How Equity Value & Enterprise Value Change in M&A Deals
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- Опубликовано: 7 сен 2024
- In this tutorial, you will learn how Equity Value and Enterprise Value change after an M&A deal takes place. You will also learn how the combined company’s Equity Value and Enterprise Value relate to the Equity Value and Enterprise Value of the buyer and seller in the deal.
By breakingintowal... "Financial Modeling Training And Career Resources For Aspiring Investment Bankers"
Table of Contents:
1:01 Why Equity Value and Enterprise Value Matter, and the Rules
4:11 Excel Demonstration of Changes in an M&A Deal
9:49 Why the Rules Don’t Work in Real Life
How Equity Value and Enterprise Value Change in M&A Deals
A common interview question goes something like: “Company A acquires Company B using 100% debt - what is the combined company’s Enterprise Value?”
Another common variant is “Company A acquires Company B using 100% stock - what is the combined EV / EBITDA multiple?”
Fortunately, there are a few simple rules you can use to determine these answer.
First, recall what Enterprise Value MEANS: it’s the value of a company’s core business operations to all investors in the company.
So when moving from Equity Value to Enterprise Value, you add Debt and Preferred Stock (and anything else representing other investors) and subtract non-core assets, such as Cash and Investments.
The end result is that regardless of how a company finances itself, Enterprise Value does not change and neither do Enterprise Value-based multiples.
In the same way, in M&A deals the combined Enterprise Value and combined Enterprise Value-based multiples do not change regardless of how the acquirer buys the seller.
Rules for Equity Value and Enterprise Value in M&A Deals
Combined Equity Value: Acquirer’s Equity Value, plus the value of stock it issues to buy the Seller.
Combined Enterprise Value: Acquirer’s Enterprise Value + the Seller’s Enterprise Value
Combined EV / EBITDA: Add both companies’ Enterprise Values and EBITDAs; not impacted by cash/stock/debt mix.
Combined P / E: No “shortcut”; impacted by funding mix.
Calculate it by determining the Combined Equity Value first, and then the combined Net Income after factoring in foregone interest on cash and interest paid on new debt, and any tax rate differences.
Example Calculations:
Say that Company A has an Enterprise Value of $100, Equity Value of $80, EBITDA of $10, and Net Income of $4. Its tax rate is 25%.
Company B has an Enterprise Value of $40, Equity Value of $40, EBITDA of $8, and Net Income of $2.
The foregone interest rate on cash is 2%, and the interest rate on debt is 10%.
So if Company A acquires Company B for $40 with 100% debt:
Combined Enterprise Value = $100 + $40 = $140
Combined Equity Value = $80 + $40 * 0% Stock Used = $80
Combined EBITDA = $10 + $8 = $18
Combined Net Income = Company A Net Income + Company B Net Income + Acquisition Effects = $4 + $2 - $40 * 100% Debt * 10% Interest Rate * (1 - 25% Tax Rate) - $40 * 100% Cash * 2% Foregone Interest Rate * (1 - 25% Tax Rate) = $3
Combined EV / EBITDA = $140 / $18 = 7.8x
Combined P / E = $80 / $3 = 26.7x
If you then change around the mix of cash, stock, and debt, the Combined EV / EBITDA, Combined EBITDA, and Combined
Enterprise Value will not change at all.
However, the Combined Equity Value, Combined Net Income, and Combined P / E will all change depending on the financing mix.
In Real Life
These rules don’t quite hold up… because:
Premium Paid for Seller: Will have to use seller’s Enterprise Value at the share price premium instead.
Most sellers are acquired for more than their current market caps!
Share Price After-Effects: Does the market like / not like the deal? If so, the buyer’s share price and therefore its Equity Value and Enterprise Value will change after the deal is announced.
Synergies, Other Acquisition Effects: Could affect share prices, EBITDA, Net Income, and everything else!
RESOURCES:
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![Equity Value and Enterprise Value Interview Questions: What to Expect [REVISED]](http://i.ytimg.com/vi/21BE38E3zu8/mqdefault.jpg)
Great video! That cleans up all the mysteries or false conclusions found in other sources.
So, is it possible to conclude that in M&A deals, the intent is to increase share price. however, due to the synergies effect, share price after market effect or the like, it is almost impossible to predict the share value up or down after the deal?
Could you make a video about how Mezzanine financing impact the equity value please?
The goal in M&A deals is for the acquirer to buy the target and become more valuable after the deal closes, ideally with EPS accretion as well. That said, it's hard to predict how the acquirer's share price will change because it depends on how the market views the deal in the short-term and long-term. A few of the Debt and LBO-related videos have coverage of mezzanine.
