Enterprise Value Analysis

Enterprise value (EV) is a financial matrix reflecting the market value of the entire business after taking into account both holders of debt and equity.

Enterprise Value Analysis

INDEX

1. What is Enterprise Value?

2. Methods to Calculate Enterprise Value

✓ DCF

✓ Multiple Based Valuation/Relative Valuation

✓ EV Equation

3. Types of EV: Total, Operating and Core

4. Equity Value Versus Enterprise Value

✓ What is Equity Value

✓ Equity versus Enterprise Value

✓ Equity Value Multiples

Enterprise Value Analysis

WHAT IS ENTERPRISE VALUE?

Enterprise value (EV) is a financial matrix reflecting the market value of the entire business after taking into account both holders of debt and equity. EV, also called firm value or total enterprise value (TEV), tells us how much a business is worth.

It is the theoretical price an acquirer might pay for another firm, and is useful in comparing firms with different capital structures since the value of a firm is unaffected by its choice of capital structure. EV is one of the fundamental metrics used in business valuation, financial modeling, accounting, portfolio analysis, etc.

METHODS TO CALCULATE ENTERPRISE VALUE

Enterprise Value can be calculated using one of the following valuation methods:

➢ DCF Valuation ➢ Multiple Based Valuation/Relative Valuation ➢ EV Equation

DCF VALUATION

A DCF analysis yields the overall value of a business (i.e. enterprise value), including both debt and equity. The DCF method of valuation involves projecting FCF over the forecast period, calculating the terminal value at the end of that period, and discounting the projected FCFs and terminal value using the discount rate to arrive at the NPV of the total expected cash flows of the business or asset.

Steps in the Calculating EV from DCF Analysis:

➢ Project Free Cash Flows (FCFs) ➢ Choose a discount rate ➢ Calculate the TV ➢ Calculate the enterprise value (EV) by discounting the projected UFCFs and TV to net present value ➢ Calculate the equity value by subtracting net debt from EV

Note: For detailed DCF Analysis please refer to “DCF Valuation” document.

Enterprise Value Analysis

MULTIPLE BASED VALUATION/RELATIVE VALUATION

Enterprise Value can also be derived via EV based multiples. Some of the most commonly used EV multiples are:

➢ EV/EBITDA: is one of the most commonly used valuation metrics, as EBITDA is commonly used as a proxy for cash flow available to the firm

➢ EV/EBIT: Unlike EBITDA, EBIT recognizes that depreciation and amortization expense. When D&A expenses are small, as in the case of a non-capital-intensive company, EV/EBIT and EV/EBITDA will be similar.

➢ EV/Sales: When a company has negative EBITDA, the EV/EBITDA and EV/EBIT multiples will not be material. In such cases, EV/Sales may be the most appropriate multiple to use. However, revenue is a poor metric by which to compare firms, since two firms with identical revenues may have wildly different margins

➢ EV/NOPAT: NOPAT is post-tax EBIT. NOPAT is a more sophisticated and complete form of EBIT that allows for differences in tax efficiency and effective tax rates. If the company were all equity-financed, NOPLAT would equal earnings.

➢ EV/FCF: FCF is similar to operating cash flow but is calculated using actual working capital changes, capital spending and other non-cash adjustments.

Where:

EV = Enterprise Value

EBITDA = Earnings before Interest, Taxes, Depreciation and Amortization

EBIT = Earnings before Interest and Taxes

NOPAT = Net Operating Profit after Tax

FCF = Free Cash Flows (refer to “DCF Valuation” document for detailed calculation of FCF

One very important point to note about multiples is the connection between the numerator and denominator. Since enterprise value (EV) equals equity value plus net debt, EV multiples are calculated using denominators relevant to all stakeholders (both stock and debt holders). Therefore, the relevant denominator must be computed before interest expense, preferred dividends, and minority interest expense.

For example, an EV/Net Income multiple is meaningless because the numerator applies to equity holders and debtors, but the denominator is attributable only to equity holders. Enterprise Value Analysis

EV EQUATION

EV equals market capitalisation plus seasonally adjusted net debt, pension provisions, the value of minorities and other provisions deemed debt.

EV = Equity Value + Net Debt + Non controlling Interest + Preferred Stock - Investment in Associates

Equity Value: It is calculated as the current share price multiplied by the number of diluted shares outstanding. To calculate diluted shares, you need to first find the number of basic shares and add to that number any restricted shares and net shares resulting from the exercise or conversion of options, warrants, and convertible securities to get diluted shares outstanding.

Net Debt: Net debt is equal to total debt less cash and cash equivalents. When calculating total debt, be sure to include both the long-term debt and the current portion of long-term debt, or short-term debt. Any in-the-money (ITM) convertible debt is treated as if converted to equity and is not considered debt. When calculating cash and equivalents, you should include such balance sheet items as Available for Sale Securities and Marketable Securities, even if they are not classified as current assets on the balance sheet.

Non Controlling Interest: Also known as minority interest, it represents the interest of non controlling shareholders in the net assets of a company and is reported in the shareholders' equity section of the balance sheet.

Preferred Stock: Preferred equity that is not convertible into common stock is treated as a financial liability equal to its liquidation value and included in net debt.

