# Enterprise Value and Minority Interest

Why do we add back the minority interest when calculating the Enterprise value?

### What is Minority Interest?

Minority interest is an accounting concept that refers to a situation when a parent company owns over 50% of another firm. Due to the fact that the parent company has majority ownership of the subsidiary, it includes the assets, income, liabilities etc of the subsidiary in its balance sheet. However, if it does not own 100% of the subsidiary then it does not actually have claim to 100% of the financial performance, and whatever percentage it does NOT own must be subtracted as a liability.

### Adding Minority Interest in the Enterprise Value (EV) Formula

First, let's review the Enterprise Calculation.

**The calculation for Enterprise Value is:**

Market Capitalization + Debt + Minority Interest + Preferred Shares - Cash & Cash Equivalents

With that being said, minority interest is an important factor in Enterprise Value. If the company being valued has majority ownership in another company, whatever percentage it does NOT own must be added on to equity value because the parent company will not have all of the claim on assets, income etc of the subsidiary.

Another way to think of it is that since you are accounting for the full subsidiary throughout the financial statements - if we want to look at metrics such as EV/Revenue or EV/EBITDA the Enterprise value needs to account for the value of the main company and the subsidiary since the denominator accounts for the main company and the subsidiary. This allows you to compare apples to apples rather than apples to oranges.

#### Read More About Enterprise Value On WSO

- How Tax Rate Affects Enterprise Value (EV)
- Enterprise Value Less Than Equity Value
- Enterprise Value Interview Questions For Banking

#### Preparing for investment banking interviews?

The WSO investment banking interview course is designed by countless professionals with real world experience, tailored to people aspiring to break into the industry. This guide will help you learn how to answer these questions and many, many more.

Minority interest is part of the enterprise value. It could be thought of as the minority ownership in the company. Since you're trying to find the total value of the company(EV), then it clearly must be added in.

If you get a chance to take Business combinations and consolidations while in school, do it.

This is not right at all. Like I can't even fathom your logic behind thinking this. If you get a chance to take Business combinations and consolidations while in school, do it again.

when calculating Enterprise Value you're trying to find the total value of the company. Another way of thinking about it is what would you have to pay to acquire the company (acquisition value)? Thus, you need to include all minority interests in the company.

minority interest and Calculation of EV(Originally Posted: 07/27/2011)Dear Fellow Bankers,

This has been discussed a lot and understand most (but not all) of it.

I do understand what minority interest means. But I do NOT understand why it has to be ADDED to the market value of equity to arrive at the EV.

Let's say - there are 3 companies P, S, O. Parent P owns 70% of Subsidiary S. And some other company named O owns rest of the 30% in S.

Now P has to consolidate its statements and it shows minority interest (non-controlling interest) in its shareholders' equity section. If S has $100 of profit then $30 (=30% of the $100 that P does NOT own) is shown in the P's balance sheet as minority interest.

This much is ok. I understand this much.

Our goal is to calculate multiples such as EV/Sales. I also understand that in order to make the numerator compatible with denominator we have minority interest in the numerator equation to calculate EV. This much is ok.

But I do not know why it is added ? And why not subtracted ?

This is my understanding of it: When P owns 50%+ of S, it consolidates its financial statements and reports all of S's revenues, expenses, etc which is reflected in the denominator of multiples like EV/EBITDA and EV/Sales. So in order to make it more "apples to apples" you have to add back the minority interest in the numerator to account for all of S's value (since the denominator counts for all of S's operating results).

The above poster is right.

minority interest is the biggest scam that FASB has ever pulled.

Initially minority interest showed up in liabilities. So when you're looking at credit multiples: Liabilities / Equity or Liabilities/Total Capital, you would see that the ratio increases if you have non-controlling interest in a company (in this case, your 30%).

But in 2008 FASB changed it so that minority interest shows up in Equity instead of liabilities. This improves credit multiples: both assets and equity go up, and your % equity of your total assets goes up.

Thank you very much Asdfad123123. It is crystal clear now. Thank you very much lavak3. You response deepened my understanding of minority interest.

Thank you both of you.

sorry not into asian women.

usually you are trying to find the total value of the business, you should realize that any common share or equity analysis should then also reflect the minority interest adjustment (the equity value leftover isn't all yours, some goes to the minority interest holder). Usually just a rounding error, so doesn't matter. Matters only when minority interest begins to make up a big portion of the company

Enterprise Value and minority interest: finance-dictionary(Originally Posted: 02/20/2012)This is an edited version of my previous post to clarify some issues related to the calculation of EV as well as other minor editsI have come across a number of questions on this and other forums regarding the calculation of “Enterprise Value” (EV), how to deal with minority interest and why we deduct cash in the EV calculation. This topic seems to be an interview favorite and almost never fails to generate some interesting replies. However, in my view at least, even a lot of interviewers asking the question fail to fathom exactly what it is they are asking or its implications, instead expect some rote formulaic response they deem as correct, something akin to what is written up in Wikipedia or the like.

