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M&A Fundamentals – Enterprise Value

Enterprise Value is an important concept whenever an M&A professional is trying to value an M&A target.  The ordinary shares (equity) of a company only make up part of its capital structure, and therefore only part of the capital invested in the enterprise.   If an acquirer buys the shares of a company in an M&A transaction, they will also take on the company’s obligations to repay any outstanding debts in addition to the consideration paid for the shares.

Boiled down to its simplest form the concept of Enterprise Value recognises that in addition to whatever is paid for the equity the buyer will also have to settle outstanding debt, either at the closing of the M&A transaction or at the end of its term.

The concept of enterprise value is clearly crucial when an M&A professional is preparing an offer for an M&A target listed on a stock exchange.  The market capitalisation (number of ordinary shares x trading price) is only a part of the value of a listed M&A target.  The concept of enterprises value also has implications when the M&A professional is preparing an offer for an unlisted M&A target.  The typical offer formulation for an unlisted M&A target – “free of cash and debt” – is also a consequence of the enterprise value concept.

We will examine the application of the enterprise value concept to both listed and unlisted M&A targets in the next two sections, starting with listed companies.



Enterprise Value and Listed M&A Targets


Most companies traded on a stock exchange are large multinational corporations with revenues of at least several hundred million dollars, and in all probability several billion dollars.  As you might expect these large enterprises often have complex financial structures.  This complexity adds additional layers to the straightforward market capitalisation + debt formulation for enterprise value laid out in the introduction to this article.

Diagram 1 lays out the elements of the calculation of enterprise value for an M&A professional preparing a valuation of a listed M&A target.  Mathematically the formula is:

Enterprise value = Market Capitalisation + control premium + debt – cash + preference shares + minority interests.

Let’s look in more detail at each of the elements of this calculation.


Diagram1:  The structure of the enterprise value calculation




Market capitalisation for a listed M&A target is the number of the company’s shares traded on the stock exchange multiplied by the price at which they trade.  Most of the M&A professional’s questions for this element of the enterprise value calculation concern what price to use.  It is important to use a share price before any news of a potential offer for the M&A target leaks into the marketplace.  We will explore why this matters when we look at the next element of the enterprise value calculation, the control premium.



The price quoted for a share on a stock exchange is driven by trades for many small parcels of shares on a “retail” basis.  A small parcel of shares offers no control over the direction of the M&A target.  If an M&A acquirer wishes to buy a controlling interest in a listed company, it will have to pay a hefty premium over the retail price known as the “control premium”.  Control premiums typically run at between 30% and 40% of pre-rumour share price but premiums as high as 70% or more might apply to high growth sectors.  Market investors are aware of this premium and once rumours start that a company might be the target of an M&A transaction, they buy into the takeover target in the hope of selling out at a premium.  This inevitably builds part of the control premium into the share price.  To avoid putting too high a value on an M&A target the M&A professional needs to use a pre-rumour share price to calculate market capitalisation.

The market capitalisation plus the control premium is the “equity value” of a listed M&A target.



If an acquirer buys an M&A target company off a stock exchange the company will be liable to repay any debt in its financial structure, either at closing of the takeover transaction, or when the debt reaches the end of its term.  We examine the different types of debt the M&A acquirer might find in a listed company’s financial structure in our article on debt and equity.  This means the debt carried by the M&A target is part of the price paid for the enterprise, and must be added into the enterprise value calculation.



Any cash balances held by the M&A target can in theory be used to pay down the debt held by the target.  This might not happen immediately in practice, but for the purposes of the enterprise value calculation any positive cash balances are subtracted from the debt.

Outstanding debt minus any positive cash balances is referred to as “Net Debt” by M&A professionals.



Preference share are hybrid from of corporate finance that have features of both equity and debt.  They usually pay a fixed amount of dividend, rather like the coupon on a debt instrument, and rank ahead of ordinary equity in a winding up.  For this calculation, they are treated as debt and added into the enterprise value calculation.  In an M&A transaction for an unlisted M&A target, preference shares will often be repaid alongside the debt, or converted to equity, at the closing.



This final element of the enterprise value calculation is a consequence of the way accounting standards treat majority equity stakes that a listed M&A target holds in other companies.  Where the M&A target holds more than 50% of the equity of another company it must consolidate 100% of that company’s income statement and balance sheet into its own accounts.  This means, in order to compare apples with apples, the value of the minority party’s equity must be added into the enterprise value calculation.


Enterprise Value and Unlisted M&A Targets


There is no such thing as market capitalisation for an unlisted M&A target – for obvious reasons.  Nevertheless, the enterprise value concept impacts the way transactions for unlisted companies are structured.

When an M&A professional makes an offer for an unlisted M&A target, they will invariably make an offer for the enterprise value “free of cash and debt”.  This means the offer price must cover both the equity and the debt portion of the balance sheet.  This works as follows:

Buyer makes an offer of $10m for the M&A target.

Target has debts of $2m and cash of $500k.

The $500k of cash will be applied to the debt leaving net debt of $1.5m.

$1.5m of the $10m dollar consideration will be applied to the debt.

$8.5m of the consideration will be paid for the shares.

This example assumes an offer for shares, but the process is similar for an M&A asset purchase transaction.  (See our article M&A fundamentals – Share Sale or Asset Sale for a full explanation of this distinction.)  In an M&A asset transaction the $8.5m balance of the consideration will be paid to the limited liability corporation as payment for the commercial assets.  The limited liability corporation can then distribute the $8.5 as a dividend to shareholders, or the company can be wound up in a solvent liquidation and the $8.5m distributed as a capital dividend.



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