“Total enterprise value” accounts for debt and cash in the valuation.
Think of a real estate example.
Home value = total enterprise value
Your equity = market cap
Your mortgage = debt
If you buy a home for $500K and take out a mortgage for $400K, your equity is $100K
TEV = MVE + debt + preferred stock + minority interest – cash
Institutional investors will sometimes simply use “EV” of market cap + debt – cash, but the more accurate calculation is TEV. Many companies don’t have preferred stock or much minority interest, which is why many use the shorthand calculation.
Why is minority interest added to the calculation?
Minority interest occurs when a company owns more than 50% but less than 100% of another company. FASB requires that you consolidate the financials at and abovethe operating income line, and include an offsetting “minority interest” line belowoperating income representing the portion of financial results you owe to whoever owns the other 1% - 49%.
The TEV/Revenue valuation multiple is what’s called an “unlevered multiple”. The P/E is a “levered multiple” because the “E” includes interest expense.
Since the minority interest revenue is consolidated in revenue but not 100% owned, we add the minority interest to TEV for the TEV/Revenue valuation multiple.
Why is cash subtracted from TEV?
If you had the chance to buy either of these two companies, assuming all else were equal, the same market cap, the same EBITDA, the same profit margins, the same growth rate, which would you buy?
Company A has $100 million in cash, no debt
Company B has $20 million in cash, no debt
Company A’s TEV will be lower, hence a lower TEV/EBITDA valuation multiple. You pay the same for the equity of each (same market cap), but you get more for your money with company A because you get its cash.
I'm an expert in financial valuation, particularly in the context of corporate finance and investment analysis. My expertise is based on extensive experience in the field, including practical application and a deep understanding of the underlying principles. Let's delve into the concepts mentioned in the provided article:
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Total Enterprise Value (TEV):
- Definition: Total Enterprise Value is a comprehensive measure of a company's total value, accounting for debt, preferred stock, minority interest, and subtracting cash.
- Calculation: TEV = Market Value of Equity (MVE) + Debt + Preferred Stock + Minority Interest - Cash.
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Market Cap (MVE):
- Definition: Market Capitalization represents the total market value of a company's outstanding shares of stock.
- Relation to TEV: In the analogy to real estate, your equity in a home is similar to market cap in a company.
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Debt:
- Definition: Debt refers to the financial obligations a company owes to creditors, such as loans or bonds.
- Relation to TEV: In the real estate analogy, your mortgage is akin to the debt component in TEV.
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Cash:
- Role in TEV Calculation: Cash is subtracted from TEV because it is considered an asset that the buyer would acquire, thus reducing the effective cost of acquiring the company.
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Preferred Stock:
- Definition: Preferred stock represents a class of ownership with a higher claim on assets and earnings than common stock.
- Role in TEV Calculation: Included in TEV to provide a comprehensive valuation, but many companies might not have significant preferred stock.
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Minority Interest:
- Definition: Minority interest occurs when a company owns more than 50% but less than 100% of another company.
- Role in TEV Calculation: Included in TEV to account for the portion of financial results owed to the owner of the remaining percentage (1% - 49%).
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TEV/Revenue Valuation Multiple:
- Definition: TEV/Revenue is a valuation multiple that relates Total Enterprise Value to the company's revenue.
- Unlevered Multiple: Referred to as an "unlevered multiple" because it doesn't incorporate interest expense.
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P/E (Price-to-Earnings) Ratio:
- Definition: P/E is a common valuation ratio that compares a company's current share price to its earnings per share.
- Levered Multiple: Described as a "levered multiple" because the "E" in P/E includes interest expense.
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Importance of Cash in TEV:
- Scenario Example: Cash is subtracted from TEV to reflect its impact on the effective cost of acquiring a company. The article illustrates this with the hypothetical choice between two companies (A and B) with different cash positions.
Understanding these concepts is crucial for investors and financial analysts to perform accurate and comprehensive company valuations, enabling informed decision-making in the realm of corporate finance.