For most young budding IB analysts and others in the field, the calculation of EV is fairly straightforward: EV=Market Cap + Debt – Cash. This is usually the standard answer for standalone companies. It gets more complex when consolidated financials are involved, and the term “minority interest” (MI) rears its ugly head. An interview question would be posited to some starry-eyed candidate dreaming of striking it big: “Calculate the EV of XYZ that owns 51% in ABC with so and so cash and debt involved." The seemingly simple question really disconcerts some people, leading to a flurry of posts as to what exactly EV is, why we subtract cash, and how does one calculate EV in cases of consolidated financials involving minority interest?

The purpose of this post is to present this writer’s view that this seemingly innocent question is not deserving of a simple all encompassing reply, and that many considerations need to be taken into account. Sometimes so many that the entire relevance of the question needs to be re-thought. For the purpose of this discussion, let us consider the case in which a majority (>50% ownership) or controlling interest (which can sometimes include less than 50% ownership) results in consolidated financials involving a minority interest.

Let us begin first with what exactly is Enterprise Value:

Simplistically, it is the “Value of Operations”. For a firm, ignoring capital structure for the moment,

Value of Firm =PV(Net assets today + Future Growth Opportunities)

Future growth opportunities from core operations can be called “Value of Operations”, but in order to have an ongoing operations, you need an asset base today, an operating asset base for working capital needs. So, we can rewrite the above equation as:

Value of Firm =PV(Net Operating Assets today + Net Non-Operating Assets today +

Future Growth Opportunities) =PV (Operations + Net Non-Operating Assets) =Value of Operations + Net Non-Operating Assets today

We refer to Enterprise Value ("EV") as the “Value of Operations”. It would be intrinsic amount the market is valuing the core operating assets of the company. Since the value of the firm is the total amount which is split between capital providers, it follows, that to ordinary equity holders, their share, which is typically defined as the “market cap” is:

Mkt. Cap=EV + Current Value of Net Non-Operating Assets – (Debt + Preferred + Other senior Claims)

The value of the firm comes from the value of operations + the net value of non-operating assets. (Strictly speaking, adding debt, in many cases depending on the operating regime, will add value to the enterprise because in most cases, interest on debt is tax deductible – the “tax shield” and the company will pay less taxes.) In the subordination hierarchy, debt & preferred holders will get seniority to ordinary equity holders, who will get the residual, which is why the debt, preferred and senior claims are subtracted to get market cap. So to get EV, you’d have to add them to market cap. A lot of questions concern why we subtract “cash” in calculating EV. This above equation shows why – more on this below.

The Net-Non operating assets usually consist of “excess cash”, but could also include other items like appreciated land, IP, patents or investments, or even certain liabilities and commitments not related to the core operations of the firm. It’s important to consider if these are not being double-counted in the EV itself. EV is an IMPLIED figure, after taking into account what the market is valuing the stakeholder stakes (debt, common equity, preferred, etc) and all the other identifiable assets. A lot of discretion is sometimes required on the analyst’s part to evaluate the “operating” vs. passive vs. off-balance sheet components of value and understand what is reflected in the market prices and at what discount/premium, but the basic question the analyst is trying answer when calculating the EV is: how much are the operations by themselves worth, given how the market is valuing the stakeholder stakes and net assets?

In addition to the calculating the market implied EV, an analyst should also conduct and analyze the FCF (free cash flow) to the firm to validate this number. A secondary but extremely important point is how to calculate these FCFs, especially the treatment of stock based compensation, a seriously underestimated and misunderstood element of valuation – I’ve already written about this controversial topic on this forum in the past.

For simplicity and ease, we usually deduct ALL the cash & equivalents to derive a value for EV, rather than just the “excess cash”. Reason: Who has the time to adjust for what is excess and what is not? Strictly speaking, this is incorrect. The going “explanation” for such logic is that if we were to “purchase” the enterprise, we would assume all the debt, but this would be offset by the cash at hand. The main flaw in this logic (other than the fact that one rarely assumes all the debt without restructuring it some way in any acquisition), is that the fact that the market cap and debt values assume the firm is a going concern, and to keep the concern going, you need operating cash at hand for working capital. So unless you’re planning on liquidating the enterprise, all that cash is not really going to be available, even if you were to “purchase” the entire firm and assume the debt. Only the “excess” cash will be available for that purpose of retiring the debt. But it is simply easier to deduct the whole amount. These calculated EV values are mainly used for comparison purposes as a ratio of some other metric, not as proxies for the actual price a firm might be acquired for – that would be far more complicated – involving premiums, transaction costs, breakup fees, debt covenants, synergies, restructuring costs, tax impacts etc.

