Ok, let's say there's a business with a $1 billion market cap and it also has $1 billion in cash and cash equivalents. There's no debt, no minority interest, no preferred stock. So EV would be $1 billion - $1 billion , right? How would it technically cost $0 to acquire this business and all the cash it has? What concept am I not getting here? I'm a freshman just getting started with learning technicals, so I appreciate the help.
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It actually wouldn’t cost 0, if you include your transaction and legal fees. Put it this way, a man has $10. You give him $10 (the transaction price being the EV), and in return he gives you his $10. This is why the net is 0, because you simply exchanged the same amount of cash in the transaction. Now, normally you’d need to pay your banker and legal team a fee for their services, so I guess you would end up around 50 cents negative at the end of the day.
Yes no shit there are transaction fees. Did you just learn this in your CorpFinance101 class? How is this relevant to OP's query?
Implicit in this example is that the only thing of value in this business is its cash, and the market is valuing that cash at face value.
If this were a public company, you would acquire its $1bn equity value, and shareholders would receive the par value of the cash.
As others have said, in a cash free / debt free transaction, sellers sweep the $1bn in cash (so receive $1bn) and get paid nothing for the remainder of the business, because excluding the cash it isn’t worth anything.
If a business is worth $1 billion, including $1 billion in cash, then the actual business is worthless. It probably has 0 sales, 0 cash flow. So it's literally a useless business with just $1 billion of cash laying around. So you can get the useless business for $0 since you aren't keeping the cash.
Many good answers above. And you have some real examples in the market with SPACs. Market cap is usually around the cash they have on BS (so $0 EV) until they de-SPAC.
You could buy the company for the market cap of 1 billion, then dividend the 1 billion of cash to yourself for a net cost of $0. The fact that the market cap is $1b means the intrinsic value of the business’s operations is $0. As another poster pointed out, it’s very similar to a SPAC in which the market cap of a spac is equal to the cash they raised (before they identify a target)
I always thought of EV like a home. If you buy a house that costs 1m but only put 100k down payment and 900k mortgage, the EV would be $1m (true worth) but Equity Value would be $100k
I don't think this example really works at all. The home is worth $1M w/ no cash. That is its enterprise value. If there is cash in the basement, then the equity value increases by the amount of cash in that basement, but the enterprise value stays the same.
If a company has 1B in cash and has an equity value of 1B, investors are essentially saying that the value of the business operations (the value of the “enterprise”) is 0. Basically, the company only has worth because it is sitting on a pile of cash.
LOL if a company with $1B in cash has a market cap of only $1B then it has some issues.
Think of this as a house. If a house with a market value of $1MM has $500K worth of cash sitting on the kitchen countertop, how much would you pay to the seller to give you the keys? It's $1.5MM. This is the market cap in your example because there is no debt. Then you take that $500K on the kitchen countertop and deposit into your bank account. You essentially paid $1MM for the house, which is the enterprise value.
In your example, if there is $1B of cash sitting on the kitchen countertop and the seller is only asking you to pay him $1B (again the market cap here), that means the house is worth zero.
I think the easiest way to think about this is the following: pretend this is a brand new (private) business venture (... think lemonade store...). As the owner, you inject $1mm of cash out-of-pocket for the start up investment. So far, the balance sheet is: $1mm cash, $1mm equity value. At this time, you have yet to "start" your business via buying inventory, selling lemonade, etc. You haven't even set up the store yet (no PP&E - assets - or overhead - any other expenses). All you have is literally $1mm in cash... maybe it's in a box somewhere. The enterprise value of this business at this time is theoretically $0. You have no real business. Assuming no transaction costs or premium paid above the equity value, a buyer for this "business" would pay $1mm for the equity value and get $1mm cash in return. On a net basis, this implies the business was free. (enterprise value = 0)
Put another way, if I pay $10 for item X and in return I get $10 + item X, then item X was for free.
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