Equity Value & Enterprise Value - Advanced Flashcards
Are there any problems with the Enterprise Value formula you just gave me?
Yes – it’s too simple. There are lots of other things you need to add into the formula with real companies:
- Net Operating Losses – Should be valued and arguably added in, similar to cash.
- Long-Term Investments – These should be counted, similar to cash.
- Equity Investments – Any investments in other companies should also be added in, similar to cash (though they might be discounted).
- Capital Leases – Like debt, these have interest payments – so they should be added in like debt.
- (Some) Operating Leases – Sometimes you need to convert operating leases to capital leases and add them as well.
- Pension Obligations – Sometimes these are counted as debt as well.
- Restructuring / Environmental Liabilities – Similar logic to Unfunded Pension Obligations.
So a more “correct” formula would be Enterprise Value = Equity Value – Cash + Debt + Preferred Stock + Minority Interest – NOLs – Investments + Capital Leases + Pension Obligations…
In interviews, usually you can get away with saying “Enterprise Value = Equity Value – Cash + Debt + Preferred Stock + Minority Interest”
Should you use the book value or market value of each item when calculating Enterprise Value?
Technically, you should use market value for everything. In practice, however, you usually use market value only for the Equity Value portion, because it’s almost impossible to establish market values for the rest of the items in the formula – so you just take the numbers from the company’s Balance Sheet.
What percentage dilution in Equity Value is “too high?”
There’s no strict “rule” here but most bankers would say that anything over 10% is odd. If your basic Equity Value is $100 million and the diluted Equity Value is $115 million, you might want to check your calculations – it’s not necessarily wrong, but over 10% dilution is unusual for most companies.
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.
This is a very subtle point, but you were warned: these are Advanced questions. Most bankers would probably not understand the explanation above.
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.
How do you factor in Restricted Stock Units (RSUs) and Performance Shares when calculating Diluted Equity Value?
RSUs should be added to the common share count, because they are just common shares. The only difference is that the employees who own them have to hold onto them for a number of years before selling them.
Performance Shares are similar to Convertible Bonds, but if they’re not in-the- money (the share price is below the performance share price target), you do not count them as Debt – you just ignore them altogether. If they are in-the-money, you assume that they are normal common shares and add them to the share count.
What’s the distinction between Options Exercisable vs. Options Outstanding? Which one(s) should you use when calculating share dilution?
Options Exercisable vs. Options Outstanding: Normally companies put in place restrictions on when employees can actually exercise options – so even if there are 1 million options outstanding right now, only 500,000 may actually be exercisable even if they’re all in-the-money.
There’s no “correct” answer for which one to use here. Some people argue that you should use Options Outstanding because typically, all non-exercisable Options become exercisable in an acquisition, so that’s the more accurate way to view it.
Others argue that Options Exercisable is better because you don’t know whether or not the non-exercisable ones will become exercisable until the acquisition happens.
However you treat it, you need to be consistent with all the companies you analyze.
