How is it possible to have a negative EV?

baloneymaloney's picture
Rank: King Kong | 1,640

So the answer is that a company has more cash than the market value of equity. That makes no sense because the market value of equity takes into account cash, thats why you have to subtract cash from enterprise value in the first place...

Comments (68)

Jun 25, 2017

What? I don't understand what you are saying; the market value of equity, which is the equity value, does not include cash. Equity value is simply a company's total shares multiplied by the share price. Enterprise value is in theory, the total cost of a company. If the company's cash value is greater than the sum of its equity value, debt, preferred shares and NCI, it will have a negative enterprise value. This can happen, and examples of companies with negative enterprise value today also do exist

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Jun 25, 2017

"Why do you subtract cash in the formula for Enterprise Value? Cash is subtracted because it's considered a non-operating asset and because equity value implicitly accounts for it. "

So if Equity value already accounts for cash, how is it possible to have more cash than equity value?

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Jun 25, 2017

The equity value is simply the market value of the equity of a company.

If you think about the Enterprise Value as the costs to aquire a company, think about cash (which is substracted from the equity value) as a revenue for the aquirer. You'll get the excesss money (in theory) after a purchase, therefore it does not belong into the EV

Jun 25, 2017

You're confusing Book value with Market value of equity.

Absolute truths don't exist... celebrated opinions do.

Jun 25, 2017

check my comment above

Jun 25, 2017

Best explanation I ever received was this.

If you buy a wallet for $10 but discover it contains $5 inside. How much did you really pay for it?

Same applies here.

You buy a company a its market value and you also receive its debt, but you also receive its cash.

Absolute truths don't exist... celebrated opinions do.

Jun 25, 2017

Using your example, you buy a wallet for $10 and discover it contains $15 in it. the seller basically paid you to buy it. Why in the world would the seller price the wallet at $10 knowing there is $15 in it.

In this example, if the $10 represents the equity value, then you are basically saying that the equity value takes into account cash already. That's why the seller isn't selling it for $5 because he knows there is $5 in the wallet already, which means the $10 takes into account the cash. Do you get why I'm confused lol

Jun 25, 2017

You got your wording wrong.

If you buy a wallet for 10$, its EV is 10$. Assuming that all it got is the 15$ cash, it means that the equity value is 25$.

Jun 25, 2017

That scenario is rare and would only happen in OTC stocks due to factors such as: illiquidity, fraud, bankruptcy and psychology.

I think we really need to distinguish the difference between equity value and market value of equity.

Equity value is what you get when you do a DCF using FCFE. After discounting the cashflows, you add back the current cash balance, then divide by # of shares.

Market value of equity is simply the price per share x # of shares. It is the amount required to buy a company.

Due to market inefficiency, equity value does not always equal market value of equity.

Absolute truths don't exist... celebrated opinions do.

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Jun 25, 2017

So are you saying assuming markets 100% efficient, it is impossible to have a negative enterprise value, but if markets are inefficient, it is possible to get have a negative enterprise value since the market value of equity could be lower than the true value of equity?

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Best Response
Jun 25, 2017

It can actually happen in pre-revenue companies with a majority of their value tied up in intangibles, and can sometimes be a natural progression of their story as a company.

Imagine a biotech in clinical trials with a single drug they're trying to bring to market. They IPO w/ equity value of $100mm, including $50mm in cash, no debt. So EV is $100mm - $50mm = $50mm.

Now imagine the late-stage clinical trial that they need to get to market fails, and the drug doesn't appear to work. The market believes the drug is a zero, but the company still has cash that it is burning. So negative EV actually makes sense in this case since the majority of the market is assuming the company will continue burning cash over time (you'll sometimes hear people refer to this as "they are trading below cash").

Next, imagine that they figure out the problem wasn't with their drug, but rather how they designed the clinical trial. So they use the remaining cash on hand to re-design and run a clinical trial and it exceeds beyond everyone's wildest dreams! Suddenly the EV of the company skyrockets (as approval is now a near certainty and it'll be a blockbuster, woo!), and then Pfizer takes them out for 50x peak sales estimates.

The end.

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Jun 25, 2017

Most likely the market is pricing in some significant cash burn or debt obligations that's not on the B/S (like a pending lawsuit that'll like be in favor of plaintiff), or the excess cash you're subtracting out of equity value is overstated.

Jun 25, 2017

This makes sense intuitively.

