Enterprise Valuation and Equity Valuation

Enterprise Valuation and Equity Valuation

Sarah Martin

30 years: Corporate Valuations

In the previous video, Sarah introduced the free cash flow perpetuity formula, derived the key value driver formula and showed how it is used to arrive at a valuation. In this video she makes the distinction between enterprise value (EV) and equity value.

In the previous video, Sarah introduced the free cash flow perpetuity formula, derived the key value driver formula and showed how it is used to arrive at a valuation. In this video she makes the distinction between enterprise value (EV) and equity value.

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Enterprise Valuation and Equity Valuation

10 mins 5 secs

Overview

Enterprise value (EV) is the total value of the whole asset or whole business. Equity value is the value of the business to its owner. Every firm has a different capital structure, different types of shareholders and debt structure. It is not always straightforward to arrive at a correct valuation. It is important to understand the difference between enterprise and equity valuation and adjustments we need to make.

Key learning objectives:

  • Understand the difference between enterprise value (EV) and equity value

  • Understand the complication in calculating valuations because of NCIs

  • Understand the complication in calculating valuations due to different classes of shares

  • Understand the complication in calculating valuations due to the definition of net debt

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Summary

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.

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Sarah Martin

Sarah Martin

Sarah Martin has a degree in economics from the London School of Economics and stock exchange and regulatory qualifications from London and New York. She has worked in investment banking for 17 years, as well as private equity transactions and as an expert witness in financial trials. She became a financial trainer 15 years ago and specialises in credit, distressed debt, and valuation. Recent assignments have included the European Central Bank, the European Investment Bank, the EBRD, Gibbs Business School in Johannesburg, the Bahrain Institute of Business Finance, the Bank of China, BBVA, the African Development Bank, Siemens, Carnegie Bank, Rand Merchant Bank, the Hamburg Central Bank, and Mizuho Bank.

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