Well done for taking time to explain those complex topics so well to a born again
technical trader who always combines both technical and fundamental analysis.
Keep it up. I hope RUclips algorithm will raise this video high because it is an
essential topic. Really well presented. Many thanks.
Glad you liked it!
Thanks a lot, I have 2 questions -
1) Is the concept that the EV is capital structure-neutral a consequence of the Miller Modigliani theorem?
2) But on the other hand, if the capital structure changes, the WACC and discount rate will also change, and as a consequence, the EV will change (based on DCF analysis)...
1) Yes.
2) Yes. This is why it's NOT correct to say that Enterprise Value is truly "capital structure-neutral." It's best to say that Enterprise Value is *less* affected by a company's capital structure than Equity Value. See some of the other tutorials in this playlist.
Useful and clearly video, thanks a lot!
Thanks for watching!
What if it is not an acquisition. Say a company is raising $100mm equity and $50mm debt, does my post-money enterprise value change?
Please see the tutorials on Equity Value and Enterprise Value. Financing changes do not affect Enterprise Value because Net Operating Assets do not change, so Enterprise Value does not change here.
In BIWS M&A guide, it says the total combined equity value of the buyer and seller is equal to the buyer's market cap plus the seller's market cap even when using 100% debt or cash. But in this video it seems like the total combined equity value doesn't change if you use cash or debt. I directly quoted the question below. Could you explain this? Thanks!
"11. Good. Now, Company A decides to acquire Company B using 100% cash. What are the combined EBITDA and P / E multiples?
In this scenario, you add the Market Caps of both companies together and then adjust for the Cash, Debt, and Stock used.
Combined Market Cap = 120. Previously, A had 20 more Debt than Cash, and B had the same amount of Cash and Deb"
"12. Now, let’s say that Company A instead uses 100% debt, at a 10% interest
rate and 25% tax rate, to acquire Company B. What are the combined multiples?
Once again, you can add the Market Caps so the Combined Market Cap is 120.
The combined company has 40 of additional Debt, so if we continue with the assumption that A has 60 of Debt and 40 of Cash the Enterprise Value is 120 + 60 + 40 - 40 = 180, the same as in the previous example."
You're using a really, really old/outdated/wrong version of the guide. That question is wrong. Please get the newest version on our site. We update and revise materials periodically, and we do not take responsibility for older/wrong versions that are floating around.
Help me out here. How can a business function without expensing/capitalizing depreciation and amortization? D&A is basically a pretax on operations, expensed over the life of the business and or the life of PPE. I still don’t understand how it makes sense to add it back in to some of the calculations. That money is already spent on PPE. Maybe I’m not understanding how business works.
I don't really understand what you are asking or how it relates to this specific video. If you're asking why people add back D&A in the EBITDA calculation, even though it represents the amortization of money already spent, the answer is that it's done to normalize companies so a proper comparison can be made (e.g., if CapEx and D&A levels as percentages of revenue are very different). But EBITDA is not a good proxy for FCF, which is why people may use EBITDA - CapEx instead or just skip all of that and calculate FCF directly.
Thanks a lot; I’m looking to understand how minority interest/ NCI will get reflected here if company A were to purchase only 51% of company B
Please see the Noncontrolling Interest video in this channel (you can do a search for it).
Great Video. Quick Questions: (1)When you compute the Net Income, why do you subtract the foregone interest oncash, the company is not "realy" losing this interest, it's just alternative cost fot the company. (2)When we compute the Net Income we do'nt need to subtract the cost of the stocks issued?
1) Because the projections already include the interest earned on cash, so the company really is losing it. 2) You factor in the additional stock issued in the EPS metric... that is the whole point of using EPS rather than just Net Income.
Very useful tips, thx!
Really helpfull man ! Thanks a lot !
Brian, without a premium, EV of buyer and target can simply be summed up. However, when there is a premium, you wrote "use seller's EV at share price premium instead". Does that mean to add the premium to the seller's EV and then add to buyer's EV to get the combined EV?
Take the seller's Equity Value at that offer price and calculate Enterprise Value the normal way from there and then add that to the buyer's Enterprise Value.
Thank you!
I believe the premium if there is one should be added to the seller's equity value instead of enterprise value tho.
The purchase premium will affect both.
Hello! Thanks for such an informative video. However I've some questions which I hope you can clarify. Does the 'equity value' here refers to book value as well? I can't seem to understand why funding for an acquisition with 100% cash won't affect the equity value? Assuming Company A purchase Company's B ($4 billion worth of net assets; I assume its $10billion assets vs $6 billion liabilities), shouldn't its book value incorporate this $4 billion somewhere?
