Why You Add Noncontrolling Interests (Minority Interests) to Enterprise Value

Why you can't just "ignore" a company's ownership stakes in other companies.
By breakingintowallstreet.com/
You'll also learn how to factor in partially owned companies when calculating Enterprise Value and valuation multiples.
This time around, we'll focus on Noncontrolling Interests (AKA Minority Interests) -- cases where the company owns over 50%, but under 100%, of other companies.
1:55 How to Consolidate the Statements with Noncontrolling Interests
3:37 Why You Can't Ignore Noncontrolling Interests in the Enterprise Value Calculation
6:41 How to Adjust for Noncontrolling Interests in Enterprise Value
8:44 Summary
Why You Calculate Enterprise Value the Way You Do...
Pretty much everyone agrees that you take a company's Equity Value, subtract Cash, and add Debt to calculate Enterprise Value.
But after that it gets murkier, and not everyone agrees on which items to add or subtract.
One common scenario: a company owns a % of another company, and it reflects that ownership somewhere on its Balance Sheet... what do you do?
With an Equity Investment or Associate Company, the Parent Company owns less than 50% and records the stake as an Asset on its BS.
With Noncontrolling Interests (formerly "Minority Interests"), the Parent company owns more than 50% but less than 100%, consolidates the financial statements 100%, and records the value of the stake it does NOT own on the L&E side of the BS.
You CANNOT ignore these items when calculating Enterprise Value since they impact the valuation multiples that are based on Enterprise Value.
E.g for Noncontrolling Interests (formerly known as Minority Interests):
The Parent Company has the following stats:
Equity Value = $390
Cash = $50
Debt = $200
Parent Company EBITDA = $63
Consolidated EBITDA = $78
It owns 70% of another company, and that Majority-Owned Company is worth $100.
So you just say Enterprise Value = $390 -- $50 + $200 = $540, right?
Wrong!
Here's the Problem: That Equity Value of $390 already reflects 70% * $100.
In other words, it already includes the ownership percentage in the Majority-Owned Company times the Majority-Owned Company's value.
Without that stake, the Parent Company's Equity Value would be $320 instead.
So as it stands, this Enterprise Value of $540 also includes the value of that 70% stake.
BUT
EBITDA includes 100% of the Majority-Owned Company's EBITDA, because accounting rules state that the statements should be consolidated -- you literally add together each item 100% - when the
Parent Company owns over 50% of another company.
Let's say the Majority-Owned Company had $15 in EBITDA.
The Combined Company's EBITDA would NOT be $63 + $15 * 70% = $73.5.
It would actually be $78 ($63 + $15)!
So Enterprise Value reflects 70% of the Majority-Owned Company, but EBITDA reflects 100% of the Majority-Owned Company's EBITDA.
Theoretically, you could fix this by subtracting 30% of the Majority-Owned Company's EBITDA...
But in real life, companies don't disclose enough information for you to do this.
They only show the Majority-Owned Company's Net Income - not enough to calculate EBIT or EBITDA.
So instead, we add 30% * $100 to Enterprise Value -- representing the portion the Parent Company does NOT own -- to make sure that BOTH Enterprise Value AND EBITDA reflect 100% of that other stake.
The equation then becomes:
Enterprise Value = Equity Value + Debt -- Cash + Noncontrolling Interests
Enterprise Value = $390 + $200 -- $50 + $30 = $570
Summary:
The key concept is "Apples to Apples" comparison -- that's the easiest way to think of Equity Investments (Associate Companies) and Noncontrolling Interests (Minority Interests).
Equity Value will always implicitly reflect the value of the Parent Company's stake in other companies.
If that stake is 70% and the other company is worth $100, Equity Value therefore reflects 70% * $100, or $70.
If that stake is 30% and the other company is worth $200, Equity Value therefore reflects 30% * $200, or $60.
And that's fine.
The problem, though, is that due to accounting rules (under both US GAAP and IFRS), the Parent Company does NOT actually reflect 70% or 30% of the other company's financials on its own Income Statement... until the adjustments to Net Income at the very bottom.
Instead, accounting rules say: "Hey, you have to take an 'all or nothing' approach and either add 100% of the other company's numbers to your own, or add 0% of the other company's numbers... and then adjust for the percentage that you do actually own at the bottom of the Income Statement."
And that creates problems for valuation multiples, such as EV / EBITDA, EV / EBIT, and so on...
Since Enterprise Value reflects the 70% or the 30% you own in another company, but EBIT or EBITDA reflect 0% or 100% ownership.
To fix it, you adjust Enterprise Value to make sure IT also includes 100%, or 0%, of the partially owned company's value.

[@matheuscintra8858]

Great video !!!

[@financialmodeling]

Thanks for watching!

