What Is Total Enterprise Value (TEV)?
Total enterprise value (TEV) is a valuation measurement used to compare companies with varying levels of debt. Total enterprise value includes not only a company's equity value but also the market value of its debt while subtracting out cash and cash equivalents.
Some financial analysts use market capitalization analysis to derive the value of a company. Market capitalization is the value of a company by multiplying the current stock price by the total number of outstanding shares. However, companies often have different financial and capital structures, making TEV a better value measure when comparing companies.
- Total enterprise value (TEV) is a valuation measurement used to compare companies with varying levels of debt.
- TEV is calculated as follows: TEV = market capitalization + interest-bearing debt + preferred stock - excess cash
- TEV helps with valuations of potential takeover targets and the amount that should be paid for the acquisition.
- TEV is used to derive the overall economic value of a company.
Introduction To Enterprise Value
Understanding Total Enterprise Value (TEV)
TEV is used to derive the overall economic value of a company and is often seen as a more comprehensive metric since it factors in a company's debt and cash, which can have a significant impact on a company's financial health and value.
TEV is calculated as follows:
- TEV = market capitalization + market value of debt + preferred stock - excess cash and cash equivalents
Market capitalization is added to the company's total amount of debt. Preferred stock is also added because it is a hybrid security, which has features of equity and debt. Preferred shares are treated as debt since the shares pay dividends and have a higher priority when it comes to claiming earnings versus common stock. Also, preferred shares are repaid similar to debt in the event of an acquisition.
Cash and cash equivalents are subtracted from the formula because it reduces the cost of acquiring the company. Cash equivalents may consist of short-term investments, commercial paper, money market funds, and marketable securities.
Total enterprise value is helpful when companies engage in mergers and acquisitions. If an acquiring firm is interested in a company, it would need to know how much debt the target company has on its balance sheet. The acquiring firm might need to pay off the debt as part of the takeover. Also, if the acquiring firm also had debt on its balance sheet, it would be critical to know the amount of outstanding debt for the target company since it could impact whether or not the deal gets done.
Total Enterprise Value vs. Market Capitalization
Often, two companies that seem to have similar market capitalizations have very different total enterprise values.
For example, if a company was trying to compare its value to the value of a competitor, it would have to look beyond market capitalizations. Let's say that the competitor has a market capitalization of $100 million but has $50 million in debt. The company conducting the comparison might also have a market cap of $100 million but might instead have no debt and $10 million cash on hand. Based on TEV, the competitor's value would be $150 million while the company conducting the comparison would have a value of $90 million.
Let's say that instead of a comparison to a competitor, the company was looking to acquire the competitor. Using the market capitalization value, we would say that the takeover price for acquiring the company is worth $100 million. However, TEV shows that the cost of acquisition is really $150 million, due to the debt of $50 million in addition to the $100 million market cap.
It's important to remember that the acquiring company would be buying the target company's debt as well as its assets. As a result, TEV is a more accurate measure for valuing the price of a company during a merger or acquisition.
Total enterprise value can be used to compare two companies with different levels of debt and equity or to analyze a potential takeover target.
Using the TEV to Normalize Values
The TEV, in addition to being a metric for comparing potential takeover candidates, also allows a company or financial analyst to normalize the valuation of a company. Many financial analysts use the price-to-earnings (P/E) ratio to derive a company's value, above and beyond its market capitalization. The P/E ratio is a ratio for valuing a company that measures its current share price relative to its earnings per share (EPS). However, a company's P/E ratio does not always provide a complete picture since it only includes the market capitalization and profits (or earnings) of the company. P/E ratios can make a company appear expensive compared to another company when, in reality, it's not since one company might not have any debt while the other company has debt on its balance sheet.
Instead, financial analysts can normalize a company's valuation by taking the EBITDA (earnings before interest, tax, depreciation, and amortization)-to-enterprise value. The EBITDA-to-enterprise value metric allows the stock price of public companies to be better evaluated for investment purposes. The reason for this is that the calculation includes the components of the P/E ratio, such as profits and market capitalization, as well as all of the components in the TEV calculation such as total debt.