46

Discretionary cash flow is the money from business operations left over once all capital projects (i.e.: CapEx) have been funded and required payments such as wages have been made.

Discretionary cash flow can be used to pay cash dividends, provide bonuses to employees, buy back common stock, and pay down debt.

Discretionary cash flow is a helpful metric, because it can be used to assign a value on a business when buying or selling it.

It reflects how much cash flow the company’s core business is generating on a recurring, predictable basis

Question 47

On what two basis do the three main types of FCF differ?

Answer 47

1. Investor Groups (i.e.: discretionary cash flow avilable to all investors vs. equity investors, etc.)
2. Treatment of Debt (i.e.: deduct debt principal repayments, etc.)

Question 48

What is Unlevered Free Cash Flow (UFCF)?

Answer 48

aka Free Cash Flow to the Firm (FCFF)

Discretionary cash flow available to ALL investors (i.e.L how much discretionary CF the company generates before interest expense and debt principal repayments)

UFCF = NOPAT + D&A and sometimes other non-cash adjustments +/- Change in Working Capital - CapEx

Question 49

What is NOPAT?

Answer 49

Net Operating Profits After Taxes

NOPAT = EBIT * (1 - Tax Rate)

Question 50

Which cash flows are only available to equity holders?

Answer 50

Free Cash Flow (which is equal to CFO - CapEx)

Levered Free Cash Flow (LFCF) aka Free Cash Flow to Equity (FCFE)

Question 51

What is the difference between FCF and LFCF?

Answer 51

FCF does not deduct debt repayments or add debt issuances

FCF = CFO - CapEx

LFCF = Net Income to Common + D&A and sometimes other non-cash adjustments =/- Change in Working Capital - CapEx - Debt Repayments + Debt Issuances

Question 52

What are the two main differences between Levered FCF and Unlevered FCF?

Answer 52

1. Net Income to Common is the starting point, not NOPAT for Levered FCF
2. Debt Repayments and Debt Issances are factored into Levered FCF

LFCF = Net Income to Common + D&A and sometimes other non-cash adjustments +/- Change in WOrking Capital - CapEx - Debt Repyaments + Debt Issuances

Question 53

True or False: Unlevered FCF correspond to EV and Levered FCF corresponds to Equity Value

Answer 53

True

Question 54

What are some valutation multipes for FCF, UFCF and LFCF?

Answer 54

Equity Value / FCF or P/FCF per Share

EV / UFCF

Equity Value / LFCF or P/LFCF per Share

Question 55

What does FCF mean?

Answer 55

Represents how much discretionary CF the company generates after interest but before debt principal repayments)

Question 56

What does Levered FCF mean?

Answer 56

Represents how much discretionary CF the company generates after servicing all of its debt-related expenses

Question 57

What is Book Value?

Answer 57

Total Assets - Total Liabilities

Pairs with Equity Value (i.e.: Equity Value / Book Value or P / BV, etc.)

Question 58

What is EV/ IC

Answer 58

Tells you have valuable a company is relative to the cumulative capital amount it has raised or generated over time/how efficiently a company is using its capital

Question 59

What is P/BV?

Answer 59

Tells you how efficiently a company has used its equity (both internally and externally generated)

Useful metric for commercial banks and insurance firms, which are balance sheet driven

Question 60

Why are forward multiples useful? How do forward multiples compare to historical multiples if the company is growing?

Answer 60

Represent consensus expectations for a company

Forward multiples should be lower (because higher denominators such as EBITDA, etc.)

Question 61

What are some challenges with valuation multiples?

Answer 61

1. Valuation multiples are usually based on I/S metrics like Revenue, EBIT, EBITDA, etc., but the company’s value depends on CF and CF growth rate
2. Discount Rates aren’t always the same (which is what valuation multiples assume)
3. Non-financial factors affect valuation multiples (i.e.: a lawsuit expense could plummet stock price, thereby reducing valuation multiple, even though nothing about the company’s expected long-term performance has changed)