Some purists would argue that the interest on excess cash is already incorporated into the FCF thus thereby making the “excess” not excess, but that is usually not very significant and distracting from the discussion. If this interest were a significant portion of the cash flows, one would have to consider the fact that the market would take this into account in determining the cost of capital to discount the company’s FCF – the company’s WACC would change, because a large component of its earnings and cash flow would be essentially be lower risk, and the market cap would still reflect the amount appropriately. But this still does change the fact that the “value of operations” should only include the level of cash that is required for operational needs.

So now, let us move on to the case where there is a “minority interest” (MI). MI arises when a company owns more than 50% or exerts a significant controlling influence over another entity “the sub” (and in some cases even if the ownership is less than 50%). In that case, accounting rules, at least US GAAP, usually require consolidating the sub’s financials into the parent company, as if it were 100% owned. The portion of the net EQUITY that is not owned by the parent at the time of the acquisition, is listed as minority interest. Additionally in the income statement, this is also deducted from the Net income usually with a “Non-controlling interest” label, because the income statements too are consolidated as if they were one company, 100% owned.

So, when one tries to calculate EV for a company with MI, some interesting phenomenon results. For simplicity, let us just assume there is only one sub involved. Bear in mind that MI is a “book” value that is derived at the time of acquisition. It can vary dramatically given time and change in the operating or value profile of the sub (i.e. has it suddenly become very valuable due to PE expansion or recently become very profitable) since the acquiring of the ownership stake. Unless the company is in a distressed state, the current book value of debt is probably a good assumption for market value for analysis purposes. It is reasonable to expect that the market cap of the parent would include the market value of the percentage ownership of the equity in the sub. So, when asked the question, what is the EV of a parent that owns a less than 100% stake in a sub, what is the correct response?

If we use the standard formula: EV=Mkt Cap + Debt – Cash, we realize that Mkt. Cap is a blended figure, i.e. Mkt. Cap of the parent + % of the market value of the equity of the sub. However, the Debt & Cash are consolidated as if 100% of the sub was owned. Thus we get a spurious number. What if we add MI to that figure? Well, then we get a proportioned Market Cap + a historical MI + consolidated Debt – consolidated Cash. Now that you’ve calculated this new value what is the relevance of this figure? Not much actually, from an economic perspective. Some would say, when calculating ratios like EV/EBITDA or EV/Sales, this aggregate value makes sense to use, since the EBITDA and other income statement metrics are consolidated as if 100% (one has to be careful if there are intercompany transactions between the parent and sub – for instance if a company owns a part of a supplier, or its customer – which can have serious implications depending on the analysis). Assuming there aren’t any intercompany complications, if you do construct a ratio like EV/EBITDA by adding back MI, you’ll get in the numerator, an attempt at EV of the parent +% of sub (the mkt caps are proportioned, but the balance sheet is consolidated), and in the denominator, a summed EBITDA of the two companies. Does this result make sense? That is the equivalent of looking at (a+%ofb)/(x+y) for the combined entity whereas each company individually would have a ratio a/x and b/y. Depending on the numerical values of each company’s actual EV’s and EBITDA’s, it could give some seriously irrelevant numbers that have the illusion of looking relevant. Also if a majority of the EBITDA comes from one entity and majority of the EV of the total derives from another, its another relevance inducing headache. Or if the companies are in different industries, where the EV/EBITDA’s are expected on average to be different, this further adds to the complication as to the validity and usefulness of a combined number. In my view, this combined ratio too is a spurious number. And what is the point of all this calculation? Why do we even care about this jumbled mixed up EV/EBITDA figure? Beats me. If you’re trying to build a comp table, there are more relevant ways to gauge relative value – try using pure plays.

What about subtracting the MI from the EV calc? Again, now you have a Mkt. Cap that is already reflecting the correct % of the earnings contribution, assuming the markets are pricing the value correctly. You have the consolidated debt and consolidated equity. Subtracting out MI gives you what? I’m not even sure there is a term for whatever calculated abomination that results. Excluding MI altogether. Well, to the extent that the cash and debt’s are in equal proportions in both the parent and sub, that might be the best option to get to the most accurate ‘quick’ estimate of the combination’s EV (since the cash and debt would cancel out). But again, these are questionable assumptions, and what good is a combined EV if the companies are in different industries and the ratio is constructed in that (a+b)/(x+y) way? The safest way, in my view, is to first ask, what is it you’re exactly trying to calculate, why, and then use a DCF to isolate the cash flows relevant to the stakeholder to which they matter and value those using current market values and projections.