No, equity value is different from book value. Equity Value represents the market value of the common shareholders' equity on a company's Balance Sheet. Acquired companies' book values and equity values are written down to 0 in >= 50% deals.
Brilliant Thank you
Thanks for watching!
Hello Thank you for the video.
I have an question for "Combined Net Income".
In the Excel file, the formula subtracts sources of funds(cash, debt) multiplied with "(1-tax rate)"
I thought We should subtract it with cash and debt proportion multiplied with "(tax rate) " Is it right?
Thank You.
No, because Net Income = Pre-Tax Income * (1 - Tax Rate). So if you want to directly calculate Net Income based on other items that have affected Pre-Tax Income, you must multiply by (1 - Tax Rate) instead.
Thank you!!!!
how would the result be different if the buyer and seller have different tax rates?
+Jialin Liu Combined Equity Value, Enterprise Value, and EBITDA would be unchanged. Combined Net Income would be different since you have to combine both companies' Pre-Tax Incomes and then tax it as the buyer's rate to determine the Combined Net Income. So the Combined P / E multiple would also be different since you would have to use that new figure for the Combined Net Income.
Wouldn't the combined equity value be lower due to dilution if the buyer issues stock?
+kbogosian No. Dilution refers to EPS or other per share metrics, but the Combined Equity Value depends on only the buyer's Equity Value plus the value of the stock issued to acquire the seller. It is not a per-share metric.
Good 1
Thanks for watching!
Hi there, I know this may be basic, but I'm struggling to wrap my head around why Equity value of the target company disappears, but Enterprise values add together. I thought that Equity value was a constituent of enterprise value, or am I thinking about it in the wrong way? Is there any way you could explain this concept to me?
Thanks for your help and amazing videos! they have helped me to no end :))
That's not the best way to think about it. They are related, but Equity Value is not really a "component" of Enterprise Value. Equity Value represents the stake of the common shareholders' in the company on all the company's Assets. If the common shareholders disappear because their shares are bought out, then Equity Value also goes away... however, other investors still remain, and the acquiring company, if it uses Stock to do the deal, effectively recreates the target's Equity Value based on the amount of Stock it uses. So you should think of it in terms of the capital structure *after* the deal takes place.
@@financialmodeling This makes perfect sense - thank you so much!
Hi!
1. you didn't bring up the question of the change in EV/Equity if the company issues dividends for NCI and in general how can they be interpreted here ? So for example if we have net income that extends to NCI, how would EV/Equity change ? Or for example the company pays dividends to NCI ? Can you please explain this point?
And the second point, the same thing with preferred investors
Do I understand correctly that Equity value will increase if we pay a dividend to NCI? The EV will remain the same since we are not touching the core business and overall EV is neutral to structure changes? Please explain in terms of accountability and logic
Let's make a real case, for example if there are two companies, one owns the other 70%, the company (which is 70% subsidiary) issues dividends, 70% of them will be intragroup turnover and the other 30% not, and if we add the two EVs and subtract the reduced NCI (by the amount of dividends and debt for example we get EqV which has increased, right?
Dividends to NCI is a more advanced topic that we can't go into detail on in this free RUclips channel, but the company doesn't "issue" dividends to a non-controlling interest because the parent company doesn't own that portion of the other company. The relevant question is what happens when a partially owned company issues dividends to the parent company, as they always flow in that direction. When that happens, Enterprise Value does not change because Net Operating Assets stay the same (only Cash and the NCI line item change). Equity Value stays the same because Net Assets (Assets - Liabilities - Preferred - NCI) stays the same as well. The intuition is that the company's cash goes up, but a non-shareholder investor group was responsible, and its net operating assets do not change.
If a company issues preferred dividends, its cash decreases and common shareholders' equity decreases due to the lower Net Income to Common on the IS. So Equity Value decreases but Enterprise Value stays the same.
@@financialmodeling
Where can I see such consolidation threads with other examples? What paid courses do you have that I can see more examples of?
@@financialmodeling what does it mean?
“The intuition is that the company’ s cash goes up, but a non-shareholder investor group was responsible….”
I do not really understand this point, can you please elaborate?
@@eugene7678 Unfortunately, we can only answer so much on this free channel. Happy to respond or explain in more detail if you are a client or student of one of our courses.
breakingintowallstreet.com/breaking-into-wall-street-courses/
Where can I find the excel file used here ?
Click "Show More". Scroll to the bottom. Click the links.