Enterprise Value during M&A

It would be great if someone could clear this concept for me. So the Enterprise Value is basically = Equity Value + Debt - Cash. So if Im not wrong., when a 100% Acquisition happens., The acquiring company pays for the 100 % Stake in the Equity Capital. After the acquisition, the acquirer also absorbes and is responsible for the debt of the target’s balance sheet. Therefore the actual price of acquisition was equity + debt. Since the acquirer can now use the cash of the target company to pay off debt, it is essential to minus cash from the value of debt. Hence the enterprise value formula. Now what happens if - 1. If the acquirer does not fully acquire the target but invests for significant majority.,i.e say 51% or 75% or 90% of the equity capital. In such a situation is the acquirer still responsible for the debt of the target? If no, than is it safe to say that calculating EV for such transactions is irrelevant ? 2. If two companies merge, than how is Enterprise Value calculated? By adding the equity and debt of both companies which got merged into a single entity?

First of all, debt here must engulf the market value of all non-common equity claims for the formula to hold.

  1. A corporation is almost always a limited liability, they are not entitled to pay for the subsidery in the case of default. The Enterprise value is the price you need to pay today to claim all of the firm’s operating (or total depending on the transaction) assets, so EV is actually relevant, although what you really pay in cash/stock in acquisition is only usually the equity portion, which gives you control over the company’s operations. But in some cases, you’d have to pay more if you’re buying a bankruptcy, then you need to pay off some debt. In both cases, the EV doesn’t change.

  2. It might be a little more complicated than that, but generally, yes.

There are basically three terms to distinguish:

  1. Firm Value (FV): Market value of all the assets of a company (operating and non-operating) = market value of total equity and total debt. This is the market value of the total business. (Note: Firm Value is sometimes referred to as Total enterprise Value (TEV))

  2. Enterprise Value (EV): Firm value minus non-operating assets (i.e. cash, marketable securities, non-operating assets). This is the market value of the operating business and untouched by the financing structure of the company.

  3. Equity Value (EqV): Enterprise value minus market value of total debt minus market value of non-controlling interest minus market value of preferred stock minus market value of capital leases plus market value of non-operating assets (i.e. cash, marketable securities, non-operating assets). This is the market value of the equity and influenced by the financing structure.

Regarding your questions:

  1. If you acquire only a share in a company nothing changes basically you just hold a share in each of the three terms above. That means that you could even express a share price in all three terms of FV, EV and EqV. So you acquire a certain share in the equity capital but also are responsible for the same share in the net debt portion.

  2. If you merge 2 companies and want to calculate the Enterprise Value you sum the operating value of both companies plus potential synergies to be realized through the merger (1+1=3). From a value perspective the important thing is that you add market values here and not balance sheet values. The accounting treatment of a merger is something very different and part of the purchase price allocation of the acquisition or merger.

Best,

Oscar