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An Investment Banking View of Enterprise Value

  • Sutter Securities Financial Services, San Francisco


This article discusses how investment bankers treat cash in defining enterprise value.
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Only one definition (not by an invest-
ment banker) did not deduct cash, one
definition deducted only “excess
cash,”6and a total of 208 (99 percent)
of the definitions deducted all cash on
the balance sheet.7 The definitions
called for the deduction of cash from
the sum of debt and equity regardless
of whether cash exceeded the amount
of debt.
Our review shows clearly that
the practice of investment bankers is to
deduct cash and cash equivalents
when calculating multiples.
Why Cash shouLD Be
The investment banking practice of
using net debt (interest-bearing debt
minus cash) rather than gross interest-
bearing debt reflects economic reality.
The appropriateness of deducting cash
in an EV calculation can be demon-
strated by looking at the impact on EV
of both a material debt repayment and
a material debt issuance.
Consider a company with an
equity market value of $200 million,
debt of $200 million, and cash of $100
million. Its EV net of cash would be
$300 million, but its EV would be $400
million if cash were not deducted. If
we assume that the company were to
use half its cash to repay debt, both
debt and cash would be reduced by
$50 million and, when cash is deducted
from debt, its EV would still be $300
million. However, if cash were not
deducted, EV would be reduced from
$400 million to $350 million.
Alternatively, if the company
were to borrow an additional $100 mil-
lion, it would then have an incremental
$100 million in debt and an incremen-
tal $100 million in cash, so that its EV
would still be $300 million if cash were
deducted; however, EV would increase
from $400 million to $500 million if
cash were not deducted.
When cash is deducted, the com-
pany’s EV stays at $300 million in both
the repurchase case and the debt
issuance case. If the definition of EV
were to provide that cash should not
be deducted, the company’s calculated
EV would fall from $400 million to
$350 million when it repays debt and
would rise to $500 million after a debt
financing. Such disparities in the EV
value of a company whose net debt is
unchanged throws into question any
calculation of multiples based on EV. If
a company’s calculated EV were to
change materially as a result of a debt
retirement or of a financing, its EBIT-
DA multiple would be materially
affected even though the economics of
the company would remain substan-
tially unchanged.
A company’s value is not reduced by
retiring debt nor is its value increased by
borrowing. Since cash is, in effect, neg-
ative debt, the logical and accurate
method is to deduct cash in the compu-
tation of EV. Valuators who calculate
multiples for guideline companies and
acquisitions with EV unadjusted for
shouLD Cash Be DeDuCteD
When CaLCuLatIng
enterprIse vaLue?
The valuation community currently
uses two different approaches to calcu-
late Enterprise Value (EV) as the
numerator for multiples in the guide-
line company and acquisition meth-
ods. EV is sometimes defined as debt
plus equity and sometimes as debt
plus equity minus cash. We believe that
in calculating EV, cash should be
deducted. The valuation literature
reflects this disorder: some writers
exclude cash from the definition,1
while others (including the author)
state that cash should be deducted.2
Pratt writes that both are acceptable
approaches.3We set out to see what
investment bankers actually do in
practice. We then set forth our reason-
ing as to why the valuation profession
should adopt what is the overwhelm-
ing investment banking practice: to
deduct cash when calculating EV. We
also discuss other factors to be consid-
ered in the determination of EV.
To determine how investment
bankers and others rendering fairness
opinions defined EV and, particularly,
how they treated cash, we reviewed
the published descriptions of fairness
opinion methodologies used in cash
acquisitions of U.S. companies. Under
S.E.C Rule 13e-3, summaries of fairness
opinion analyses must be included in
the proxy statements or tender offer
documents sent to shareholders. We
examined documents filed with the
S.E.C. for 315 acquisitions that con-
tained 351 fairness opinions.4
We reviewed the 351 opinions to
identify those which contained invest-
ment bankers' definitions of EV. Of the
351 opinions, 282 used multiples of
revenues, EBITDA and/or EBIT with
EV (by any name) in the numerator.5
Of these 282 opinions, 210 described
how EV was defined while 72 did not.
When calculating enterprise value,
cash should be deducted from the
sum of interest-bearing debt and
Continued on next page
gILBert e. mattheWs, Cfa
Sutter Securities Incorporated
San Francisco, CA
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cash end up making invalid compar-
isons that lead to questionable valua-
other faCtors to ConsIDer
In CaLCuLatIng enterprIse
Our review of the data shows that
investment bankers sometimes include
additional data when calculating EV.
The inclusion of minority interests and
preferred stock is customary when
these items are on the balance sheet.
Marketable securities are usually con-
sidered to be cash equivalents and are
therefore deducted. Depending on
facts and circumstances, other items
may be considered; e.g., capital leases
may be added and non-operating
assets and the present value of loss car-
ryforwards may be deducted. We cite
several examples of definitions:
[E]nterprise value … is the market
value of common equity plus the
book value of debt and minority
interest less cash and the value of
unconsolidated assets.8
Firm value of a particular compa-
ny was calculated as market value
of that company’s common stock
based on fully diluted shares using
the treasury method … plus the
value of that company’s indebted-
ness, minority interest and pre-
ferred stock, minus that company’s
cash and cash equivalents and
marketable securities.9
Enterprise value of a particular
company was calculated as market
value of the company’s equity . . .
