Negative Net Debt in an Acquisition

Hi Guys,

Hi have a have a couple of questions that confuse me:

1) If I am going to acquire a company with negative net debt, should the price I need to pay be tied to the equity value or I buy the company at the Enterprise Value (i.e paying a lower price)? What I mean is, when the Equity Value is larger than the Enterprise Value, does the Equity value repreesents the floor in the M&A transaction?

2) If I am buying a minority stake (let's say 30% of a company which prior to the acquisition was wholly owned by only one shareholder), I am not taking a controlling position. In this case, should the price I pay for it be equal to 30% of the Equity Value or Enterprise Value?

Thanks a lot in advance for your help.

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Comments (13)

Dec 13, 2018

This caught my attention but I don't really understand it. I assume you mean private companies?Isn't Enterprise Value derived from market cap? [Market Capitalization + Total Debt - Cash = Enterprise Value]. Equity Values are found by several methods, none of which should represent a floor. Minority shares should be discounted for lack of control/liquidity.

Most Helpful
Dec 13, 2018

I'm assuming you're looking at taking a ~30% stake in a private company.

The way I'd look at it is this - pay for what you have claim to, which is really the equity value. However, cash is taken into consideration in equity value. Ex: AAPL's market cap is $800B, and I believe they still have a lot of net cash. If they have $150B of net cash, I'd look at it as AAPL's ongoing ops are worth $650B, and their cash is $150B, getting to $800B. I take that cash into account when deciding what I think the stock is worth. It could be paid out as a dividend (or used for buybacks) or it could be used to generate future returns. In this case, I'm giving them 1:1 credit. For a company that's burning cash and/or has poor management that has been to known to waste $ or do bad acquisitions, I might not give full credit for the cash - I'd discount it as a margin of safety for them making stupid decisions.

So I'd do this - figure out what the ongoing operations are worth, and then take into account the excess cash. Let's say the business generates $100 in earnings per year and has $50 in excess cash. You might be willing to value the entire business at 3x earnings + the excess cash ($350). You'd then pay 30% of this ($105), although as the poster above me pointed out, you should also discount your minority stake due to lack of control. So maybe you'd discount it slightly and only pay $90 for the 30% stake.

    • 3
Dec 13, 2018

So in essence you are saying that if my price is given by Operations (=EV) + Excess Cash, when I acquire the business I retain that Excess Cash on the business after the acquisition?

Jan 11, 2019

Yes, I would say. You essentially buy the ENTIRE business, so the cash as well. Even if the owners would take it out via dividends, this would take the equity value down and thus again the "purchase price".
So basically the cash lowers what I have to pay because I will just be giving that cash to the owners or use it to repay debt.

Dec 13, 2018
  1. Assume that all of the excess cash gets paid out to the existing equity owners prior to the close of the transaction, net of any cash required to maintain ongoing working capital needs.
  2. Equity value, but whether it is primary or secondary shares is dependent on whether you are owing 30% of the pre or post money equity value.
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Dec 13, 2018
  1. So I buy the business at the enterprise value if cash gets paid out to existing shareholders prior to acquisition (net of any cash for WC needs)
Dec 13, 2018

Yes exactly right.

Dec 13, 2018

I try to make it more clear:

  • Company A is a private company with $100 Equity Value, $50 Cash and $30 debt, implied Enterprise Value of $80.
  • Company B wants to acquire 100% shares of Company A.

Below I figured three scenarios. My question is which of these three represents what happens in reality in an M&A transaction:

1) Company B pays $80 (i.e. the Enterprise Value) to acquire Company A.
As the consideration is calculated on a "deft free / cash free basis", the business is acquired with zero debt and cash balances when Company B becomes the new owner.
Transaction summary - Company B pays $80, Company A receives $100 = $80 from B + $20 of excess cash.

2) Company B pays $100 (i.e. the Equity Value) to purchase Company A's shares. In this case the price paid is not computed on a "deft free / cash free basis", and consequently Company B purchases the business with a cash balance of EU20.
Transaction summary - Company B pays $100 but receives a Company with $20 cash making the actual price equal to $80, Company A receives $100. Same as Scenario 1

Hope this has clarified my question. Thanks for the help.

Dec 13, 2018

You're correctly reaching identical results from both scenarios, so what difference would it make?

Jan 11, 2019

Well, in scenario 2, company A will have to gather (often borrow, I guess) more money which would be linked to more expenses and less chances the deal would go through (I reckon).
It would make a lot more sense if the company would pay 80 and use the 20 already in the company to pay part of the total sum. Right?

Jan 12, 2019

In the Share purchase agreement you will find an equity offer, makes sense as this is what you pay equity holders. In addition EV says very little as the bridge to equity value will include other debt items apart from financial debt like capex backlog, required pension payments, Net working capital adjustments, fines that are due, etc which will differ from buyer to buyer because they might have different views or already include the cash out in their DCF.

However most banks will not allow you to just roll over the debt in case of new controlling shareholder. Therefor you need to arrange your own debt acquisition facilities to REFINANCE the existing debt at the day of the transaction.

Equity value will include the cash that will stay in the business unless you agree in SPA it gets paid out of course.

Dec 13, 2018

Out of the two scenarios you listed, the first is correct in that Company A receives the $20, not Company B. While this may seem trivial, there could be implications such as the tax treatment of proceeds and other nuances that impact value.

    • 1
Jan 11, 2019