Sexnical Question Challenge, SB for winners
I have 14 credits, first few solid answers get SBs.
Let's assume a parent company owns, say, 80% of a subsidiary. How is the parent's 80% majority interest accounted for within its enterprise value? Is it assumed that the market valuation of the parent's equity includes 80% (and only 80%) of the subsidiary's equity value? And if that's the case, wouldn't that be predicated on the assumption that smart market participants, when valuing the stock, have stripped out the 20% minority interest from the parent's income statement in order to NOT include the 20% of earnings the parent company does NOT have claim to? And how do analysts strip it out - is the needed info given in the footnotes?
If my logic is off, please edify me on how the majority interest is included in enterprise value, and also how a true "apples to apples" enterprise value multiple (in regards to minority/majority interest) is calculated. The BIWS explanation isn't incisive enough for me. Thanks!
If the ownership is >50%, the balance sheet and the income statement are consolidated. The subsidiary's income, expenses, assets, liabilities, etc are all combined with the parent. However, the parent company will report minority interest in the shareholders equity section of the balance sheet (negative entry) and as an expense on the income statement reflecting the non-controlling portion of the subsidiary. So if you are using some sort of book value (in the case of financials maybe) or a P/E multiple you wouldn't need to back anything out in this case.
As for EV and EBIDTA based multiples I have no fucking idea lol.
What's sexnical about this?
2 things need to be addressed here, working under the assumption that you are already familiar with the concept of consolidation (see Flake's post).
1) If you are taking the perspective of the equityholders, then yes, the equityholders do take into account the 80% majority interest. This is because 80% of the earnings of the sub flows through to net income to shareholders of the parent. Hence, when looking at P/E multiples, you do not need to make any adjustments: the "P" (or market value) accounts for the 80% stake, and the "E" (or net income) accounts for the 80% of earnings. So its apples-to-apples.
2) However, if you are looking to value the company as a whole (as in, from an EV perspective), then you need to make adjustments so that the multiples you look at (e.g. EV / EBITDA) actually make sense. There are 2 different ways to adjust for this:
a) The non-typical way is to adjust the EBITDA. Why? Because the parent's EBITDA will consolidate 100% of the P&L of the sub. Hence, if you are able to strip out the 20% of P&L that the parent does not own, then you can actually compare the adjusted EBITDA to an unadjusted EV (given that the market cap will take into account the 80% stake). However, this is almost impossible to do because there usually is not enough information given to strip out 20% of the P&L....and even if there was enough info, it would be a fucking pain in the ass to do.
b) The typical way is to adjust the EV. Why? Since as explained above, we can't adjust the denominator (EBITDA), we adjust the numerator (EV) instead. The logic behind this is that since the parent's EBITDA includes 100% of the P&L from the sub (consolidation), we adjust the EV to assume that it also includes 100% of the sub (to make sure it is apples-to-apples). We do this by adding the remaining 20% of the sub to our EV calc, e.g. market cap [which includes the 80% interest] + debt - cash + MINORITY INTEREST [20% stake that isn't already owned]. This equation now assumes that 100% of the sub is included in the EV. Now you can use EV / EBITDA multiples as both the denominator and the numerator account for 100% of the sub.
There are also 2 different methods of finding minority interest: 1) if the sub is private, we just use the book value of the minority interest on the parent's balance sheet, or 2) if the sub is publicly traded, we can actually find the market value of the 20% interest.
Hope that helps. Pay me my SBs bitch.
Ok, everyone has a chance to earn even more SBs.
It seems flake is saying there’s an entry on the IS deducting the 20% minority interest from operating results, so that income numbers only include the 80%...is that true?
Anyways, I hate banking, in your “1)” section you seem to agree with Flake, saying both market price of equity, (the “P” in PE) and net income (the “E” in PE) both include only 80% so it’s apples to apples. From that, my conclusion at this point is that the parent’s GAAP income statement does somehow explicitly strip out the 20% minority interest.
However, your later statements implicitly contradict that, when you say there’s not enough info to strip out the 20% minority interest from operating results.
So…it’s probably my fault but I’m still confused and still wondering: 1) What does the parent’s IS look like? Is minority interest stripped out at any point on the statement, or is it just all included and impossible to differentiate? 2) How does the parent’s stock market value include 80% of the sub value IF it’s impossible to strip out the 20% of sub earnings they don’t own…in other words, how does the market properly include 80%, and only 80%, of the sub’s value within the parent’s market value?
Those are some good questions. Let me try to clarify a bit more.
If you re-read Flake's post, he mentions that there is an EXPENSE on the parent's IS -- this is true as that is how the 20% unowned stake shows up on the IS. However, its how / where this expense line shows up that is important. So for example this is what the IS of the parent would look like:
Revenue -Expenses (COGS and OpEx) -Interest -Taxes =Net income [Every line item up to this point is consolidated] -Net income attributable to minority interest [the 20% stake in the sub] =Net income attributable to common shareholders / # of shares = EPS attributable to common shareholders
So for your questions: 1) As you can see, unless you have the sub's financial statements infront of you, it will be impossible to strip out 20% from the EBITDA given that everything above the Net income line is consolidated. And again, even if you did have the sub's IS, it would be a giant hassle to factor out 20%. 2) If we are working under the assumption that the parent's stock price is a function of EPS, then it makes perfect sense that the stock price will implicitly include the 80% ownership and exclude the 20% minority interest. Just look at the last line of the sample IS I put up there: the EPS to COMMON SHAREHOLDERS excludes the 20% minority interest --> those are the earnings available to equityholders.
Boom, crushed it ihatebanking. Thanks so much guys.
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