plus the value of the company’s
indebtedness, capital leases,
minority interest and preferred
stock minus the company’s cash
and cash equivalents, and mar-
ketable securities.10
[Firm value] … [is] equity value …
plus straight debt, minority inter-
est, straight preferred stock and
out-of-the-money convertibles,
less cash and long term equity
investments valued at the current
market price where available, and
at book value where market price
is not available.11
The enterprise value of each com-
pany was obtained by adding its
short- and long-term debt to the
sum of the market value of its com-
mon equity, the value of any pre-
ferred stock (at liquidation value)
and the book value of any minori-
ty interest, and subtracting its cash
and cash equivalents and the pres-
ent value of the net operating loss
carryforwards, if any.12
Investment Bankers
CommonLy InCLuDe DeBt
at Book vaLue
Based on a separate, ongoing review of
more than 100 fairness opinion presen-
tations, investment bankers include
debt in EV at book value rather than at
market value, which is the academical-
ly preferred but impractical approach.
Book value is used because the differ-
ence between the market value and
book value is seldom material and
because it is often difficult to obtain
prices of illiquid debt securities.
Because zero-coupon debt and
any other debt issued at a discount are
carried on a company’s books at accret-
ed value, market value is usually in
line with accreted book value. Since
accounting rules require that zero-
coupon debt and other debt issued
below par be carried at accreted value,
the book value for reporting purposes
should be reasonably close to market
If a company’s debt has an aver-
age market value of 95 percent or 105
percent of book and debt is 40 percent
of EV, the impact on EV is only 2 per-
cent. This is effectively a rounding
error when the EV/EBITDA ratio is cal-
culated to two significant figures, so
that it is seldom worthwhile to expend
the time and effort necessary to mark a
company’s debt to market.
ConCLusIon: an Investment
Banker’s vIeW
1) When calculating EV, cash should be
deducted from the sum of interest-
bearing debt and equity. The valuation
community should adopt this practice
for two reasons. First, it is economical-
ly realistic. Second, it should do so
because having two or more conflict-
ing definitions for the same measure
not only casts doubt on the validity
and accuracy of valuations based on
that measure, but also may contribute
to criticisms of valuations in general as
2) When appropriate, EV should recog-
nize other balance sheet items, such as
preferred stock, capitalized leases, and
marketable securities.
3) Valuing debt at book value is a prag-
matic approach that can be used in
most situations. c
1E.g., James R. Hitchner, Financial Valuation Applica-
tions and Models, 2nd. ed. (Wiley, 2006), p. 241; Philip
J. Clements and Philip W. Wisler, The Standard &
Poor’s Guide to Fairness Opinions (McGraw Hill, 2005),
p. 40.
2E.g., Patrick A. Gaughan, Mergers, Acquisitions, and
Corporate Restructuring, 4th ed. (Wiley, 2007), p.12;
Matthews, “Fairness Opinions: Common Errors and
Omissions” in The Handbook of Business Valuation and
Intellectual Property Analysis, Robert F. Reilly and
Robert P. Schweihs, eds. (McGraw Hill, 2004), p. 212.
3Shannon P. Pratt, Valuing a Business, 5th ed. (McGraw
Hill, 2008), p. 265.
4This report is part of a larger study in which the 351 fair-
ness opinions in cash acquisitions were reviewed to
analyze valuation methodologies used in fairness opin-
ions. That study is still in progress.
5The numerator was called “enterprise value” in 88% of
the disclosures. "Firm value" or "company value" was
used in 8%, "aggregate value" in 3%, "market capital-
ization" (which is also sometimes used as a synonym
for "market value of equity") in 1% and "total value of
invested capital" once. It has been suggested in the
past that “enterprise value” might also mean “market
value of equity,” but this study shows that investment
bankers do not view the phrase to be ambiguous.
6“Excess cash” was not defined. The same investment
banker deducted all cash in 20 other opinions.
7Most expressly deducted cash, while some used the
phrase “net debt,” which in industry practice means debt
minus cash.
8California Pizza Kitchen, Inc. Form 14D-9 dated June 8,
2011, p.31; fairness opinion by Moelis & Co.
9EnergySouth, Inc. proxy statement dated August 20,
2008, p. 22; fairness opinion by JP Morgan.
10 United Retail Group, Inc. Form 14D-9 dated September
25, 2007, pp. 25-26; fairness opinion by Bear Stearns.
11 Anheuser-Busch Companies, Inc. preliminary proxy
statement dated August 15, 2008, p. 39; fairness opin-
ion by Citigroup Global Markets.
12 Mediacom Communications Corporation, p. 21; fairness
opinion by Barclays Capital.
Michelle Patterson, J.D., Ph.D., participated in
the preparation of this article.
ResearchGate has not been able to resolve any citations for this publication.
The Standard & Poor's Guide to Fairness Opinions
  • E G James
  • R Hitchner
  • J Philip
  • Philip W Clements
  • Wisler
E.g., James R. Hitchner, Financial Valuation Applications and Models, 2nd. ed. (Wiley, 2006), p. 241; Philip J. Clements and Philip W. Wisler, The Standard & Poor's Guide to Fairness Opinions (McGraw Hill, 2005), p. 40.
Fairness Opinions: Common Errors and Omissions" in The Handbook of Business Valuation and Intellectual Property Analysis
  • Matthews
Matthews, "Fairness Opinions: Common Errors and Omissions" in The Handbook of Business Valuation and Intellectual Property Analysis, Robert F. Reilly and Robert P. Schweihs, eds. (McGraw Hill, 2004), p. 212.