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Cash
Do we separate cash into operating cash or excess cash? or treat all cash as excess cash?
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by Kervin T.
added 10 years ago
Re: Cash
In the definition of TEV, it should indeed be Total Debt less EXCESS cash to arrive at Net Debt. Therefore, one SHOULD split cash into operating cash required for the business and excess cash. However, it is not always standard practice to do so and so, the default is that all cash is treated as exc...
In the definition of TEV, it should indeed be Total Debt less EXCESS cash to arrive at Net Debt. Therefore, one SHOULD split cash into operating cash required for the business and excess cash. However, it is not always standard practice to do so and so, the default is that all cash is treated as excess cash when spreading comps for market multiples. Mostly this is because a) bankers are lazy; b) it's sometimes hard to figure out excess cash without additional information that isn't disclosed in the filings; c) see below.
In an actual M&A transaction, there is always a minimum working capital requirement that is treated as a purchase price adjustment that essentially handles this discrepancy in a real deal. For instance, insurance brokers usually have a 30 - 60 day expense requirement for working capital. Any excess working capital above that amount is distributed back to the seller and any shortfall reduces purchase price. If that's the case, then one can assume that all companies have minimum excess working capital requirements and so, that's the other way to rationalize treating all cash as excess cash. Read More
In an actual M&A transaction, there is always a minimum working capital requirement that is treated as a purchase price adjustment that essentially handles this discrepancy in a real deal. For instance, insurance brokers usually have a 30 - 60 day expense requirement for working capital. Any excess working capital above that amount is distributed back to the seller and any shortfall reduces purchase price. If that's the case, then one can assume that all companies have minimum excess working capital requirements and so, that's the other way to rationalize treating all cash as excess cash. Read More
Re: Cash
Thanks. So if we assumed a minimum working capital that include a minimum operating cash, then this same amount of operating cash should also be excluded in the terminal value in calculating the equity IRR, right?
Re: Cash
Yes, correct. However, keep in mind the previous explanation that most of the time, companies have enough working capital already, so hence the adjustment is not typically made.
Re: Cash
Thanks again. I understand. But for an asset-sale type of transaction wherein target will sell asset only without working capital. Any project loan will include a working capital line/revolver, so we must make sure we are paying the "fair" multiple for this type of asset on a going concern basis. At...
Thanks again. I understand. But for an asset-sale type of transaction wherein target will sell asset only without working capital. Any project loan will include a working capital line/revolver, so we must make sure we are paying the "fair" multiple for this type of asset on a going concern basis. At EV = Equity + Net Debt and Net debt = Amortizing Loan + Revolver - Cash. Although cash is fundamentally an amount that buyer will put in to bankroll the initial ~3 months of operating expenses so we can say its "operating cash". Since without the initial cash, EBITDA cannot be earned so to speak. On the other hand, if on Day 1, we would flip and sell it back to the market again, then we can technically free up those cash immediately and can be used to pay back those revolver line drawn and can be treated as excess cash. Thus, it can be argued both ways. What is your view?
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Re: Cash
If a true asset sale, then correct, you are only purchasing certain assets and liabilities. Each of those would be valued separately to arrive at "fair" value. The analysis basically becomes build the asset vs. buy the asset. You could also look at it from an TEV perspective based on the nature of t...
If a true asset sale, then correct, you are only purchasing certain assets and liabilities. Each of those would be valued separately to arrive at "fair" value. The analysis basically becomes build the asset vs. buy the asset. You could also look at it from an TEV perspective based on the nature of the assets and if the assets are a whole "set" - if so, then the concept of TEV and working capital sort of still applies. It really depends on what the assets are and what they are used for - to run as a standalone or part of another set of assets? Your logic is correct, because if you put up the 3 months of operating expenses and you sell the asset right back in the market without working capital level, then in theory you get your locked up working capital back in cash (or the buyer pays for it, which gets us back to the exact same point).
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Re: Cash
How should we treat underfunded pension or pension deficit in an acquisition? Is it a "debt-like" and should form part of TEV/EBITDA multiple calculation? as it will be paid in cash in case employment termination after acquistion?
