Do you purchase the firm at equity value or asset value?
Hey all, (values in millions)
Did a valuation for a tech company and I came to an enterprise value of $1,231 (in millions) of unlevered cash flows. I added back cash in year 0, thus giving me asset value in year 0 of 1,311.I subtracted debt today which is 320 and got to an equity value of 991.
As im new to valuation I am confused on the following issues:
1) If I want to acquire this firm, do I acquire on the equity value or asset value?
2) How is it rational that if I buy the company at equity value, I would own it debt free and id get it at a lower price (991
Bear in mind this is a theoretical valuation of the company. You purchase the firm at the price agreed to with the seller. Think of EV as the price you are hypothetically willing to pay for this company as an investor, including its balance sheet at the point of valuation. You then adjust for items that you effectively don't pay to the seller, such as debt, which is assumed to be paid off entirely as the original debtor ceases to exist and the lender is assumed to want his loan back as the circumstances under which it was written have changed. Cash, which you can't really 'buy', is also stripped out. Generally, cash and debt are bundled together as net debt, because you're looking for the figure that's left after you've used the cash of the company to pay off the debt left on its balance sheet at acquisition. This gives you the equity value of the firm, i.e. what you value ownership of the company at. These are not equivalent to purchase price, but much rather are means of valuation that allow for comparison to other companies (think of EV/EBITDA or P/E multiples). Asset value is not meaningful here, as it doesn't allow you to compare the company to others in a useful fashion.
Thank you very much. I am still confused on a bit of the points above. So in simple terms, I as an investor would not want to buy the company with its debt, so I subtract debt from cash and thus leaving me with net debt. Am I also paying for this?
For valuation purposes, the debt is assumed to be restructured after the acquisition, which means the lender will want his money back because the entity to which the money was lent to doesn't exist anymore (it becomes part of/ is owned by another company). You therefore assume in your valuation that you have to pay it all back. Since you then own the company however, you can use the cash in the company to repay the debt. So yes, you pay the net debt out of your own pocket. In reality, these things are all up to negotiation. A lender might be willing to roll over the debt to the new entity, or reissue a similar facility at different terms.
Others should step in and and correct me if my line of thinking is wrong here, but it also depends on the terms of how the deal is structured. If the seller agrees to pay off the debt or the buyer agrees to refinance it, then the price paid should be closer to the equity value. Another instance of paying closer to the equity value is if its a publicly traded company, and >66% of the shareholders are willing to tender their shares at a certain price. That gives you effective control of the company without having to worry about paying for the debt upfront.
Deal structure is important. Think about asset vs stock sale, think about whether the debt can even transfer to new owner, etc, etc. Nothing is straightforward and things are negotiated. But I think many people have already added enough details above to get you on the right path.
I'm going to try to do this as concise, but as clear as possible. I'm doing this at my desk so I'll do my best to be comprehensive and error free but I'm doing this in a rush.
Asset value i.e. net asset value: This is liquidation value. Generally it's used when you're valuing an entity that is has going-concern issues and will most likely cease operations. Its what you could make if you as a debt holder seized the company upon default and liquidated all assets. CF left over would then be used to make whole all debt holders. Typically this is not what you would use to value a company especially for an acquisition.
equity value: This is the intrinsic value of the CF available to equity holders. FCFF - after tax interest expense + net borrowing = FCFE. In theory equity value is divided by total shares outstanding which gives you the intrinsic value on a per share basis and its how much you should pay for the stock of the company. If as an investor you were looking to add a few hundred shares to your portfolio, this is the value you'd use.
Enterprise value: This is the value of operations. FCFF is the cash flow available to all claim holders against the entity. Remember that debt is used (along with equity) to finance a working capital base for operations. Revenue is generated by this working capital base. In theory if you were to acquire a controlling interest in the business you would be looking at the Enterprise value; it's the intrinsic value of CF available to all capital providers to the entity.
To answer your second question. Remember that value is the present value of the future benefit streams to the owner of the asset. If you're an equity holder you don't receive the CF that bond holders receive. It's not that you're paying less for the business; it's that the CF available to equity holders isn't identical to the CF used to value the company at the enterprise value level i.e.; the cash flow is less after debt repayment.
I hope the above helps provide some clarity. I found the article below highly useful when I was sorting out the different value measurements when I was starting out. Hope it helps you too:
aswathdamodaran.blogspot.com/2013/06/a-tangled-web-of-values-enterprise.html
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