Non-controlling Interest Explanation

The point I am confused on is why it is included in enterprise value. I thought market cap would include non-controlling interest because it is all outstanding shares multiplied by the stock price. If someone could help clarify where I am going on, it would be greatly appreciated.


You're not really a PE associate are you?

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Fair question, 400Q guide gives you the bullshit memorizer EV/EBITDA "apples-to-apples" answer

It's included in enterprise value because that is the value of the firm (i.e. all of the assets) to all investors. The NCI people are giving you control over all of their assets despite you only paying for 66% of them. So it's almost like they are an investor in your firm, they're "lending" you assets you haven't technically paid for. You have control over the assets therefore you consolidate them on your balance sheet (accounting rules). That minority interest in the assets (i.e. NCI) must then be added on the RHS of the balance sheet to even out the LHS increasing by that extra amount when you consolidate the assets. So that's how I look at it from an equity value going to an enterprise value POV. Balance sheet gotta balance myguy. 

If that didn't make sense to you, going from an enterprise value to an equity value via bridge should make total sense. 

Let's say I do a DCF to find the enterprise value of a firm. Once I find the EV, I subtract net debt and then boom I have the equity value right? Let's back up. When I was doing the DCF I was working off of the income statement to find my NOPAT before getting to my Unlevered Free Cash Flows (UFCF), and then discounting those back at the WACC. Since I own the majority of Company B, I consolidated all of their financials despite only owning 66% (accounting rules). So my UFCF is going to include cash flows that don't belong to me, since I working off NOPAT that was consolidated, in addition to all the NWC adjustments that were consolidated, and the CAPEX that was consolidated. These UFCFs are "fake" cash flows from an equity investor point of view (after subtracting net debt from EV) because some of it is actually going to the minority interest holders. They own 34% of Company B and thus are entitled to 34% of the net income and 34% of the dividends. Equity investors are smart and sophisticated, they know GAAP (i.e. consolidated) cash flows are not real cash flows, and they only want to pay for real cash flows. So they subtract NCI from (EV - Net Debt) to get the true (and lower) equity value. 

To round it all out revisit the DDM, which literally says the value of a stock is the present value of all the cash flows to equity holders. Equity holders are not going to pay for dividends that are not going to them but are instead going to NCI. Case closed. 


My thought process:

EV represents the present value of unlevered free cash flows a given enterprise will generate. To the extent that you own a controlling stake in a subsidiary and your UFCF is a consolidated figure, the present value of this UFCF number would equal the implied EV, where the EV equals Equity Value + Debt Value + Minority Interest Value (assume firm has no cash). Now let's dissect this term by term. Equity Value is included since the equity investors will presumably receive some portion of the UFCF the firm will generate. Same with debt investors, hence the inclusion of Debt Value. Finally, we include Minority Interest Value since the minority owners of the firm's subsidiary's presumably have some claim on the UFCF since it's a consolidated number. However there is something slightly off with this. The Minority Interest Value should conceptually represent the PV of UFCF available to minority interest holders. If we were to mechanically calculate the EV of a firm (i.e., not an implied EV via a DCF), we would use some book value Minority Interest figure that doesn't represent the market's perception of the PV of FCF available to minority interest holders. The market value of equity and market value of debt, on the other hand, do represent the market's perception of the PV of FCF available to equity and debt investors, respectively. In short, there isn't some "market" minority interest value. Also on the DCF point, it's really just a byproduct of the fact that financials are consolidated. I would encourage to think more liberally about conceptually what you think UFCF should include/represent (see next paragraph for similar discussion) and not confine to what GAAP mandates.

Further, a lot of it just depends on what you think EV should "represent." EV should in fact represent the value of a business's operations attributable to all investors in a business, but the vague part is the 'investors' part. Debt and equity investor of a given firm, by definition, supply that firm with cash and require a return on that cash invested - I'd consider these parties unquestionably to be 'investors'. Should you think of minority owners in the same light? I would argue not. Picture an example: firm A owns 80% of firm B, which means some group of minority owners own 20% of firm B. Are these minority owners 'investors' in firm A? Do they supply firm A with capital and require a return on firm A? After all, these minority owners only depend on firm B's performance to generate a return (i.e., receive dividends) and, at best, indirectly rely on the performance of firm A in its entirety.   


So why isn't there a market value of NCI? If it's publicly traded we could get that. See my comment further down I give my reasoning as to why we should use the market value. 

I see what you mean as UFCF conceptually vs. GAAP mandates, but in my mind I do see NCI as an "investor" although I agree the link is not as clear as for debt and equity.  


NCI accounts for the assets of the company that belong to a party other than the common shareholders, preferred shareholders or debt holders. That is, when a company (the “Parent”) acquires a controlling interest in a subsidiary, it consolidates its financials with those of the subsidiary. While the Parent is accounting for 100% of the assets, it doesn’t own 100% of the assets. Thus, NCI represents equity in the consolidated businesses (Parent financials) not owned by the Parent. When we think of market cap, our goal is to identify the market value of equity in the Parent’s business and NCIs are simply the opposite.


I think the idea is that you would use the market value of everything when doing the bridge. I'm pretty sure the book value of NCI would change as Company B earns net income and pays dividends, so at least it's not totally stagnant.  

The whole idea (from my other comment) is that equity investors are smart and if they're doing the bridge from EV to Equity Value to then divide by the number of shares to get share price to figure out at what price is fair, they wouldn't use the book value of NCI since that would overstate equity and thus the share price. Stocks would incorrectly look "cheap" since it would seem everything is trading at a discount to the intrinsic value. This is the point you brought up.

I think what they would do if Company B was publicly traded and has 1000 shares is subtract 300 shares (assuming NCI is 30%) multiplied by B share price to then get to the Company A equity via the bridge (after already having subtracted Company A net debt from the EV). 


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