Purchase Price in M&A Deals: Equity Value or Enterprise Value?

welcome to another tutorial video once again this time we're going to take a look at a question that came in the other day so a question is in an M&A deal does the buyer pay the equity value or the enterprise value to acquire the seller and more specifically what does it mean in press releases when they say that the purchase consideration for a deal includes the assumption of debt does that mean that the price is the enterprise value so as an example of what he or she is referring to here here's a press release for this particular deal that took place in Switzerland and they have this language the total transaction value of approximately 1.7 billion including assumption of net debt so these types of press releases are confusing if you learn about finance and M&A the real way because they'll use terms like transaction value which doesn't really mean anything instead of equity value in enterprise value so to address both of these questions let's take a step back for a second and just take a few seconds and go over these basic concepts equity value is the value of all the company's assets but only to the common equity investors in other words the shareholders in the company whereas enterprise value is the value of only the core business operations and those assets but to all the investors in the company so you have equity investors debt investors preferred stock investors and so on now the implications of this definition are that if you calculate enterprise value starting with equity value you're going to add items when they represent other investors debt preferred stock or when they represent long term funding sources like capital leases or unfunded pensions because you could also really view these as being other investor groups as well and then you subtract items when they're not related to the company's core business operations side businesses excess cash they're not that they're not using for anything or sometimes simplify to just all cash investments real estate that has nothing to do with their core business items like that this question confuses a lot of people because a lot of sources say that enterprise value is what it really costs to acquire the company and as we just saw it's not really the definition of enterprise value now it is a convenient way to think about it and for some people it makes more intuitive sense to think about it like this but the problem is that it's not exactly true yes sometimes in M&A deals the enterprise value purchase enterprise value is closer to the actual price the buyer pays but it depends on the terms of the deal and it also depends on the items that go into enterprise value for the seller so let's start with some basic facts that we can definitely say about the purchase price in an M&A deal and then we'll start from there show how we can get a rough idea of what the purchase price might be and then show how these concepts of equity value and enterprise value don't exactly hold up when we talk about the true price the buyer is paying to acquire a seller so first off if you acquire 100 percent of a company you have to pay for a hundred percent of its common shares there's just no other way to do a deal like that so regardless of what happens you have to pay for all of its common shares and if you look at merger models there's usually some assumption like this at the top it's usually called the purchase equity value I'm just bring up an example from one of our courses here but essentially we are taking the company's diluted shares outstanding and multiplying by the offer price per share so we offer a certain price for the company we multiply by the number of shares outstanding they have and that gets us to in a sense the minimum that we're going to have to pay to acquire the company so you can think of the purchase equity value as being sort of like a floor for the purchase price and M&A deal no matter what else happens they're going to have to pay at least that much because they need to acquire all the common shares outstanding of the company but then the question becomes should you really add the debt the preferred stock and the other funding sources and then subtract 100% of the sellers cash balance yes we do that when calculating enterprise value but should we be doing it to actually calculate how much the buyer really pays for the seller and there are two main problems with this and assuming that the enterprise value equals the actual price paid I'm going to go through the first problem first involving debt then we'll look at the second problem involving cash and then we'll talk about a few other issues and summarize everything at the end so first off you have to ask yourself does debt really increase the purchase price in an M&A deal because certainly in most models we have some type of line like this where we look at the amount of total debt and then somewhere in a merger model we'll have some type of line that looks like this refinance target's debt or acquires debt or refinance some type of debt a better example is actually another case study that we have on beam and Suntory where we have this choice between assuming versus refinancing a target's debt so it seems pretty obvious that if as is the case here we have some debt and we pay it off yes paying off the debt is going to increase the purchase price but that's not necessarily what happens debt can be either assumed meaning kept on the balance sheet as is or refinanced and then even if you refinance debt it doesn't necessarily mean that you pay it off with cash it could just mean that you raise new debt to replace it so the treatment here really depends on the terms of the debt and what it requires and then also what the buyer and seller want to do now normally when there's debt outstanding it is required to be refinanced and a change of control so in most cases the buyer is going to come along and raise new debt use the proceeds to pay off the existing debt and that's all there is to it but the total debt amount doesn't necessarily change so if you think about the possible scenarios here if the debt is assumed so if the buyer just keeps it around well that's not really going to increase the amount the buyer really pays for the sell and if you look at cases where this happened so with this b'man Suntory example for example for target debt assumed if you look at the sources in you schedule it appears on the uses side and then it also appears on the sources side if you look at a calculation like funds required which gives a better indication of how much the buyer is really paying for this Celer it doesn't even show up here we just have the equity purchase price any debt that's actually pre fenced and then the any excess cash that's used to fund the deal so it doesn't even show up here and if you look at some of these numbers the purchase equity value and purchase enterprise value in this case since we are just assuming debt the purchase equity value of around 14 billion u.s. dollars is actually exactly the same here as the funds that are required to do the deal now if you repay debt using the cash on end then of course yes this will increase the amount that the buyer really pays for the company and then if you take the third option here and you raise new debt and use the proceeds to pay off the existing debt it sort of increases the amount the buyer really pays because they have to raise new debt to do it but it's not as if the buyers using any of their cash on hand to do it they're simply raising new debt and assigning it to the company they just acquired and using it to repay the existing that they