Not to belabor the discussion, but another interesting complication arises from the debt subordination structure. Let us assume, for example, A owns 51% of B. B has little cash, assets and equity but a lot of debt. A by itself has no debt. In that case, 100% of B’s debt would be consolidated onto the parents books. So now if you look at the parent, it looks like it has a ton of debt. Is this debt real? Consider the situation in which B goes bankrupt. B’s debt holders will normally only have a claim on B’s assets – NOT A’s (if A structured the deal intelligently). So in that case, despite a lot of debt showing up in the consolidated A’s financials, it is technically not something A’s shareholders should have to worry about too much. Their exposure would be to the extent of their EQUITY investment in B. At worst they’ll lose what they invested – not more. This “loss isolation” principle is basically how PE (private equity) funds operate and also where they derive a lot of their value – if one entity goes belly up, the debt holders do not have claim to the other investments or assets of the PE fund - usually only to those assets secured in the entity that went bankrupt. The PE fund takes a loss on the equity, which was small relative to the EV of the overall investment, shrugs, and moves on.

Thus one might even reasonably ask, what is the point of calculating EV for a company that has consolidated controlling interests in other companies, especially when large amounts of debt are involved? Assuming you have to, so what is the right way to do it? Well, again it depends on what exactly you are trying to do. Why do you want to calculate this EV? If it is for getting valuation ratios in a comp table, it would be better to use pure plays. Else use a DCF to get the most accurate estimate of the relevant cash flows to the relevant stakeholders. There is no substitute for digging into the footnotes and historical filings to figure out or estimate what assets belong to whom. Certainly, a rote answer like EV=Mkt. Cap + MI +Debt – Cash might suffice in an interview, but I would hazard the real answer is a little more complicated.

Blew my mind.

For those of you who actually want to learn something relevant to the banking trade, read this.

Thanks (im going back to read your other posts as well. You clearly know your shit)

subscribed.

Liked the analogy of a company that owns over 50% of another company but has no debt, while the sub has a lot of debt, to a private equity company. Definitely helped me better understand how PE works. Entire post was really helpful actually, would recommend anyone still going through interviews or otherwise to read it all.

Boom!

Start a blog.

Bumping.....just because

"Some purists would argue that the interest on excess cash is already incorporated into the FCF..."

Why would this be the case? In most cases, you are not considering interest income in FCF calculations so excess cash is not included in the EV which is the result of DCF. When constructing your cash flows, you are taking into operating revenues, operating costs etc so that your DCF result is the value of the operating assets, the EV.

Going to the equity value you add this cash as it was not already there in DCF in the first place. Additionally you would want to add any non operating assets and deduct any non operating liabilities, provided that these were not included in DCF in the first place. (i.e. cash from these assets/liabilities)

FCF by definition, is all the cash flow that is available to the owners of capital - the stock AND bond holders, excess or not. How we value the streams that make up the FCF is really at issue here. I understand what you are saying and don't disagree. I did point out that if excess cash was included in the FCF used to calculate the EV, then the discount rate would have to be adjusted. Ultimately you should get the same answer::PV of FCF(without interest from excess cash) @ discount rate + EXCESS CASH vs. PV of FCF(with interest from excess cash) @ adjusted discount rate + ZERO excess cash.

"Some purists would argue that the interest on excess cash is already incorporated into the FCF thus thereby making the "excess" not excess, but that is usually not very significant and distracting from the discussion. If this interest were a significant portion of the cash flows, one would have to consider the fact that the market would take this into account in determining the cost of capital to discount the company's FCF - the company's WACC would change, because a large component of its earnings and cash flow would be essentially be lower risk, and the market cap would still reflect the amount appropriately. But this still does change the fact that the "value of operations" should only include the level of cash that is required for operational needs."

The thing is that it's usually extremely difficult, if not impossible, to tell what is excess vs. what is not. That's really a subjective determination. So then when you are determining the what the appropriate discount rate should be, when you list out comps for your baseline assumptions, you'd have to try and isolate any "excess" they have may have as well, for the market returns will reflect that implicitly. At some point the value-add from the analysis approaches not worth doing it, unless it's patently obvious what the value drivers are. But yes, I agree I could have phrased it better in my post and thanks for pointing that out.

In the consolidation of companies, you bring in 100% of the results of controlled companies. If one or more of these companies has minority interests, you need to either adjust the results (reversing out the share or revenue, costs, etc) to reflect the part of the company that does not belong to you (adjusting the denominator) or to add the value of the minority to the EV (adjusting the numerator). Of the two methods, the latter is easier â€“ which is why is the most common.

For the same reason, you need to adjust for associates and investments if you are looking above the Operating Profit line.

