Enterprise Valuation and Equity Valuation

What do we mean by enterprise value and how does it differ from equity value?

To understand the difference between equity value and enterprise value, we can refer to the following example. If we own a house, the enterprise value is the market value of the house, let’s say $1mn - this is the enterprise value. If we deduct the mortgage of $700k, the value to the owner (equity value) is $300k. 

So, enterprise value equals equity value plus net debt and equity value equals enterprise value less net debt.

What are some of the complications in calculating equity and enterprise value?

• Dealing with non-controlling interests
• Different classes of shares
• Definition of net debt 

Dealing with NCIs

NCIs represent minority shareholders in the subsidiaries or opcos under a top holdco. If an opco with a NCI is profitable, then the value of that opco to the holdco shareholders is reduced because the holdco shareholders have to share the opco profits with the NCI.  Moreover, when the opco upstreams dividends to the holdco, it will have to pay pro-rata dividends to the NCI - hence when there are NCIs in profitable opcos, the equity of the holdco is reduced. 

This issue is usually prevalent when dealing with a publicly listed group, the equity market capitalisation of the holdco shows the valuation of the group after deduction of the value attributable to the NCI.  Hence, themarket capitalisation does not show 100% of the equity value of the group.  However, it can be problematic to work out the market value of the NCI. It is very rarely the book value and if the NCI are in multiple opcos, it can be even more difficult. NCI valuations are also complicated by discounts for illiquidity and lack of control.

Different classes of shares

The second issue in working out the correct market value is that the firm may have issued different classes of equity in the holdco – this can be a problem for both listed and private firms. The market capitalisation is based on the traded non-voting shares and does not reflect the value of the voting shares, valued at a premium. Therefore, to estimate the full equity value of a group in this situation, we need to estimate the premium of the non-traded voting shares to the traded non-voting shares and multiply by the number of non-traded voting shares and then add the result to the market capitalisation.

Dealing with net debt calculations

Many firms have complex capital structures, off balance sheet liabilities and quasi-debt, including pension deficits and derivative liabilities. They may also have financial assets in addition to cash and equivalents and it is arguable whether these should be included to reach net debt as net debt is not defined by either IFRS or by US GAAP.  Firms normally try to make their reported net debt look as low as possible to maximise their equity value.