Enterprise vs Equity Valuation

CFA General
#1

Starting from Enterprise Value and deducting market value of debt, should the following also be deducted to determine Equity Value?

  1. Unfunded pension obligations (defined benefit) - the fair value of pension assets is lower than actuarial valuation of pension liabilities.

  2. Deferred tax liability - (reflected in the books at present value)

#2

I think a good rule of thumb is that it should if you would need to write a check at closing. If you were valuing the company using a discounted cash flow valuation you should be incorporating these items into your future cash flows so deducting them from the enterprise value would be double-counting them. I think you should assume that the market has them included into their valuation too.

#3

Thanks for the very clear explanation, Chad. I agree that if EV had been determined using, say, DCF, then these items should already be incorporated as future cash outflows. Hence, it would be double-counting to deduct them again from EV. But what if target company is unlisted, & EV had been determined using EV/EBITDA multiples of comparable listed companies? (The comparable listed companies also have Deferred Tax Liabilities & Unfunded Pension Obligations on their balance sheet). Is the same argument still valid, i.e. that the stock prices of the comparable listed companies already reflect these future obligations?

#4

As long as the comps also have these items on their balance sheet the same argument is valid. You could also normalize the comps enterprise value by adding back these items and then removing the subject company’s items to account for any differences.

#5

A lot of the time, things like deferred tax liabilities and unfunded pensions or other off-balance sheet liabilities do NOT turn up on screens or multiples or whatever. Perhaps they don’t even turn up on DCF’s either (from the DCF’s I have seen, usually these are not included, but if they are you don’t want to double-count them as Chad pointed out). Best thing is for you to do your bottoms-up analysis. In most cases if you do a PV of the operations then you would also need to back out these items to get from enterprise value to equity value since this stuff doesn’t normally show up in the continuing operations section of a company.

#6

Thanks for the useful insights, guys!