Jun 25, 2017

in this scenario, could the company pay all its cash to shareholders as a special dividend and then declare bankruptcy? If that wasn't legal then the market value would hold up as at least the cash; but my gut is that dividend wouldn't hold up in court

Jun 25, 2017

in this scenario, could the company pay all its cash to shareholders as a special dividend and then declare bankruptcy? If that wasn't illegal then the market value would hold up as at least the cash; but my gut is that dividend wouldn't hold up in court

Jun 25, 2017

Defer to someone that spent more time in Rx on the actual legal proceedings, but this is very unlikely to happen. Assuming the dividend is somehow actually paid out (there are usually negative covenants in credit agreements that prohibit/limit amount of dividends and would require board approval), debt holders could sue the company for fraudulent conveyance, in this case probably actual fraud, after the fact to get the dividends paid back.

Jun 25, 2017

Agree with everyone (except OP) here, market inefficiencies, financial distress, illiquidity and more come into play. In theory, it represents an arbitrage opportunity but it usually does not factor in other things such as the factors mentioned in my previous sentence

Jun 25, 2017

this could be possible for a liquid company if there are very little operating assets and a lot of overseas cash. equity value could be less than cash here because the market cap would be reduced by the cost to repatriate the cash

Jun 26, 2017

Just because the cash is on the balance sheet does not mean it's accessible to the marginal minority shareholder.

Jun 26, 2017

Enterprise value is the market value of a firm's operations. The market value of equity, as you note, includes the value of non-operating assets (i.e., cash, marketable securities, etc.). Therefore, EV =/= MV of Debt + MV Equity. It's equal to MV of Debt + MV of Equity - Non-op Assets (EV = operating assets contributed by debt holders + operating assets contributed by equity holders. TIC = operating assets contributed by debt holders + operating assets contributed by equity holders + non operating assets. EV = TIC - Non-op assets).

To answer your question: EV can exceed BEV when the value of Non-op Assets exceeds that of the operating assets. Your confusion, in other words, is due to your misunderstanding of the "Market Value of Equity" (MVE). The MVE does not reflect the value of operating assets contributed by equity; it reflects the market value of all assets (op and non-op) contributed by equity. EV only considers the operating asset component contributed by capital (both equity and debt).

Hope this helps.

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Jun 26, 2017

BIWS recently posted an Enterprise Value vs. equity value piece that basically stated Esuric's answer.

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Jun 26, 2017

A simple answer is that the OP is assuming 50 million in cash & cash equivalents is perceived as 50 million in value to equity holders. I.e a 1:1 ratio. That is not the case, however.

Equity investors value their equity with the going concer principle in mind (the assumption that a company will continue to operate indefinitely). Therefore, 50 million sitting on the books now is absolutely worth 50 million to an aquifer purchasing the company right now which is why the full 50 million is subtracted when calculating enterprise value. On the other hand it is not worth the full 50 million to equity holders for multiple reasons. The company could blead cash over the coming years, etc. Even if the company liquidated in 5 years and distributed the 50 million to equity holders it would only be worth 50 mm / (1+cost of capital) ^5 to the equity holders.

Another example, imagine with current operations that will generate cash flows who's present value to shareholders is 20 million.

The company has 50 million in cash that is has plans to invest in XYZ and shareholders only perceive this investment as generating future cash flows worth 20 million presently.

The company has no debt.

It would, appropriately, have an enterprise value of (10) million.

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Jun 28, 2017

If this was the case, an activist would force said co to distribute all cash. Ppl would see this coming and co would be valued at least at cash on equity basis

Jun 26, 2017

The OPs question literally has nothing to do with market efficiency. He's simply confusing BEV with TIC. TIC can't be negative. BEV can. In true WSO fashion, he gets convoluted, incorrect, bullshit answers to a basic, technical question.

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Jun 27, 2017

Cam is that you?

Jun 28, 2017

Because having cash doesn't mean cash will be distributed. The equity value is the market's perception of the company's value (to shareholders). Debt and cash are just the market values of all claims (creditors, preferred owners, minority interest) on the company and all the cash holdings, respectively.

With that in mind, imagine the car example again, but this time, imagine there is a lock inside the car, and there are 50,000 dollars in it. You, one of the minority owners of the car, don't know the combination, but the driver (CEO) does. He publicly has admitted he plans to just hold that money and never use it. The car might be worth 20k, as a car and to the market, because of it's gas mileage, usage, wear and tear, etc. The loans on it are worth 20k. The cash is worth 50k. So, the EV, knowing what you know about the equity value, the debt, and the "locked" cash would be negative.

Of course, that in real life is nearly impossible.

Jun 28, 2017

The vast majority of these answers are just wrong, in my opinion. In all of theses startup / biotech examples the cash is required for the company to exist as a going concern. It is not excess cash on the balance sheet. Really the whole equity + debt - cash matters in more steady state businesses, even then the only cash that should be removed is in excess of what is required to operate the business.

A company that continues to operate can't have a negative enterprise value, that is ridiculous. Think about it intuitively. If the value of the enterprise is negative you lock to doors, file for bankruptcy and leave all claims holders holding the bag. You do not keep operating.

