Enterprise Value using EV/EBITDA
Hi all,
I'm struggling mightily with this concept of enterprise value, and why cash is subtracted specifically from a multiples standpoint.
Let's say I have a business that has the following characteristics:
EBITDA: $3
EBITDA Multiple: 5
Equity Value: $15
Cash: $20
Therefore, enterprise value would be: -$5 assuming zero debt.
First off, I do understand from a buyer's standpoint, that the enterprise value represents the effective price they are paying to acquire a business. If they were able to purchase all of the equity of the company, they would pay $15 and basically take over a company with $20 in cash, which makes sense as to why enterprise value is -$5.
What I fail to understand is and can't wrap my head around is, what would be the actual sale price in the above hypothetical?
In a perfectly efficient world, why would any seller accept anything that is less than the equity value ($15) PLUS the excess cash they have in the corp ($20) for a total of $35?
Interestingly, I was working on an acquisition where this actually occurred. The vendors valued their company using a DCF and then ADDED all excess cash (instead of subtracting) to the purchase price...
Will let someone else explain in greater detail but you have equity value and enterprise value flipped.
EBITDA = 3, EV/EBITDA = 5, hence EV = 15. If you have cash of 20 you subtract that to get to equity value of -5.
This means the market thinks that management will allocate the cash to value-destroying initiatives, i.e. they will take the cash of 20 and turn it into 15 by making bad investments.
To your point, the seller obviously wouldn't accept this offer.
Thanks for correcting me
On what planet do u subtract cash from TEV to arrive at equity value lol. Stop pretending to be AS1 and just change title to prospect.
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As another commenter noted, I mistakenly flipped equity / enterprise value. After factoring that I think the question still stands?
Either way I'm not professing that I know my stuff which is why I'm happy to be corrected
The question I'd have is: in what scenario would a business with only 3m in normalized ebitda and 15m in EV have 20m in cash sitting in the company? Believe small businesses just pay out most SDE to owners anyways, there shouldn't be that much cash there
Basically, the two times this tends to happen are:
Basically, you need to delineate the value of a single “company” into a few constituent parts:
Net / net: I buy the enterprise for whatever the actual operations are worth, separate from cash and debt. I also pay you 1:1 for every dollar of cash that I get, and then you pay off “your” debts. Therefore, TEV + Cash - Debt = Equity Value (what you get to take home)
The only situation where the business is worth less than its net cash position is one where I expect the “enterprise” to lose money, in which case $1 of cash isn’t really worth $1 because I expect to spend it in order to make the company positive again. By the same token, the reason a seller would accept a negative TEV is because continuing to own the business will cost them money, and they’re effectively paying you to take on the losses. This is certainly possible, but exceedingly rare unless you work in the distressed world
Thanks for your detailed response. That makes a lot more sense to me!
Great post
By the way, that same "Equity = EV + Cash - Debt" identity can also be rearranged into Equity + Debt = EV + Cash. Which you can think of as:
Wow great explanation, never thought of the equation this way before.
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