Enterprise Value: Why You Add and Subtract Certain Items (Version 2.0)

In this revised and updated lesson, you’ll learn about how to decide which items go into the Enterprise Value calculation, and which items you can safely ignore.
Resources:
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Table of Contents:
0:00 Introduction
5:26 “Always” Items
8:21 “Never” Items
11:01 “More Complicated” Items
14:50 “Maybe” Items
19:16 Recap and Summary
Lesson Outline:
Since Enterprise Value represents a company’s Net Operating Assets to all investors, and Equity Value represents its Net Assets only to common shareholders, you can move between them by adding and subtracting line items from the Balance Sheet (sometimes with adjustments).
You add any Liability & Equity line items that represent additional investor groups beyond the common shareholders, and you subtract any Assets that represent non-core or non-operating items.
Typically, this means that you subtract Cash, Financial Investments, Equity Investments, Net Assets Held for Disposal, and Net Operating Losses.
None of these is required to operate the company’s day-to-day business except for some minimum level of cash (which is ignored for simplicity).
You add items like Debt, Preferred Stock, Noncontrolling Interests, Unfunded Pensions, and sometimes Leases because all these items represent additional outside investors (or could be argued to represent additional investor groups).
With the standard items, such as Cash, Debt, and Preferred Stock, it’s quite simple: go to the company’s most recent Balance Sheet and get the values. If you have time, you can also search the filings for the “Fair Value” or “Fair Market Value” of items like Debt, as they sometimes differ from the figures on the Balance Sheet.
You should never add or subtract items that are part of the company’s Working Capital, long-term operational assets (Net PP&E, Goodwill, etc.), accrual items that represent timing differences, Lease Assets of any type, or industry-specific items such as Content Assets for Vivendi.
A few items are more complicated: if the Net Operating Losses have not already been tax-affected, you should multiply the total off-Balance Sheet figure by the Tax Rate to do that before subtracting them, as this represents the company’s actual savings from these items.
With Unfunded Pensions, you add Pension Liabilities - Pension Assets as long as Pension Liabilities are bigger - but the tax treatment differs.
If contributions into the plan are tax-deductible, as is usually the case in the U.S., you multiply this number by (1 - Tax Rate) to reflect the tax savings the company will realize by contributing to fully fund the plan eventually.
If not, as with many European plans, you do not multiply by (1 - Tax Rate), as contributions will not reduce the company’s cash taxes.
Finally, there’s a whole category of “Maybe” items, such as Leases, Restructuring/Legal Liabilities and Deferred Tax Liabilities.
We believe the typical rationale for the latter two (“they could represent large cash outflows!”) is weak because these items do not actually represent outside investor groups in the same way that Debt does (for example). These are also not interest-bearing liabilities.
Leases are more of a grey area, and it’s acceptable to add all Leases, exclude all Leases, or add just Finance Leases but not Operating Leases as long as you’re consistent with the metrics and multiples.
Specifically, if the denominator, such as EBITDA, excludes the Lease Expense, make sure you add the corresponding Lease Liability in Enterprise Value, and vice versa if it deducts the Lease Expense.
Adjustments may be required for metrics such as EBIT that deduct only part of the full Lease Expense.