had before the acquisition so it does sort of increase the purchase price but it's not exactly the same as say you paying off your student loans or paying off a mortgage or something like that where the debt just goes away now the second problem with equity value and enterprise value here is the treatment of cash and the question is does cash really reduce the purchase price if you take the definition of enterprise value at face value that's what it implies so if you go and look at a company for example and you look at how enterprise value has been calculated we start with equity value we subtract cash and cash equivalents and then we get to enterprise value at the bottom so does that mean that it is literally going to cost us a lot less to acquire this company and of course the answer is no it's not that easy because cash just doesn't work like this even when you calculate enterprise value outside the context of M&A deals it doesn't really work like this it's actually a simplification the reason it's a simplification is because all companies need a certain minimum amount of cash to keep operating paying the bills paying for rent making payroll the like that so that amount of cash is actually a core business asset now sometimes in merger models you will see this defined we have it right here combined minimum cash balance so this gives us an idea of how much cash we need after the deal to keep things running at both companies here now normally when calculating enterprise value as a simplification we just ignore the minimum cash and we just subtract the entire cash balance but as we just saw it doesn't mean that the entire cash balance can just be taken away and have and there will be no impact on the company it's just a simplification because we don't always know what the minimum cash balance is and in an M&A deal a buyer can't just walk in and take all the sellers cash for itself because the seller needs to keep a certain amount on hand to keep operating paying the bills paying for rent and more and even if the seller does have a lot of excess cash the buyer can't necessarily take everything for itself it depends on the sellers plans and what they want to do with it and discussions between both companies so it's not quite as simple as this and then of course there are other complications for example transaction fees always exist and they're always going to increase the price to pirate pace so these refer to fees that you have to pay to lawyers and bankers and accountants and other people who were involved with deals and these never show up with an equity value or Enterprise value but when you look at the actual amount of funding that's required to do the deal you have to factor these in regardless of what they are if there are fees associated with it you need to include them and then you have items like unfunded pensions and capital leases and so on and these items will factor into enterprise value but they don't necessarily have to be pay or repaid upon change of control so they may not even affect the price and you can really see that if you look at the sources and use the schedule because you'll never see these types of items here because no upfront payment is required for them from the buyer and then finally another twist in this is that what if both the buyer and the seller are using their cash balances together to fund the deal that's actually the scenario I've been showing you here where we have a minimum combined cash balance and then a combined cash balance from before the deal took place so it gets very murky here because should we be looking at the buyers Enterprise value or the seller's enterprise value to approximate the real cost of acquiring the company or should it be something in between when you start mixing and matching these items with two different companies it gets very confusing to figure out how much they're actually paying and how it relates to enterprise value so the bottom line on this question is that you have to think about the valuation of a company or a deal and then the actual price paid as separate items for valuation yes equity value and enterprise value are very useful you can form multiples like PE and enterprise value to eBay da and enterprise value to e bit with them but for the actual price paid these concepts are not quite as useful because the real price paid is often somewhere between these metrics or is very different from these metrics all together so in our two examples the purchase enterprise value is around 1.3 billion for this one deal between Joseph a bank and Men's Wearhouse but then if you look at the actual amount that is being used to fund the deal here we need about 2.1 billion which is significantly higher than that equity purchase price and then to get it we issue debt and then we also use some excess cash so in this case the price is actually higher than the purchase enterprise value primarily because of refinancing debt and those fees that I told you about before and then if you look at the other deal I've been referring to here the actual amount is greater than the purchase equity value but it's also not quite as high as the purchase enterprise value so we have a purchase enterprise value of about 1.6 or 1.7 billion some of the debt is being assumed and then if you look at what they're actually using to buy the company here so cash debt issued and an additional cash for the transaction fees it's actually right between equity value and enterprise value and this is often what happens for all the reasons that I mentioned for you have issue of debt being assumed versus refinanced you have the minimum cash problem your fees you have liabilities that are there but they don't really increase the cash cost of doing the deal and so on and so forth so going back to the second part of this question the person asked in the beginning when you see language like transaction value of approximately 1.7 billion including assumption of net debt that really means the approximate purchase enterprise value for the deal because assumption of net debt means that they're taking the purchase equity value what a cost to acquire the shares they're adding debt and they're subtracting cash so that's what it means if it doesn't say something like that if it just has the purchase price chances are it is a purchase equity value so that's a quick way you can tell them apart you should always check this yourself though just by doing some quick math and Google Finance to see what they're really referring to and remember even if you do this it's still not really what the buyer actually pays in a lot of cases it's just a way to value the deal and to get to multiples like enterprise value to eBay da so it's useful for comparative purposes and for valuation but the actual price paid by a buyer in most cases is neither enterprise value nor equity value but is often in between them and sometimes above them and sometimes even below them depending on any terms of the deal you you

Channel: Mergers & Inquisitions / Breaking Into Wall Street

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Keywords: purchase equity value, purchase enterprise value, m&a valuation, M&A deals, enterprise value vs equity value, equity value, M&A, merger models, enterprise value, mergers and acquisitions, debt, transaction fees, Wall Street Prep, Investment, TheStreet, Corporate Bridge, EduPristine, cash, WallStreetOasis, Excel Model Tutorial, excess cash, WSTSS, mergers and inquisitions, breaking into wall street, company valuation, equity investments, business valuation, ev / ebitda

Id: JaIqStF8bTw

Length: 15min 28sec (928 seconds)

Published: Wed Mar 09 2016