Free cash flow to equity and minority interest

Hi, how is the minority interested reflected in the FCFE? ie is the minority interest deducted to derive the FCFE or is it included in the FCFE?

Thinking about it I tend to guess it is included in the FCFE as there is no automatic payment of cash to minority holders.

Thanks

I believe that minority interest has no effect on cash flow of any sort.

Minority (or noncontrolling) interest is typically accounted for by reducing the firm’s valuation with the value from the balance sheet just like you would with debt.

But if one starts calculating FCF based on earnings, do you strip out minority interest portion of earnings?

You remove _ all _ noncash revenues; that would include your interest in subsidiaries’ income as well as the minority interest in that income.

Usually you don’t subtract the minority interest because you don’t have the needed information.

And here is why:

NCI happens when the company you are valuing has a subsidiary (or subsidiaries) where not all 100% of shares are held by the company.

The company you are looking at consolidates the financial statements (for instance, based on IFRS 3, or GAAP equivalent).

The way it is done is that the financial statements in front of you incorporate 100% of everything - revenues, expenses, assets, liabilities, cash flows, … Which includes the portion that is attributable to other shareholders in these subsidiaries.

FCFE you calculate based on these statements refer therefore to all shareholders - to the company you’re looking at and to all minority shareholders.

IF you have the info about the subsidiary, you can theoretically adjust the financial statements to reflect only the share attributable to the holding company. And then you will get to the FCFE that exactly represents the share of the company and you will value only it.

Alternatively, you can value all the equity and then subtract the value of the NCI. This raises the question how to value the NCI.

When it is relatively small:

  1. Use the book value, or

  2. Estimate value of NCI by applying the Market/Book value of equity multiple of the parent, or

  3. Estimate value of NCI using a P/E multiple applied to the earnings of the NCI.

When it is substantial - value the subsidiary separately or be prepared that there might be severe distortions in your valuation.

Last but not least, pay attention that NCI has the potential to influence the ratios, metrics, and eventually the cost of capital.

For instance: ROE. You have to be consistent - if your earnings include earnings attributable to NCI, then the equity part should include NCI as well.

Another example: When you calculate the cost of capital, one of the components you use is the market value of equity. If you take only market capitalisation of the holding company, you do not take into account the market value of the NCI. If you use the cost of capital, caluclated without tkaing into account the MV of NCI, to discount the cash flows that DO include NCI - you are being inconsistent.

and so on…