Enterprise Value and minority interest: interview favorite(Originally Posted: 02/20/2012)This is an edited version of my previous post to clarify some issues related to the calculation of EV as well as other minor editsI have come across a number of questions on this and other forums regarding the calculation of “Enterprise Value” (EV), how to deal with minority interest and why we deduct cash in the EV calculation. This topic seems to be an interview favorite and almost never fails to generate some interesting replies. However, in my view at least, even a lot of interviewers asking the question fail to fathom exactly what it is they are asking or its implications, instead expect some rote formulaic response they deem as correct, something akin to what is written up in Wikipedia or the like.

For most young budding IB analysts and others in the field, the calculation of EV is fairly straightforward: EV=Market Cap + Debt – Cash. This is usually the standard answer for standalone companies. It gets more complex when consolidated financials are involved, and the term “minority interest” (MI) rears its ugly head. An interview question would be posited to some starry-eyed candidate dreaming of striking it big: “Calculate the EV of XYZ that owns 51% in ABC with so and so cash and debt involved." The seemingly simple question really disconcerts some people, leading to a flurry of posts as to what exactly EV is, why we subtract cash, and how does one calculate EV in cases of consolidated financials involving minority interest?

The purpose of this post is to present this writer’s view that this seemingly innocent question is not deserving of a simple all encompassing reply, and that many considerations need to be taken into account. Sometimes so many that the entire relevance of the question needs to be re-thought. For the purpose of this discussion, let us consider the case in which a majority (>50% ownership) or controlling interest (which can sometimes include less than 50% ownership) results in consolidated financials involving a minority interest.

Let us begin first with what exactly is Enterprise Value:

Simplistically, it is the “Value of Operations”. For a firm, ignoring capital structure for the moment,

Value of Firm =PV(Net assets today + Future Growth Opportunities)

Future growth opportunities from core operations can be called “Value of Operations”, but in order to have an ongoing operations, you need an asset base today, an operating asset base for working capital needs. So, we can rewrite the above equation as:

Value of Firm =PV(Net Operating Assets today + Net Non-Operating Assets today + Future Growth Opportunities) =PV (Operations + Net Non-Operating Assets) =Value of Operations + Net Non-Operating Assets today

We refer to Enterprise Value ("EV") as the “Value of Operations”. It would be intrinsic amount the market is valuing the core operating assets of the company. Since the value of the firm is the total amount which is split between capital providers, it follows, that to ordinary equity holders, their share, which is typically defined as the “market cap” is:

Mkt. Cap=EV + Current Value of Net Non-Operating Assets – (Debt + Preferred + Other senior Claims)

The value of the firm comes from the value of operations + the net value of non-operating assets. (Strictly speaking, adding debt, in many cases depending on the operating regime, will add value to the enterprise because in most cases, interest on debt is tax deductible – the “tax shield” and the company will pay less taxes.) In the subordination hierarchy, debt & preferred holders will get seniority to ordinary equity holders, who will get the residual, which is why the debt, preferred and senior claims are subtracted to get market cap. So to get EV, you’d have to add them to market cap. A lot of questions concern why we subtract “cash” in calculating EV. This above equation shows why – more on this below.

The Net-Non operating assets usually consist of “excess cash”, but could also include other items like appreciated land, IP, patents or investments, or even certain liabilities and commitments not related to the core operations of the firm. It’s important to consider if these are not being double-counted in the EV itself. EV is an IMPLIED figure, after taking into account what the market is valuing the stakeholder stakes (debt, common equity, preferred, etc) and all the other identifiable assets. A lot of discretion is sometimes required on the analyst’s part to evaluate the “operating” vs. passive vs. off-balance sheet components of value and understand what is reflected in the market prices and at what discount/premium, but the basic question the analyst is trying answer when calculating the EV is: how much are the operations by themselves worth, given how the market is valuing the stakeholder stakes and net assets?

In addition to the calculating the market implied EV, an analyst should also conduct and analyze the FCF (free cash flow) to the firm to validate this number. A secondary but extremely important point is how to calculate these FCFs, especially the treatment of stock based compensation, as seriously underestimated and misunderstood element of valuation – I’ve already written about this controversial topic on this forum in the past.

For simplicity and ease, we usually deduct ALL the cash & equivalents to derive a value for EV, rather than just the “excess cash”. Reason: Who has the time to adjust for what is excess and what is not? Strictly speaking, this is incorrect. The going “explanation” for such logic is that if we were to “purchase” the enterprise, we would assume all the debt, but this would be offset by the cash at hand. The main flaw in this logic (other than the fact that one rarely assumes all the debt without restructuring it some way in any acquisition), is that the fact that the market cap and debt values assume the firm is a going concern, and to keep the concern going, you need operating cash at hand for working capital. So unless you’re planning on liquidating the enterprise, all that cash is not really going to be available, even if you were to “purchase” the entire firm and assume the debt. Only the “excess” cash will be available for that purpose of retiring the debt. But it is simply easier to deduct the whole amount. These calculated EV values are mainly used for comparison purposes as a ratio of some other metric, not as proxies for the actual price a firm might be acquired for – that would be far more complicated – involving premiums, transaction costs, breakup fees, debt covenants, synergies, restructuring costs, tax impacts etc.

