EV: Price or Value?
Guys,
I can't help, but I always feel like price is confused with value when talking about "Net Debt" in the most common definition of Enterprise Value (EV). We talk about Enterprise Value, but in fact, we should say it's the Purchase Price, right?
An example: If I were to sell a box worth 5 USD, with a 5 USD bill inside. What's the Value of this box? It's 10 USD, isn't it? But what's the effective Purchase Price? That's 5 USD (either I pay 10 USD and get 5 USD, or the owner keeps the 5 USD bill and sells the box without the bill inside). And that's what we call EV. My point is that when we say, for instance, "cash may be used to pay down debt", we are actually not talking about value, but rather about price (this, of course, assumes that markets are not perfectly efficient, which I think is a realistic assumption): The price is 5 USD, the value 10 USD. Of course, this is a different issue when we say that Cash is non-operating and should therefore be subtracted together with all other non-op assets. I am just referring to the "debt paydown" argument here (and many other arguments in which people tell that in reality the buyer "wouldn't pay for it")...
Am I missing something here?
Curious to hear your thoughts!
The value of something is only what someone else (or the highest bidder) is willing to pay for it. People, particularly some bankers, like to get hung up on valuation analysis and figuring out what a company's value is. The analysis should provide some data points and directional guidance, but a company is only worth what the buyers will pay.
Your reference to the intrinsic value of what is inside is more akin to book value.
What if the company is cash flow breakeven or has negative cash flow? Couldn't you make the argument that it has zero or a negative intrinsic value (NPV
Hmm ok, two thoughts on this:
1) I do not necessarily agree. Something can have a value without anyone in the world being willing to pay that amount, for diverse reasons: "Price is what you pay, value is what you get"
2) Even if this were the case, there has to be a reason why noone would be willing to pay for certain assets/ liabilities. Saying that noone would pay for something means that noone attaches a value to this something; so if we say something has no value because noone would buy, it is like saying "something is of no value because it is of no value" - that's like describing a term with the same term. What's your view on that?
If no one in the world is willing to trade something with actual value for a given item or company in this case, then it has no tangible value. It's really as simple as that. You can argue that you believe something is currently being undervalued by the market, but that is your belief (although you may have very good reasons to belive so). If the market never comes around, then the gap between undervalued and fair value is never achieved.
Well, something is of no value, if it has no value, but that is not the same as saying that something has no value as a result of the broader market assigning it zero value. One statement is a cause/effect, the other is just saying 1 = 1.
To elaborate on my first post, the EV will become equal to the purchase price at the time a transaction is consumated, if they were disparate prior to that point in time, like in the purchase of a public company that trades (usually slightly) differently than a pending offer.
In your example:
EV = Current market cap + debt - cash = $10 + 0 - 5 = $5.
Enterprise value is what you would have to pay in cash to acquire the company. You have to pay $5 to acquire the company. Why? If you pay $10, you get $5 in return. it's like a rebate. But the purchase price is still $10. What if inside the box, there are five $1 bills and you only have a $10 bill? You give $10, and get five $1 bills back.
However, if you are buying a company entirely in stock, then you would have to provide the equivalent of $10 of stock (fully diluted). So the purchase price is $10. The purchase price and enterprise value are not always the same, but that has nothing to do with market efficiency.
If you're doing an all-cash deal on a $1m company that has $200k in debt, $300k in cash, and $500k in equity then you pay $500k + $200k - $300k = $400k to acquire the company. If you're doing an all-stock deal on a $1m company that has the same profile, then you will have to issue $1m in securities. What is your purchase price? $1m in both cases. What is your enterprise value? $400k in both cases.
This isn't right. If the company has a $500 market cap and $200k in debt and $300k in cash, it isn't a $1M company. It has an EV of $400k, meaning that it is a $400k company, which would be equal to your purchase price. Generally speaking, when you are buying a company, you are buying both the equity and debt, hence your purchase price is equal to the EV. In this case the EV is less than the equity value due to negative net debt.
If the offer for this company was $1M, then the equity value would see a corresponding increase of $600k. For example, in the next day of trading, the stock price would go up 2.2x (assume this is in a perfect world with 100% certainty of closing).
Oops. I agree. I think I'm going mad. What happens if you decide to issue stock as part of an all-stock deal?
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