Hi All,
Was speaking with a Commercial/Corporate Banker as it's a career interest of mine and he mentioned something about evaluating Enterprise Value when underwriting/performing credit analysis and understanding how much buffer there is when multiples change. It didn't quite click at the time and I figured it was an easy google search but I can't find anything about it beyond that the "value of the firm can be used as a secondary source of repayment" on occassion....I know how to calc EV, but what exactly would one do to determine what it means in the context of lending/credit?
Only thing I can think of is how EV = Market Cap + Net Debt, etc....As market cap declines, net debt becomes bigger proportion....but can't wrap my head around a meaningful calc here. Any insight is GREATLY appreciated.
Maybe they're referring to "intrinsic" EV? As in, the kind of EV you calculate for a company based off a DCF, or throwing multiples on top of Revenue or EBITDA.
If you've got a company with, say, $50 mil EBITDA in an industry where the comparable all trade at 7-9x EV/EBITDA, your intrinsic EV should be somewhere between $350 mil to $450 mil.
As such, if this company is proposing to take on a total of $400 million of debt, you've obviously gotta be incredibly careful here. If multiples within the industry suddenly drop to, say, 4x EV/EBITDA, then the intrinsic value of the company is suddenly around $200 million, which is probably indicative of lower earnings potential or some other headwinds which could make it difficult for the company to pay up on interest, and especially to refinance. If you gave this company $300m in debt when its EV was estimated to be 350-450m, you're gonna be in a lot of trouble at maturity, because lenders will suddenly be looking at a company with an EV of around $200m, and unlikely to give a larger loan.
And, in the case of a bankruptcy, if multiples drop and the intrinsic EV of this company is expected to be a lot lower than when you initially lent to it, your recovery on the loan is going to be lower - much of your debt will not be rolled over into NewCo nor will it be converted into equity.
Yeah ok I was thinking something along these lines as well. So let me check if I'm picking up what you're saying: essentially if I have my $50mm EBITDA company and my comparables are at 7-9x like you said and so my EV should be $350-450mm. Let's say it's $400mm. If I give a $300mm loan I'm essentially giving a 75% LTV, but if multiples drop and my implied EV is now $200mm as you said, my LTV has risen to 150% and the co. is going to have extreme difficulty refinancing since lenders don't like to go to LTVs that high as lenders generally do not like to give you more than $1 for every $1 worth of underlying percieved value at max. Similarly my odds as a lender of extracting $300mm from a co. only valued at $200mm aren't so hot because if it's valued at $200mm odds are there is a reason - bleaker future prospects than when it was valued at $400mm.
Am I thinking about this correctly?
You're referring to the concept of equity cushion, and what in essence that really means is the firm has the right-sized capital structure where equity as a % of capital structure is reasonable-enough that the equity guys do not take unnecessary risks at the expense of the debt guys (incentives are aligned). That's the crux.
At least in the context of infra and renewables, EV is not used in base case evaluation, but rather in the context of so-called “stressed EV” for combined downside cases (perfect storm). One arrives at stressed EV by applying a stressed multiple to stressed EBITDA. A stressed multiple is determined by peer analysis of companies through credit cycles and their estimated trading values in a downturn. Stressed EBITDA is derived via combined downside modelling - with ultimately two drivers, being revenue contraction or margin deflation (or both) via various causes. Stressed EV then allows lenders in the cap structure to assess, from either a contractual or structural (or both) subordination perspective, their claim on the expected value of proceeds realised from exiting the defaulted project via a forced sale/liquidation event. This normally takes into account transaction/recovery costs as well as the inherent discount in being a forced seller (this is baked into the stressed multiple). I have limited experience in LevFin, but I imagine this to be somewhat similar?
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