[@vincentnguyen6833]

Hey Brian, great video, just one questions... You said that if owning a majority stake in another company you would consolidate the BS, CFS and IS. So both sides of the balance sheet will balance, but when you subtract non controlling interest at the bottom of your IS which flows into your retained earnings, which in your example, is down by $2, what other item is affected so that your balance sheet balances? Is the other item the non controlling interest that is added into your shareholders equity section on the BS? Thanks!

[@financialmodeling]

Retained Earnings goes down and Noncontrolling Interests goes up because Net Income Attributable to NCI is subtracted to calculate Net Income to Common at the bottom of the IS or top of the CFS, and then you reverse Net Income Attributable to NCI on the CFS. Net Income to Common flows into Retained Earnings, and Net Income Attributable to NCI flows into Noncontrolling Interests.

[@kanyuan6763]

Hi Brian, thanks for the video! Per accounting rule, EBIT reflects either 0% or 100% of the subsidiary's performance. Since we use EBIT in DCF analysis, am I correct in the following two cases: 1. A owns 40% of B--> Equity Method: If we run DCF on A, we only get A's standalone Enterprise Value; then after we subtract debt and add cash, we only get A's standalone Equity Value...But the Mkt Cap of A should reflect 100%*A+40%*B; so in this case, do we add 40%*B's equity value after running DCF on A? 2. A owns 80% of B--> Consolidation Method: If we run DCF on A, we get A's standalone Enterprise Value PLUS B's standalone Enterprise Value; then after we subtract debt and add cash, we get A AND B's consolidated Equity Value...But the Mkt Cap of A should only reflect 100%*A+80%*B; so in this case, do we SUBTRACT 20%*B's equity value after running DCF on A? If B is public, it's not that hard to do all these adjustments. But what if B is private? Thanks a lot!

[@financialmodeling]

In #1, yes, you need to add the value of the Equity Investments at the end, along with cash. If B is public, yes, it is 40% * Equity Value of B. If B is private, you use the book value of the Equity Investment on A's Balance Sheet. In #2, you subtract the value of the Noncontrolling Interests at the end. If B is public, this is 20% * Equity Value of B. If B is private, you use the book value of the Noncontrolling Interest on A's Balance Sheet. If A does not list any of this information, give up and pick a different company... or go and hire a team of ninja assassins to get it out of their management team, if you know a good team of ninjas.

[@kanyuan6763]

Mergers & Inquisitions / Breaking Into Wall Street Haha, thanks a lot! Folks with a ninja background seem to have an advantage when it comes to breaking into banking lol.

[@maddin241288]

Re. you last comment. Can I really use the book value of the NCI in the parents' balance sheet es an estimate for the NCI's market value? The NCI book value is only the partial net income of the not wholly owned subsidiary. For an estimation of the equity value i need to use the (disclosed) net income of the subsidiary times an P/E multiple - or not?!

[@drholmes1003]

As always, loved your vid! One thing though, I don't think anyone minds spending longer on your videos so can you please slow down a bit? :D It gets confusing real fast and you have to stop and rewind and spend even more time.

[@financialmodeling]

We have a feature on our site where you can adjust the play speed - KZbin does not allow for that unfortunately. To be honest, most people looking at earlier / older videos said, "You're moving too slowly, HURRY UP" so the newer lessons move at a much faster pace in response to that. But you can adjust that speed if you have signed up for the courses and have access to the lessons on our site.

[@user-wm8ie2qf4e]

Thx for sharing. Quick question, how can we get the fair value of the noncontrolling or equity investment, because to me, it seems like all we have is the book value? Doesn't make sense to add or subtract book value to/from market cap.

[@financialmodeling]

You can get it if the parent company discloses the fair market value or the NCI is for a public company. Otherwise, no.

[@sszoltan]

Great video about NCI Brian. If the company (namely, Tesla) differentiates between "Redeemable NCI" and straight "NCI" in its Balance Sheet, do we just add both of these together to get to EV? Thanks in advance for reading and answering the comments even after years of posting the video.

[@financialmodeling]

You could, but if you do so, then you need to exclude the shares or units that correspond to the Redeemable NCI (search the filings). The other option is to count all the shares toward Equity Value, but then only add NCI but not Redeemable NCI when calculating Enterprise Value.

[@sszoltan]

@@financialmodeling So you wouldn't add Redeemable NCI to get to Enterprise Value because you expect that to be paid out of the normal operations of the firm as opposed to be paid by the acquirer, right?

[@financialmodeling]

It's because the units represented by the Redeemable NCI should already be counted toward Equity Value... you would be double counting if you added it again.

[@sszoltan]

@@financialmodeling Hi Brian, thanks for the clear explanation. Been thinking before re-asking and I think I now understand your answer. When you say "the units represented by the Redeemable NCI should already be counted toward Equity Value", what you mean is that the Diluted Equity Value from which we proceed to calculate EV should already contain the additional shares expected due to de "redeemable" feature of this portion of NCI? Thanks a million times for making these things understandable.