Equity and liabilities 2011 2012

Shareholders’ funds Share capital Rs m 664 664 Reserves and surplus Rs m 29,124 28,538 Sub Total Rs m 29,788 29,202

Minority Interest Rs m 744 867

Non-current liabilities Long-term borrowings Rs m 21,358 20,769 Deferred tax liabilities (net) Rs m 1,560 1,714 Sub Total Rs m 22,918 22,483

Current liabilities Short-term borrowings Rs m 17,448 28,675 Trade payables Rs m 21,768 32,211 Other current liabilities Rs m 27,766 30,602 Short-term provisions Rs m 1,695 1,886 Sub Total Rs m 68,677 93,373

Total Equity and liabilities Rs m 122,126 145,925 Enterprise Value Analysis

Current assets 2011 2012 Inventories Rs m 48,425 62,181 Trade receivables 22,038 24,213 Cash and bank balances Rs m 12,150 9,732 Short term loans and advances Rs m 9,895 12,705 Other assets Rs m 196 129 Sub Total Rs m 92,704 108,959

Total Assets Rs m 122,126 145,925

Problem: From the given balance sheet, calculate enterprise value of the company. Company has 250 million shares outstanding currently trading at Rs 200 each.

Solution:

EV =Equity Value + Net Debt + Minority Interest + Preferred Capital – Investment in Associates

Equity Value =Shares Outstanding x Current Share Price

Equity Value = 250 x 200 = Rs 50,000 million

Net Debt = Long Term Borrowings + Short Term Borrowings – Cash and Cash Equivalents

Net Debt = 20,769 + 28,675 – 9,732 = Rs 39,712 million

So, what is the EV?

EV= 50,000 + 39,712 + 867 + 0 + 0 = Rs 90,579 million

Enterprise Value Analysis

TYPES OF EV: TOTAL, OPERATING AND CORE

Enterprise value comes in three flavours: total, operating and core EV, as described below.

Type Description Total The value of all the activities of the business. Includes the value of investments and associates, and non-core assets Less: Estimated market value of non-operating assets (investment and usually associates) = Operating The value of all operating activities. Total enterprise value less non-operating assets at market value Less: Non-core assets (non-operating assets and operating assets not a core activity of the business) =Core Total enterprise value less the value of non-core assets – those operations not regarded as part of core activities and which are desirable to exclude from the calculation of valuation multiples • Non-core assets include non-operating assets but may also include other trading operations which are very different in nature to the core activities of the enterprise • The exclusion of non-core assets makes the calculation of enterprise value more subjective (in most cases there is no market-determined value for the non-core assets) but it does result in more meaningful and comparable valuation multiples Source: Valuation Multiples: A Primer by UBS Warburg

Enterprise Value Typology

CORE EV OPERATING EV Total EV

NON NON OPERATING NON OPERATIN G ASSETS ASSETS CORE ASSETS Non Non Core OPERATING Core Operatin Operati g Assets ng ASSETS (CORE Assets

CORE CORE CORE and NON CORE)

ASSET ASSET ASSETS S S

Source: Valuation Multiples: A Primer by UBS Warburg

Enterprise Value Analysis

EQUITY VALUE VS ENTERPRISE VALUE

WHAT IS EQUITY VALUE?

Equity Value is another term for Market Capitalization. It is calculated as the current share price multiplied by the number of diluted shares outstanding. To calculate diluted shares, you need to first find the number of basic shares and add to that number any restricted shares and net shares resulting from the exercise or conversion of options, warrants, and convertible securities to get diluted shares outstanding.

Equity Value = Current Share Price x No. of Diluted Shares Outstanding

For example, if a company’s stock is currently trading at $100 per share and there are total 5 million shares outstanding, then equity value or market capitalisation of the company is $500 million ($100 per share x 5 million shares = $500 million).

EQUITY VALUE VERSUS ENTERPRISE VALUE

Enterprise value multiples Equity multiples Allow the user to focus on statistics where More relevant to equity valuation accounting policy differences can be minimised (EBITDA, OpFCF) Avoid the influence of capital structure on equity More reliable (estimating enterprise value value multiples involves more subjectivity, especially in the valuation of non-core assets) More comprehensive (apply to the entire More familiar to investors enterprise) Wider range of multiples possible Easier to apply to cash flow Enables the user to exclude non-core assets Source: Valuation Multiples: A Primer by UBS Warburg

Enterprise Value Analysis

EQUITY VALUE MULTIPLES

Some of the most commonly used Equity Multiples are:

➢ Price/Earnings (P/E): Current market capitalisation/net income attributable to common shareholders or alternatively, price per share/attributable earnings per share.

➢ Price/Book (P/B): Market capitalisation/book value (alternatively price per share/book value per share).

➢ Price/FCF: Market capitalisation/Total Free Cash Flows.

➢ Price/Earnings Growth (PEG): The ‘PEG’ ratio is the expected PE divided by average forecast earnings growth. It is most widely used to value growth companies where it is assumed that growth opportunities arise from reinvesting at a premium rate of return.

➢ Dividend Yield: Forecast dividend/current market capitalisation