Tuesday, November 4, 2008

EV and minority interest!

Finance is not rocket science..we have to pretend it is, to justify our salaries...Most of the terms are self-explanatory like Enterprise value, it is nothing but the value of the enterprise value, Minority interest, Interest at a minority level etc etc. I know my 7th grade english teacher would give me a nice kick at my back side for such horrendous english. Ok coming back, What is the value of the Walmart?...simply if we put this question to ourselves or to others, the obvious answer is "well Walmart is trading at c.$56, number of outstanding shares (assumed) to be 100, that makes the value/M-cap as $5,600". But what we forget is that, m-cap is just the equity component and there are other components to the enterprise value as well like debt, preferred stock etc. So simply put, EV= M-cap + net debt + preferred stock. Preferred stock should be included as it has characteristics of debt. Now the real question "should minority interest be included in the EV calculation or not". I think it should be. Minority interest is another form of capital to fund the business. what i mean, it is a form of capital that grossed up my IS and BS to give me that 100% consolidation.

Now, keep in mind that the main use for Enterprise Value is to create valuation ratios/metrics (e.g. EV/Sales, EV/EBITDA, etc.) When we take, say, sales or EBITDA from the parent company’s financial statements, these figures due to the accounting consolidation, will contain 100% of the sub’s sales or EBITDA, even though the parent does not own 100%. In order to counteract this, we must add to Enterprise Value, the value of the sub that the parent company does not own (the minority interest). By doing this, both the numerator and denominator of our valuation metric account for 100% of the sub, and we have a consistent (apples to apples) metric.

One might ask, instead of adding minority interest to Enterprise Value, why don’t we just subtract the portion of sales or EBITDA that the parent does notown. In theory, this would indeed work and may in fact be more accurate. But we do not have enough information about the sub to do such an adjustment (minority owned subs are rarely, if ever, public companies). Moreover, even if we had the financial information of the sub, this method is clearly more time consuming.

You treat minority interest "as if you borrowed that amount of money to fund 100% of the acquisition". the point to remember is "as if we borrowed"...so guys next time you calculate EV, don't forget to consider minority interest...

2 comments:

vijay said...

Adding minority interest is accepted by all while computing EV. Point to note is, to properly understand the minority interest line item coming in individual Financial Statement. As "Associate Company" market value is removed from 'Enterprise Value' calculation. So if by mistake nomenclature is not correctly taken, your EV will be wrong.

Subhash said...

Thanks Vijay for such a wonderful insight.