Enterprise Value | Investments in Associates

jeedog's picture
Rank: Senior Monkey | 77

Why substracting Investment in Associates from Entreprise Value and why at market value ?

Accounting for Associate Investments in EV

When completing a detailed EV calculation, you subtract out associate investments as they are considered like cash - something that would be liquidated to pay off debt or liquidated in the case of a sale. You would subtract the value of these investments at market value as if you were selling the investment right now to pay off debts. Our users explain below:

Alex_Kap:

From what I was explained, investments in associates is almost like a market (stock) investment. Deducting it out of EV will be done to account for the likely sale of this investment once the firm is acquired, as it is not really part of the operational enterprise. There is scenarios where the investment is something the possible acquirer may want to keep, in which case you could add it back to EV (again at market value).

BrokenWings:

Think of it like cash... when subtracting it from EV, you're implicitly classifying these investments as being highly liquid. This in turn will be used to offset the purchase price when acquiring the company (as explained by the previous poster).

User @gomes3pc, a private equity associate, shared a different perspective:

gomes3pc - Private Equity Associate:

Enterprise value is supposed to calculate the value of the core business operations. That's why you take out net cash - it is not part of the business. Investments in subs/associates are just like illiquid stock investments - they are not actively part of the company's core op's.

Check out the image below which offers a detailed breakdown of enterprise value.

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Comments (13)

Oct 14, 2008

i have never heard of this in calculating EV so please advise...

Oct 15, 2008

I am 100% affirmative about that (discussed during interview at BB and even seen on this forum) I just don't know why !

Oct 15, 2008

From what I was explained, investments in associates is almost like a market (stock) investment. Deducting it out of EV will be done to account for the likely sale of this investment once the firm is acquired, as it is not really part of the operational enterprise. There is scenarios where the investment is something the possible acquirer may want to keep, in which case you could add it back to EV (again at market value).

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Oct 15, 2008

Think of it like cash... when subtracting it from EV, you're implicitly classifying these investments as being highly liquid. This in turn will be used to offset the purchase price when acquiring the company (as explained by the previous poster).

Oct 15, 2008

thx guys

Oct 15, 2008

Enterprise value is supposed to calculate the value of the core business operations. That's why you take out net cash- it is not part of the business. Investments in subs/associates are just like illiquid stock investments- they are not actively part of the company's core op's.

Oct 15, 2008

fine - but if you are taking that out then you will have to make an adjustment to equity earnings/dividends that are coming through from the subsidiary when doing comps...

i have personally not come across anyone making an adjustment to investment in associate. the closest would be doing a SOTP valuation - where you will then value the investment in associate at market...

Finally, the fact that there is an investment in associate line (i.e. the investment in equity accounted for) should mean that the investment is core to the company's business (not "core" in the traditional sense, but in the sense that the investment is not something that intends to be traded". So actually, I don't think you should normally strip out investment in associates when calculating EV.

Oct 5, 2018

10 years later but...I would say that the market value is reflective of that investment so you want to pull that out. The hard part is adjusting earnings for that equity investment. It's impossible. So when you're spreading comps, it's easier to align the companies by adjusting that value.

Oct 16, 2008

You are confusing investment in associates with minority interest, which is added to EV as a debt on the B/S. This would be added because as you said - sort of - you would consolidate statements, and earnings from the minority interest are added to the companies operational figures.

I have rarely come across someone who does and EV comp that doesn't strip it out, this ranged from Citi to GS to TD Securities, so I'm not sure how you haven't come across this.

Oct 17, 2008

what i'm saying that you only see the line investment in associates when the company equity accounts for its investments. Earnings from the sub/assoc increases the investment in associate line in the B/S, whereas cash divs reduces this. The corresponding line in the I/S would be something like equity accounted earnings or something like that.

If you were going to strip out investment in associates, then you would haveo to strip out the equity accounted income if it was including above the operating income line.

but i understand your point above - haha. We are not as nuanced where i work - but i owuld think its a rather small adjustment in most cases. i don't even see that being made in factset or bloomberg etc when calculating ev.

Jan 28, 2011

From the article Rahul linked:

Finatics:

Effects on the Financial Statements of 'H': When 'H' holds 30% in 'S'. Equity of 'S' is Rs.1000Crs, Total profit of 'S' is Rs.100Crs and 'S' pays Rs.10Crs as Total Dividends.

Income Statement of 'H': Rs.30Cr (i.e. 30% of Rs.100Crs) as 'Share of Profit from Associates'. Balance Sheet: Rs.300Crs as 'Investment in Associates' in the year of acquisition (along with Goodwill, if any). Thereafter, 'Cash' will increase by the amount of 'Dividends Paid' i.e. Rs.3Crs and 'Investment in Associates' will increase by Rs.27Crs (Rs.30Crs - Rs.3Crs). While 'Retained Earnings' will increase by Rs.30Crs as a result of an increase in 'Net Profit'. Statement of Cash Flows: In the first year, Rs.300Crs as 'Investment in Associates' will come under Cash Flow for Investment (CFI). Thereafter, under the indirect method, Rs.27Crs (Rs.30Crs-Rs.3Crs) as 'Share of Profit from Associates (net of dividends)' will be deducted from CFO.

Income from an associate increases the investment in associate account on the balance sheet (or if cash dividends are paid out, cash), and the corresponding entry is to Retained Earnings, so the results of operations from the associate never hit the P&L.

Best Response
Aug 6, 2017

I know this is an old post, but in case anybody finds this and is looking for the right answer, I would recommend Googling "Why You Subtract Equity Investments (Associate Companies) in Enterprise Value." You should find a YouTube video by Mergers & Inquisitions / Breaking Into Wall Street that explains this concept in detail. The other answers on this thread are not really correct.

In short, your EV should be apples-to-apples with your Rev, EBITDA, EBIT, etc. When accounting for equity in earnings of affiliates, accounting rules require that companies show their proportional share of earnings or losses in affiliates after operating income. In other words, a company's share of earnings in affiliates is not included in the Revenue, EBITDA, or EBIT it reports, rather it shows up in net income. As such, the market value of those investments cannot be included in your EV either, otherwise, your multiples won't be apples-to-apples.

To be conservative, you should assume that shareholders in the company you are evaluating have priced in the value of the equity investments the company holds, and thus, the company's market cap is higher by the proportional amount of equity it holds in investments. To appropriately adjust market cap, and by extension, EV, back out the value of equity investments at fair market value. For investments in private companies, you can generally find FMV estimates in the footnotes of the 10k or 10q, and for public companies, you can find the number of shares held in the same footnotes, at which point, you can multiply those shares by the current market price of the affiliate investment to get to a current FMV.

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Oct 5, 2018
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