[@financialmodeling]

@@sszoltan Yes

[@pablomarin3791]

No Excel available yet?:-( Absolutely brilliant videos btw!

[@financialmodeling]

Thanks for your feedback. We don't make the Excel files available for every video, but you can find everything inside the Fundamentals course on our site and/or the bonus case studies there.

[@sehyungpark5182]

When you say value of the other company is this the equity value or the enterprise value and why?

[@financialmodeling]

"Value of the Other Company" refers to the other company's Equity Value because we are assuming the parent company's investment is in the other company's common shares, not its entire capital structure.

[@hugoerdmann6800]

Brian,assuming I have the market value of my minority interest (e.g. publically traded due to spin-off), I would take the market value instead of book value?Best,Hugo

[@financialmodeling]

Yes

[@akgymnastics7153]

thank you very helpful.. but I want to ask you something what if I am comparing enterprise value with free cash flow.. should I add minority interest in the EV or not.

[@financialmodeling]

+Akash Kedare If you have excluded NCI from FCF, you should add it when calculating Enterprise Value. If you have included NCI in FCF, you should leave it out when calculating Enterprise Value.

[@oxy204]

@@financialmodeling If you have excluded NCI from FCF it means your FCF shows say 70% of the full figure (assuming 70% ownership). In this case wouldn't you leave the NCI for the EV figure so that both EV and FCF reflect the 70% ownership?

[@financialmodeling]

@@oxy204 You need to make sure that both the FCF and the Enterprise Value include the same percentage contribution from the partially owned company. The problem with these questions is that people use "NCI" to mean different things - the portion of the Sub Co that Parent Co *does* own, the portion that it does *not* own, and sometimes the entire Sub Co, which means that answers are ambiguous or confusing unless you specify exactly what you mean. The easiest solution is to make both Enterprise Value and Unlevered Free Cash Flow include 100% of Sub Co's value and UFCF by not adding or subtracting any NCI-related line item, so that UFCF for the Parent starts with Operating Income (which includes Parent Co Operating Income and 100% of Sub Co's Operating Income).

[@oxy204]

@@financialmodeling Perfect Thank you! Therefore by taking 100% of the UFCF through operating income we would need to include (add) the missing NCI in Equity Value? Thank you so much for your reply

[@financialmodeling]

@@oxy204 Yes, but you always do that when calculating Enterprise Value... and you always pair UFCF with Enterprise Value since they're both capital structure-neutral. So this is nothing new/different.

[@dieuminhtran9738]

Dear Brian, Thanks for your videos. I have a small question regarding the "actual" EV of a company. It looks like your calculated EV is basically for "apples-to-apples" comparison purpose right? As for Non-controlling Interest video, EV reflects 100% of parent's major-owned enterprise while for Equity Investments video, EV reflects 0% of parent's owned enterprise. So I think your calculated EVs are used to calculate multiples correctly. If I would like to see the "actual" EV, what I need to do is looking at unadjusted EV where EV reflects the actual stake that parent company is holding. Is that a right approach?

[@financialmodeling]

+Dieu Minh Tran If you go by the official definition of Enterprise Value (the value of core business operating assets, but to all investors in the company), you should add Non-Controlling Interests to capture all the investors in the company... the partially owned other company could be counted as another investor group. But some people don't buy into that logic, so you could do it your way as well and make Enterprise Value just reflect the actual stake the parent owns. HOWEVER, this is quite difficult in practice because you then have to separate out the revenue, expenses, etc. from this other, partially-owned company, and hardly anyone discloses enough information to do that. You'd need the other company's entire financial statements to do it, really. So it's a nice idea in theory, but in practice it's probably not practical to do that.

[@dieuminhtran9738]

I got it right now. Thank you very much for your detailed explanation. And again, all of your videos are fantastic.

[@learning_with_irving4266]

How did you derive the 100 as the value of the other company

[@financialmodeling]

This is just an example for this video. It's not based on a real company. In real life, we would have to look in the company's filings to get this value.

[@yoelherman5344]

Thanks a lot, quick question: The method you are presenting is not giving the "real" value or multiplies because the parent company doesn't actually owns 100% of the other company, so I would appreciate if you could make a clarification on what are we actually getting out of these adjustments if we understand that they are not 100% "real"?

[@financialmodeling]

That is incorrect. The Noncontrolling Interest counts as "another investor group" because the parent owns above 50% of that company and can draw on its resources as necessary. So these multiples are "real" and do represent the entire parent company and subsidiary.

[@jellyproxy]

No Excel file this time? :'(

[@financialmodeling]

Sorry, not available yet - we may post it in one of the courses on the site in the future.

[@juancarlosherranzramos8392]

Why is it call "Noncontrolling" if you have more than 50% of the company?

[@financialmodeling]

Because it corresponds to the part of the Sub Co that the Parent Co does *not* own and therefore does *not* control.

[@juancarlosherranzramos8392]

@@financialmodeling Thank you very much!