Some purists would argue that the interest on excess cash is already incorporated into the FCF thus thereby making the “excess” not excess, but that is usually not very significant and distracting from the discussion. If this interest were a significant portion of the cash flows, one would have to consider the fact that the market would take this into account in determining the cost of capital to discount the company’s FCF – the company’s WACC would change, because a large component of its earnings and cash flow would be essentially be lower risk, and the market cap would still reflect the amount appropriately. But this still does change the fact that the “value of operations” should only include the level of cash that is required for operational needs.

So now, let us move on to the case where there is a “minority interest” (MI). MI arises when a company owns more than 50% or exerts a significant controlling influence over another entity “the sub” (and in some cases even if the ownership is less than 50%). In that case, accounting rules, at least US GAAP, usually require consolidating the sub’s financials into the parent company, as if it were 100% owned. The portion of the net EQUITY that is not owned by the parent at the time of the acquisition, is listed as minority interest. Additionally in the income statement, this is also deducted from the Net income usually with a “Non-controlling interest” label, because the income statements too are consolidated as if they were one company, 100% owned.

So, when one tries to calculate EV for a company with MI, some interesting phenomenon results. For simplicity, let us just assume there is only one sub involved. Bear in mind that MI is a “book” value that is derived at the time of acquisition. It can vary dramatically given time and change in the operating or value profile of the sub (i.e. has it suddenly become very valuable due to PE expansion or recently become very profitable) since the acquiring of the ownership stake. Unless the company is in a distressed state, the current book value of debt is probably a good assumption for market value for analysis purposes. It is reasonable to expect that the market cap of the parent would include the market value of the percentage ownership of the equity in the sub. So, when asked the question, what is the EV of a parent that owns a less than 100% stake in a sub, what is the correct response?

If we use the standard formula: EV=Mkt Cap + Debt – Cash, we realize that Mkt. Cap is a blended figure, i.e. Mkt. Cap of the parent + % of the market value of the equity of the sub. However, the Debt & Cash are consolidated as if 100% of the sub was owned. Thus we get a spurious number. What if we add MI to that figure? Well, then we get a proportioned Market Cap + a historical MI + consolidated Debt – consolidated Cash. Now that you’ve calculated this new value what is the relevance of this figure? Not much actually, from an economic perspective. Some would say, when calculating ratios like EV/EBITDA or EV/Sales, this aggregate value makes sense to use, since the EBITDA and other income statement metrics are consolidated as if 100% (one has to be careful if there are intercompany transactions between the parent and sub – for instance if a company owns a part of a supplier, or its customer – which can have serious implications depending on the analysis). Assuming there aren’t any intercompany complications, if you do construct a ratio like EV/EBITDA by adding back MI, you’ll get in the numerator, an attempt at EV of the parent +% of sub (the mkt caps are proportioned, but the balance sheet is consolidated), and in the denominator, a summed EBITDA of the two companies. Does this result make sense? That is the equivalent of looking at (a+%ofb)/(x+y) for the combined entity whereas each company individually would have a ratio a/x and b/y. Depending on the numerical values of each company’s actual EV’s and EBITDA’s, it could give some seriously irrelevant numbers that have the illusion of looking relevant. Also if a majority of the EBITDA comes from one entity and majority of the EV of the total derives from another, its another relevance inducing headache. Or if the companies are in different industries, where the EV/EBITDA’s are expected on average to be different, this further adds to the complication as to the validity and usefulness of a combined number. In my view, this combined ratio too is a spurious number. And what is the point of all this calculation? Why do we even care about this jumbled mixed up EV/EBITDA figure? Beats me. If you’re trying to build a comp table, there are more relevant ways to gauge relative value – try using pure plays.

What about subtracting the MI from the EV calc? Again, now you have a Mkt. Cap that is already reflecting the correct % of the earnings contribution, assuming the markets are pricing the value correctly. You have the consolidated debt and consolidated equity. Subtracting out MI gives you what? I’m not even sure there is a term for whatever calculated abomination that results. Excluding MI altogether. Well, to the extent that the cash and debt’s are in equal proportions in both the parent and sub, that might be the best option to get to the most accurate ‘quick’ estimate of the combination’s EV (since the cash and debt would cancel out). But again, these are questionable assumptions, and what good is a combined EV if the companies are in different industries and the ratio is constructed in that (a+b)/(x+y) way? The safest way, in my view, is to first ask, what is it you’re exactly trying to calculate, why, and then use a DCF to isolate the cash flows relevant to the stakeholder to which they matter and value those using current market values and projections.

