Hi -
Let's say a company reports $1,200 in EBITDA, and $1,500 in EBITDA including Equity Income from Affiliates.
If the company has a market cap of $5,000 and $2,000 in net debt, what is the correct way to calculate the EV/EBITDA multiple? Do you divide $7,000 by $1,200 or by $1,500?
Thank you all
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Issue here is that equity from affiliates (equity investments) refer to investments accounted under the equity method. Since you aren't using consolidated accounting, you can't use the EBITDA number including EBITDA from aff. Essentially, any potential debt or cash on the affiliate's BS isn't reflected on your BS or EV, so you subtract the value of the BS asset from your EV calculation and use actual EBITDA excl. aff.
So your EBITDA multiple would be 7,000 / 1,200. Though, you need to subtract the value of the equity investment on BS from that 7,000 to arrive at your actual EV. In theory, it should really be (7,000 - Equity Investments) / (EBITDA from ParentCo)
Sorry, but why do I need to subtract the value of equity investments from the $7bn? Is that because the market cap takes into account the equity investments the Company has?
You can think through it by referencing the EV formula. Essentially, EV captures the value of a business’ net operating assets in excess of its net operating liabilities. We’ll start with this idea and arrive at the formula most people are familiar with.
(i) EV = Net Operating Asset - Net Operating Liabilities.
Net Operating Assets can also be expressed as:
(a) Total Assets - Non-Operating Assets
Non-operating asset are cash and equity investments, so we can express as follows:
(a1) Total Assets - Cash - Equity Investments
Now, let’s think about net operating liabilities.
(b) Total Liabilities - Non-Operating Liabilities
Which can be expressed as:
(b1) Total Liabilities - Debt
Combine (a1) and (b1).
(ii) EV = (Total Assets - Cash - Equity Investments) - (Total Liabilities - Debt)
(iii) EV = Total Assets - Total Liabilities + Debt - Cash - Equity Investments
(c) Total Assets - Total Liabilities = Total Equity and Total Equity = Common Equity + Preferred Equity + Noncontrolling Interest
So we rewrite again.
(iv) EV = Common Equity + Preferred Equity + Noncontrolling Interest + Debt - Cash - Equity Investments
TL;DR - We subtract equity investments because they are a non-operating asset (aren’t necessary, required or used to perform the core business operations of the company).
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