NOLs and EV
I was going through the BIWS guides on equity value and EV. It said NOLs should be treated the same as cash, since it saves the company in future tax expenses, which then it concluded that NOLs decreases a firm's EV.
But just theoretically thinking, NOLs would increase your free cash flows in a DCF and increase EV. Also the fact that NOLs aren't upfront reductions in buying the company (like cash is). So I think NOLs should increase EV. Furthermore, just thinking about two companies, all else the same but one has more NOLs, you would want to pay more for it.
Can someone explain or confirm?
You're saying that you'd pay more for a company that has a net operating loss (NOL), rather than one that doesn't?
how would it increase EV?
Don't you actually mean DTAs associated with past NOLs, not current/ongoing NOLs themselves?
Yes because NOLs increase your free cash flows. The way I think about it (correct me if I'm wrong), NOLs are sort of like discount coupons when you purchase PP&E or whatever. Basically it reduces your expenses in a DCF, resulting in higher cash flows, which increases EV.
How does higher cash flows increase EV? EV is just market cap, debt, MI, preferred stock less excess cash (so if cash increases, wouldnt overall EV decrease? I may be wrong.
The cash flows I'm talking about is Free Cash Flows... you know, the item that you discount in a Discounted Free Cash Flow method? Also you're right about the formula of EV, that it's the sum of market cap and net debt etc, but you can also calculate it from a DCF (which is sort of an implied EV, to get to implied market cap)
It under no circumstance should increase ev. You could NPR it at a conservative discount rate and deduct that from ev.
deduct what from EV? Cash?
I'll bite
NOLs should in theory be factored into a publicly traded company's equity value (market cap). The reason you would subtract it is if, for example, one company in your comp set has a huge NOL. This would cause the company to have unusually high multiples (higher market cap, and thus higher TEV if you don't adjust). To normalize this multiple for comparison purposes, you would subtract the value of the NOLs.
However, you're right in that NOLs lead to higher cash flows which results in a higher TEV when you do a DCF. The TEV of the company is this "higher" TEV that includes the value of the NOLs, but for comparison purposes, you'd want to strip it out and look at the "base business".
Conversely, if you're valuing a company with NOLs but none of the peers have NOLs, then you'd want to take an EBITDA multiple of the peers and add the value of your NOLs to that TEV
I sort of agree with what you said - that you should adjust for NOLs when comparing companies. But you said in one sentence "you would subtract the value of the NOLs" and another saying "add the value of your NOLs" which confused me.
I spoke with an industry friend, he pointed out that the main problem is the classification of NOLs. Whether it should be a recurring item being generated from business operations (which then should be included in a DCF), or it is just one off items like cash, debt, preferred shares. He concluded saying it should be subtracted from EV.
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