Not to belabor the discussion, but another interesting complication arises from the debt subordination structure. Let us assume, for example, A owns 51% of B. B has little cash, assets and equity but a lot of debt. A by itself has no debt. In that case, 100% of B’s debt would be consolidated onto the parents books. So now if you look at the parent, it looks like it has a ton of debt. Is this debt real? Consider the situation in which B goes bankrupt. B’s debt holders will normally only have a claim on B’s assets – NOT A’s (if A structured the deal intelligently). So in that case, despite a lot of debt showing up in the consolidated A’s financials, it is technically not something A’s shareholders should have to worry about too much. Their exposure would be to the extent of their EQUITY investment in B. At worst they’ll lose what they invested – not more. This “loss isolation” principle is basically how PE (private equity) funds operate and also where they derive a lot of their value – if one entity goes belly up, the debt holders do not have claim to the other investments or assets of the PE fund - usually only to those assets secured in the entity that went bankrupt. The PE fund takes a loss on the equity, which was small relative to the EV of the overall investment, shrugs, and moves on.

Thus one might even reasonably ask, what is the point of calculating EV for a company that has consolidated controlling interests in other companies, especially when large amounts of debt are involved? Assuming you have to, so what is the right way to do it? Well, again it depends on what exactly you are trying to do. Why do you want to calculate this EV? If it is for getting valuation ratios in a comp table, it would be better to use pure plays. Else use a DCF to get the most accurate estimate of the relevant cash flows to the relevant stakeholders. There is no substitute for digging into the footnotes and historical filings to figure out or estimate what assets belong to whom. Certainly, a rote answer like EV=Mkt. Cap + MI +Debt – Cash might suffice in an interview, but I would hazard the real answer is a little more complicated.

Wrong....

Enterprise value (EV), Total enterprise value (TEV), or Firm value (FV) is a market value measure of a company from the point of view of the aggregate of all the financing sources; debtholders, preferred shareholders, minority shareholders and common equity holders.

Sure - if you want to use Wikipedia as your reference point for financial analysis instead of actually thinking about what the purpose of a metric is for.

Word?

Fo sho

Surprisingly good read. Good job dave man.

Nice considerations. Should be helpful to all future monkeys when confronted with this question. Might actually bring up an interesting discussion instead of just ticking the formula box.

wasn't this already posted a couple days back? good stuff nonetheless

same guy, double post.

Good stuff!

Thank you for the explanation!

MINORITY INTERESTS - clarity on definition(Originally Posted: 04/09/2012)Hi everyone,

EV = equity (market cap) + debt (ST and LT) + minority interests - cash and cash equivalent

Saw many different definitions of minority interests. Can anyone give me a good definition and explain intuitively why it is added to other components of the equation

Thanks

That is untrue. When going from equity value to enterprise value more than net debt is taken into account. Preferred shares and minority interest also must be included. When an acquisition occurs the acquiring company most often needs to take on the acquiring company's debt (thus simply adding a premium to the equity value is inaccurate). Yes, most acquisitions are reported based on some premium to equity value, but the company does in fact need to purchase their debt.

For minority interest treatment, I'll refer you back to my previous point. What is the point of enterprise value? What is it used for?

Why does your point refute my point? When you acquire a company, all you have to do is buy the equity. There may be covenants that mean you have to play nice with the debt holders but you don't have to buy it unless there's an explicit clause that forces you to.If you can really back this up then you should call up Blackstone and tell them where they've been going wrong.

No! You DON'T have to purchase the debt - it's all about the equity....My understanding is that when a parent company owns over 50% of a sub company, 100% of the sub's financials are accounted for in the financial statements.

Since we use Enterprise Value to create ratios with other metrics (EBITDA, Sales, etc.), and EBITDA will contain 100% of financial info from the sub (though we do not

own100%), we need to add minority interest to our Enterprise Value so our ratio is consistent with respect to the numerator and denominator. It seems pretty counter-intuitive, but since our EBITDA figures are going to carry information "as if" we owned 100% of a sub, we have to have our Enterprise Value figure also carry this weight.Let me know if that makes sense.

Makes sense thank tou - however if we were to use the ratio EV / REVENUE, the minority interests are not included in revenues and our ratio would be inconsistent?

I also found this way to understand it: company A owns 60% of company B (according to US law when a company owns more than 50% of another company, it has to consolidate all the financials) therefore in company A's balance sheet we see that under our assets we have 100% of company B even though we only own 60%.

Since assets = equity + liability ----> to make the balance sheet balance we have to have to add 40 of liability since we have 100 assets and 60 equity ----> 100 = 60 + 40

Therefore it's AS IF we borrowed 40 to buy 100% of company B, so treating the 40 as debt we add it to the EV.

