I understand that theoretically financing shouldn't affect EV because it's independent of capital structure. However, based on the EV formula, wouldn't an exercise of ITM stock options increase EV? The cash proceeds from the options would be less than the increase in EqV because the stock price is greater than the strike price. EqV would increase more than cash, so EV should go up. I'm conflicted about which way to think about this.
Thanks for the help!
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Okay, I know you probably understand most of these steps but to me it seems like you are missing a few concepts (not fully off though):
Stock options are financial instruments which track the market performance of a company and allow shareholders to purchase shares at a given price (the strike price)
Companies issue stock options to reduce cash outflows or compensate shareholders (for example, SBC or performance-based units to the target in an M&A transaction)
This means stock options look like this for a company (if you assume the Treasury Method, which I think it's what you're trying to get at):
Company A grants its shareholders 100MM options with a strike price of $1
Company A now trades at $2, so the holders of those shares "strike" the options. You assume the shareholders convert their options by purchasing the shares at the strike price. So, the company now receives $100MM.
We assume the company will use these proceeds to repurchase its own shares (meaning, we don't change cash, we just reduce shares outstanding). Because the shares trade at $2, the company can repurchase 50MM shares.
So, the company issued 100MM $1 options. It performed well and reached $2/share. The options owners exercise their options, "forcing" the company to issue 100MM shares for $100MM in proceeds. The company immediately uses these proceeds and repurchases 50MM shares. Thus, the net impact to cash is $0, and FDSO went up by 50MM.
That means, when options are in the money, both Equity Value and Enterprise Value will increase by the dilution (50MM) times the current share price ($2), or $100MM.
Hope this makes sense.
Oh shit good call totally forgot about TSM. Great explanation btw I would've SB'd but don't have any credits currently. Yeah this makes sense now. So whenever you have ITM stock options, EV and EqV go up by the market value of the net issued shares(net shares issued X current share price)? The concept and situation makes sense, but how come the theoretical notion doesn't hold up? That is, EV is independent of capital structure and financing decisions don't affect it. Obviously this doesn't hold true in a DCF for implied EV, but it should for current EV. Wouldn't ITM stock options be considered financing and in theory not affect current EV? Or is this just a unique exception?
Financing decisions don’t affect enterprise value, but you need to consider all ownership to get to that number, so options are part of that. So what “financing decisions don’t affect EV” means really is that whether it’s the dilution or cash or debt, EV will be the same, but first you need to consider that portion of ownership. Idk if this is making sense
This is wrong. Number of shares will change, but share price should adjust accordingly to get to the same total equity value. Because of the options, existing shareholder dilute, but EV remains the same.
If your answer was right, every company would be issuing ITM options all the time and create heaps of shareholder value :)
Right....... classic adjustment to Equity Value when we calculate FDSO.......... a bit concerned you’re a “VP” in “PE” but don’t know the difference between market cap and equity value. One is on a basic basis and the other one is on a diluted basis. So yes. Your equity value MUST be higher when options the company issued become ITM. The market already bakes the dilution into the share price.
And even in practical terms, that’s a stupid thing to say. There’s one share price. That’s the market price. You can talk about adjusting it as much as you want but the market price is the market price.
And just FYI, "issuing ITM options" is literally issuing stock. If you issue stock, you're telling me your equity value doesn't go up and your net debt goes down? Which is, by the way, the definition of the mechanics of an IPO transaction/private placement?
Does dilution occur when convertible bonds are converted?
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