I got asked about when a company would have a negative enterprise value in my superday. I answered when its cash balance is greater than its combined debt and equity (he told me to ignore the other stuff). I mentioned that banks sometimes have a negative EV b/c of their large cash balances.
He was not satisfied though and kept going in on why a company's equity would be trading at lower than its cash balance. I talked about how investors might have a lack of faith in the operating assets and their cash flow generation but could not think of much else.
He spoke more about relating this to the DCF and how investors view this company but I honestly forget. I tend to forget everything in interviews.
Can someone talk more on this topic? I am interested in learning more.
I don't think EV can be negative.
Market prices could definitely imply a negative enterprise value, although it certainly isn't common in today's world. You find a business with valuable non-operating assets, cash or securities, etc, where the market doesn't think much of the business. A classic example is Sanborn Map company, which Buffett bought back in the 60s - the business had an investment portfolio worth $20 per share above the trading price, so you got the map business for free and the investments well below book.
In today's world, however, you shouldn't see this happen given the rise of easy information. A company could appear to be trading at a negative EV because your calculation is not factoring in the whole picture. You may be overvaluing the non-operating assets. Or, what is very likely is that you are ignoring potential liabilities. It's possible that companies in certain industries could face high liabilities (enviornmental, legal, etc) that may either not be on the books or not fully accounted for on the books. Thus the business operations may in fact be worth a negative amount, and the stock not worth the full value of the excess assets
Extelleron's answer is a good expansion but honestly the OP's answer is pretty good (for what I assume to be a summer/1st year interview) in understanding that essentially it means the market is doubting the ability of the business to generate cash amd not wither away assets. Interviewer may have just been trying to push you harder but it's a B+ answer for sure.
Yeah he said I was right, I think he was just trying to get me tripped up to see how I would react.
It happened to Yahoo at one point after the Alibaba IPO - basically investors were worried Yahoo would take its Alibaba cash and make it rain in Silicon Valley. Same thing you were getting at. Linking it to the DCF, you can say that investors believe the company is investing its cash in projects with a return below its cost of capital and thus destroying value.
It's mainly because of taxes that shareholders have to pay at distribution on the one hand, and inability of the company to invest in value creative projects on the other: situations where you would rather have 1 dollar in your pocket than on the balance of a company you own. The total value of that discount on cash because of aforementioned reasons must then be greater than the value of all other activities and you have your negative EV company.
I should add that if the company's operations destroy value and you can buy the equity for less than net cash, the company should be liquidated.
Of course, best of the luck to the guy who tells management they ought to give up their salaries and liquidate...
Which brings up another point, that unless you have control or can acquire control cheaply, or have an activist shareholder base, management is going to look out for their interests, which is usually to keep the ship afloat as long as possible.
Then there's the cost of liquidation. Sears is probably an interesting case study of the "negative EV" company. People have been making the case for years that the net real estate value is greater than the market cap, and a lot of it is hard to value but they're probably right. Thus counting RE as excess asset, you're getting the operations for a negative value. But a massive retail operation can't be easily/cheaply shut down overnight, so a value-destructive retail business is worth far less than zero.
Well, yes, I'm saying it should be liquidated. Lots of companies actually should be liquidated but never will be outside of an involuntary chapter 7 filing (presumably converted from a more hopeful chapter 11)...
Confusion with why companies have negative Enterprise Value? (Originally Posted: 11/11/2015)
M&I says that companies with extremely low market caps might have a negative EV and then links that to companies which are about to go bankrupt. But if a company has an extremely low market cap, does that mean it is on the brink of bankruptcy? Do market caps and bankruptcy technically HAVE TO be related? I didn't think they did... Maybe it's just an extremely small company but isn't going bankrupt necessarily..
With negative EV, the equity value has to trade below the cash value (cash less debt) of the Company.
The key element to understand is where the Company is coming from and where it's projected to go to. If a Company has just undergone a restructuring/turnaround, it may be still trading less than cash value, but with prospects of appreciating above that point.
On the flip side, if the Company is on a downward trajectory, its equity holders may expect a bankruptcy declaration to be made. In such a case, equity holders are expecting a haircut or lower probability of being made whole on their investment.
Apologies for my ignorance, but what do you mean by trading below the cash value? Could you put that into a little more context as to what that means?
It means that the market cap is lower than the total net cash in the company - using some dummy figures:
Market Cap: $1M Cash: $10M Debt: $0
TEV is -$9M
"Do market caps and bankruptcy technically HAVE TO be related? I didn't think they did... Maybe it's just an extremely small company but isn't going bankrupt necessarily.."
This is correct, but think about it realistically - the only time a company is going to have negative TEV is when its equity value (market cap) is super low, and maybe about to go BK. The reason the market is valuing the company at less than its cash usually has to do with incorporating cash burn (i.e. normally a company ought not be worth less than the net cash it has, but sometimes there are cash uses that can be reasonably foreseen so the cash on the BS isn't a true cash figure since some of that should be reserved against the upcoming use).
FWIW I found the M&I guide to be kind of confusing in the part where it talks about negative TEV (by which I mean I still remember it and disagree with some of the reasoning, but not sure if that's the same version we're talking about here).
If your question is how EV can be negative, it is possible by virtue of: cash - debt balance > equity value, which I believe is what Bullet tooth is saying.
If EV (simplified) = equity value + debt - cash, then it holds true that if your cash balance after debt is larger than your equity value, you will have negative EV
The above responses are mostly valid. You may also see this when a high degree of leverage causes market value of debt to be less than book value. You are supposed to use market value but people shortcut (most of the time doesn't matter but it does in this scenario).
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