However do generally laws in europe say that if ownership of a sub is greater than 50% then the parent must consolidate the sub's accounts? Or is it justba US law?

Thanks

IFRS has a similar treatment, they only differ on JVs and financial investments (e.g., held for sale, held for trading bla bla).

That seems an unnecessarily convoluted way to think about it. Basically the accounting rules just distort EBITDA by including amounts that don't flow up to the parent, and it just becomes quicker/easier to distort the numerator (EV) by an offsetting amount rather than to dig through and try to strip those amounts out of EBITDA, especially since a lot of companies won't report segment data that would allow you to do that.

http://www.wallstreetoasis.com/forums/enterprise-value-and-minority-int…

Search bar is soooo good!

Damn never used it before cheers

I see. So generally we would not expect listed companies to include minority interests in their balance sheet? How would your method work if we were touse EV / SALES?

Minority interest is included in the enterprise value in a market comp approach when calculating multiples to account for the fact that the subject company's operating statistic (Revenue, EBITDA, EBIT) include 100% of the affiliated companies operating result. The equity value used in the enterprise value represents the market price (minority, controlling interest) which already takes into account the fact that the company owns less than 100% of affiliated company (even though the income statement shows 100%). Rather than adjusting the subject company's operating statistic for the unowned portion, we just add the minority interest liability (which represents the unowned portion of the affiliated company's net income) to the enterprise value. The result is an enterprise value and operating statistic that represent 100% ownership in the affiliated company.

thanks - that was very informative.

Long story short - the adjustment for a minority interest should be made such that you're adding back the expense associated with a minority interest in order to derive the appropriate enterprise multiple (e.g., EV / LTM EBITDA) - this is, as John Mack pointed out, necessary to ensure the numerator and denominator are consistent.

I would not recommend, however, trying to reach an "adjusted" EV that includes payments made for a minority interest, since the book value of this minority interest is not marked to market.

Typically if you buy 100% of the equity with say cash then you would assume the debt of the target unless the seller is forced to retire debt prior to closing. When calculating an IRR on the transaction you would include both the cash consideration and the assumed interest bearing debt as this is the total amount of invested capital that is needed to generate the cash flows of the business.

wow- this question is getting a LOT more drawn out than it'ssupposed to be.

I thought that minority interest is supposed to be SUBTRACTED out of Enterprise Value, because it is equity that the firm does not own - correct?

To illustrate. If i'm Coke, and I purchased 60% of Coke 2.0, due to accounting rules i'm going to consolidate our balance statements, as if i owned 100% of Coke 2.0. In truth, that minority interest of 40% is something that I actually do NOT own - hence, should be subtracted out of Enterprise Value.

Am I wrong here?

If you are going to subtract out anything, you would subtract the 40% of Coke 2.0 financials on the I/S. This is not technically correct accounting, but occasionally a banker might like to see it this way.

Technically you add it. Much like how the operating metrics on one side are 100% consolidated, the ownership should be as well.

Think of it this way. Say I bought a new car, but I am a bit short even with financing. I let Rich Rachel go in with me and buy 40% of the steering wheel. What I (shareholders/debt holders) actually have a claim to is the car less 40% of the steering wheel, so that part of the car is not reflected in the lease (debt) or equity (down payment on the car) associated with the car. So if I add this debt and equity, I get the worth of the car less 40% of the steering wheel. To get the entire value of the car (firm value), I would have to add the part of the car Rich Rachel owns, which is her minority interest.

In other words, because Coke has over 50% of this entity, they control it and consolidate (much like I would still control all of the steering wheel). We are concerned with what the operations of the business (or horse power, etc.) is worth, so we have to add the minority interest (Rich Rachel) to get that.

no you add back minority interest... as mentioned, the EBIT number already includes a portion of what you do not own. if you subtract minority interest away, you get an artifically inflated EV/EBIT multiple...

By the way, John Mack is right on all of his points. You (John Mack) also gave a great explanation as to why Minority Interest is added back when using EV to calculate multiples (Revenue, EBITDA, EBIT multiples etc..) - thanks.

This may be a pretty stupid question but:

When calculating Enterprise value for Firm A.....

Is the minority interest portion of EV firm a's stake in subsidiaries / other companies or is it other companies' stake in firm A?

Thanks

Minority interest is a joint venture. So if Company A and Company B work together and make Comapny X, with A owning 60% and B owning 40%, A would view it as a minoirty interest on its books.

So when calculating A's EV, minority interest would equal 60% of company x. How would company b's EV be affected? Would the 40% stake be built into its market cap valuation and not its minority interest? A stake less than 50% isn't a minority stake right?

On the topic of acquiring debt...

Don't acquirers typically have to refinance the target's existing debt once the acquisition is complete?