This is a classic case of over weighting theory from reality.

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Jun 28, 2017

based on the BIWS guide, it says some financial companies can have negative EV tho

Jun 28, 2017

Did they mention off-balance sheet financing as a possible reason?

Jul 1, 2017

An example of a company that could have a negative enterprise value is a paper company that has historically been profitable, and thus has net cash, though due to declines in demand for paper is no longer able to operate profitably. Shutting down operations will take some time and cost, so the company could have $100 / share of cash and trade for $75 / share because the market perception of the shut down cost (and NPV) is $25 / share.

In reality, these situations are much more prevalent with divisions / plants / etc that are operating as part of a bigger company. There are many examples where PE firms / other businesses have been paid by the seller to assume operations and liabilities and take it off their hands.

Jul 2, 2017

Yes these situations can both exist - however, to my underlying point 1) the first example the company doesn't intend to operate at a going concern, I'm focusing on going concerns, and 2) the second example happens when large bloated and inefficient companies and/or small immaterial neglected units are disposed of so the parent company doesn't have the headache of dealing with the turn around. PE firms that do these transaction see the long term intrinsic value in the unit and in many situation these special situation transactions lead to massive outsized returns. It's less about a unit having negative value, in fact there is often lots of unlocked value, its just a matter of who is capable of doing it. PE shops aren't charities doing these deals because there is negative value, and they aren't doing them because they get paid to wind them down, they are doing them because they believe there is a lot of money to be made.

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May 6, 2018

"A company that continues to operate can't have a negative enterprise value, that is ridiculous"

"This is a classic case of over weighting theory from reality."

I don't know why you would make an assertion like this without research. You are the one overweighting theory ("it doesn't make sense for a negative EV situation to exist") vs. reality (they do). You can literally just do a bbg screen - at any given time a significant number of (usually small) companies will be trading at negative EV. This is usually b/c they are burning cash and/or ppl think the business might be in terminal decline.

These net-net situations are pretty popular among small cap (almost all of these companies are tiny) value and special sits guys. The situation is typically pretty binary - either the company is well and truly screwed or it eventually yields amazing returns

Jun 29, 2017

The market consensus (aka the current share price) is that the discounted future cash flows are negative...plug in any example you want.

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Jul 4, 2017

Possible if you're not counting all the liabilities as part of your EV calc (assume you need to liquidate tomorrow) or your cash is not 100% unrestricted.

Jul 4, 2017

Small cap is always risky, in China even more so, the auditors for a notorious failure were also sterling. Look at management themselves, be circumspect, call IR and ask hard questions.

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Jul 4, 2017

How old is this company?

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Jul 4, 2017
Febreeze:

How old is this company?

Around 15 years.

Jul 4, 2017

http://www.investopedia.com/articles/fundamental/0...

Read the bottom sections. Should answer your question quite thoroughly.

edit: I think

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Jul 4, 2017

Could help more if I knew what company it is

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Jul 4, 2017

How is cash burn rate $10m/yr if it has "massive net operating cash flow"? Is this money disappearing via CapEx? Seems to me their operating cash flow isn't exactly massive is they're still burning $10m/yr.

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Jul 4, 2017
Febreeze:

And how long have they been public?

Just over 11 years.

MFFL:

Could help more if I knew what company it is

Griffin Mining Limited (GFM) - listed in the UK

bortz911:

How is cash burn rate $10m/yr if it has "massive net operating cash flow"? Is this money disappearing via CapEx? Seems to me their operating cash flow isn't exactly massive is they're still burning $10m/yr.

My fault, was unclear. Cash from Operations is usually around 150-200% of net profit ($43mm on $27mm of net income, $79mm of revenue in most recent FY). Operating Expenses are fairly consistent at $10mm. Gross margin is around 40%.

Febreeze:

How much of their revenue is coming from the other company?

No breakdown by revenue, but around 40% of net profit is attributable to the other company.

Jul 4, 2017

I was about to make the same comment as bortz911. Maybe it's a misunderstanding of what you typed, but that doesn't sound great to me.

Another thing I'll add is that I have learned the HARD way about small chinese companies. I'd go in with the assumption that all those fuckers are corrupt. I don't remember the company, but as I was learning a little more about options I got involved in one. It looked golden on the option screener, I did some research and it looked fine on paper so jumped on it. That thing turned so south on me it was unbelievable. I think I lost ~15% in the course of sitting through some BS planning meeting at work - and it kept getting worse. I think the company pretty much dissolved in a month or two.

twitter: @CorpFin_Guy

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Jul 4, 2017

How much of their revenue is coming from the other company?

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Jul 4, 2017

1) yes, N/A.
2) yes.

Jul 4, 2017
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