Purchase Price and Non Operating Assets
My question is whether in an M&A deal the price paid by the acquirer includes (Excess) Cash and other Non Operating Assets and Debt. From what I've understood, the base price the acquirer pays is represented by the Equity Value, which should include all Non Operating Assets and (Excess) Cash. Meanwhile, Debt is added to the purchase price if the acquirer decides to refinance the existing Debt. If this is so and the Debt is refinanced, then the actual price paid would be equal not to the Enterprise Value (since Cash is subtracted), but rather to Equity Value + Debt (for sake of simplicity don't consider premiums and other expenses such as fees etc.). Is this correct?
You're off the mark a bit. The "actual price paid" should be considered net of cash received.
Let's assume there's a cardboard box with a $5 bill inside. If I pay you $10 for it, that implies the total value of the equity of the box is $10. But the EV of the box is only $5. I subtract the cash inside the box, because that equals the net change in my cash once the deal is done. I spent $10, but I immediately got $5 back. I could have just as easily paid you $5 and told you to keep the $5 bill inside. That's why EV is a better measurement of the inherent value of the box, without consideration of how much cash is inside it.
Alright thanks. So please tell me if I'm right: -we are actually paying for all Non Operating Assets (included in the Equity Value); -Instead, Excess Cash is an exception to what just said before since we would be paying cash for cash, so that's why it must be subtracted from the total purchase price; -Debt is added to the purchase price if we intend to refinance it or pay it off;
Also, if the reason why we subtract cash from the Enterprise Value is because we would be paying cash for cash, what's the rationale behind subtracting other Non Operating Assets (ex. investments, land, offices...) from Enterprise Value?
You're paying for all of the assets, operating or non-operating. They all have a value and you've got to pay for them. You had to pay for the cash too, but at the end of the day what we care about is the net change in your cash, which is why cash in partcular is subtracted to determine "actual cost" = EV.
For your debt question, we can imagine if the box also had an IOU inside that would obligate its owner to pay $2 back to the bank. All else equal, this would change the equity value of the box, not the EV. The inherent value of the box itself has not changed, it's just that the current owner financed it with an IOU instead of owning it outright. The equity would fall by $2 to $8. My EV calculation would be $8 equity + $2 debt - $5 cash = $5. That's what it would cost me to own the box outright: I give $8 to the owner, $2 to the IOU holder, and I get $5 cash back. I could also just pay $8 to the owner, take out the $5 cash and leave the IOU in place. But now I don't own the box outright, as someone else has a $2 claim on it. EV is meant to calculate the net cost of 100% equity ownership of the business - or in this case, the box.
Referring to the excess cash as "double counting" if you don't subtract isn't the way I'd explain it. I think you said it best above when you described it as paying cash for cash.
Ok thank you, I understand what you mean. However, if the EV were the actual cost, why do we subtract (as the definition of EV says) ALL non-operating assets (not just excess cash)? Those, unlike excess cash, should be factored into the overall actual cost..
I'm not familiar with that definition of EV. I've seen more complicated versions that include minority interest, unfunded pension liabilities, etc., but never something that lumped all non-operating assets together.
I can see the reasoning for it though: any non-operating asset could theoretically be liquidated (and any non-operating liability could be paid off) and the business could continue to run. So If you treat non-operating assets as if they'd be sold and converted to cash, the logic holds.
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