Adjusting Enterprise Value (EV)
EV = Market Cap + Net Debt
Denoting EV as the sum of market cap and net debt is a good starting point, surely. But this is a fairly basic representation of EV and certain adjustments need to be made in order to calculate multiples that are both accurate and capture reality.
A company’s share price is proportionate and reflects all publicly available information. This includes the ownership stakes that a company may be having in other subsidiaries, associates and affiliates. Calculating multiples accurately is about comparing like with like. Multiples will only work if the both the numerator and denominator are consistent i.e either consolidated or proportionate.
THE PROBLEM – EV / EBITDA
The task at hand is to calculate the EV/ EBITDA multiple for company A, which is the parent and has a 70% stake in company B, the subsidiary. Company A uses line by line consolidation and takes into account a 100% of company B’s revenues, expenses, assets, liabilities etc when preparing it’s group accounts, even though it owns only 70%. Market cap for Company A can be calculated by multiplying it’s share price with fully diluted shares outstanding. EV can be obtained by adding net debt to market cap. Since share price is proportionate, Company A’s share price reflects a 70% ownership in Company B. At this stage, EV for Company A, reflects a 70% ownership in Company B. So this is the picture as far as the numerator is concerned.
What is going on with the denominator, which is EBITDA. The parent company consolidates its subsidiaries, which means that its EBITDA reflects a 100% of Company B’s EBITDA, even though it owns only 70%. At this stage, would a simple division of EV and EBITDA yield the correct multiple? Clearly there is a problem at the moment, since the numerator reflects a proportionate EV which captures 70% of Company B’s value. But the denominator reflects a consolidated EBITDA which takes into account a 100% of Company B’s EBITDA. What is the solution then?
THE FIX – NON CONTROLLING INTEREST
Since EV currently reflects only 70% of Company B, value of the remaining 30% stake that is not owned by Company A must be added to EV. This value is known as Non controlling interest or NCI and can be found on the balance sheet of the parent company. When this is done, both the EV and EBITDA reflect a 100% of Company B and there is consistency between numerator and denominator. Therefore, in cases where subsidiaries which are not a 100% owned by the parent company are consolidated, certain adjustments need to be made to EV. This is done by adding the value of non controlling interest or NCI to EV.
ASSOCIATES & AFFILIATES
Using similar logic, value of associates and affiliates are subtracted from EV in order to arrive at adjusted EV.
EV = Market Cap + Net Debt + Non Controlling Interest – Investment in Associates – Investment in Affiliates