Re: Cash
Also, in the free cash flow to firm calculation, why do they calculate income tax using EBIT * tax rate instead of getting the actual tax from EBT * tax rate, the difference being the I as interest expense or interest income. Why treat the tax savings from debt-tax shield (delta) as part of free cas...
Also, in the free cash flow to firm calculation, why do they calculate income tax using EBIT * tax rate instead of getting the actual tax from EBT * tax rate, the difference being the I as interest expense or interest income. Why treat the tax savings from debt-tax shield (delta) as part of free cash flow to equity (FCFE? and not part of free cash flow to firm (FCFF)? Should not the company management measure and decide projects' viability incorporating an optimal tax structure and thus, any debt tax shield should be incorporated in that decision using FCFF?
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Re: Cash
Recall our conversation that we adjust for capital structure in valuation at the END of the DCF valuation. FCFE, similar to PE is the root of all evil in valuation. Since the point of FCFF is to calculate pre-capital structure cash flow, we want to make sure that the taxes properly reflect this logi...
Recall our conversation that we adjust for capital structure in valuation at the END of the DCF valuation. FCFE, similar to PE is the root of all evil in valuation. Since the point of FCFF is to calculate pre-capital structure cash flow, we want to make sure that the taxes properly reflect this logic. Hence, even though in actuality you DO receive a tax shield on the interest, you model it out all before capital structure, which gives you TEV. At that point, you boil it down to Equity Value and Price per Share.
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Re: Cash
If the underfunded pension amount is material, then you treat it like debt - that is TEV of your target company stays the same but the equity value component is lower - in other words, the size of the pie stays the same but the slices of the pie are altered. The logic is that you must replenish this...
If the underfunded pension amount is material, then you treat it like debt - that is TEV of your target company stays the same but the equity value component is lower - in other words, the size of the pie stays the same but the slices of the pie are altered. The logic is that you must replenish this shortfall which is considering a massive working capital requirement which reduces equity value since they have not been properly funding their pensions. In the calculation of existing TEV multiples for your comps, you would also add the underfunded pension amounts to debt (making TEV bigger) so that you are making your comparisons correct.
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Re: Cash
Thanks. Got your point on FCFF and agree. But sometimes its not just capital structure affecting the actual tax. as sometimes the operations itself as well like income tax holiday or final tax rule. So getting a "pseudo" tax using EBT * tax rate is far from actual tax. Is FCFF being use that much in...
Thanks. Got your point on FCFF and agree. But sometimes its not just capital structure affecting the actual tax. as sometimes the operations itself as well like income tax holiday or final tax rule. So getting a "pseudo" tax using EBT * tax rate is far from actual tax. Is FCFF being use that much in practice?
But I'm using it to compute Project IRR (which is basically pre-capital structure or all funds are equity) and FCFE to compute equity IRR. This is another "hybrid" valuation using FCFF and FCFE, right? aside from using FCFF to calculate TEV, we used TEV/EBITDA multiple to calculate TEV both on entry and exit values. Is this normal practice to do in your experience?
Also, how do we derived the difference or delta between Project IRR and Equity IRR? Example, 8% and 10% respectively. Conceptually, its the difference of the debt rate and project IRR and tax savings component, right? What is the mathematically formula? Thanks! Read More
But I'm using it to compute Project IRR (which is basically pre-capital structure or all funds are equity) and FCFE to compute equity IRR. This is another "hybrid" valuation using FCFF and FCFE, right? aside from using FCFF to calculate TEV, we used TEV/EBITDA multiple to calculate TEV both on entry and exit values. Is this normal practice to do in your experience?
Also, how do we derived the difference or delta between Project IRR and Equity IRR? Example, 8% and 10% respectively. Conceptually, its the difference of the debt rate and project IRR and tax savings component, right? What is the mathematically formula? Thanks! Read More
Re: Cash
1) Regarding taxes - your tax rate utilized in theory represents effective tax rate which already incorporates income tax holiday or other abatements. Conceptually, you got the idea - just make sure your FCFF is pre-capital structure, including taxes - Just pretend there is no debt and model out FCF...
1) Regarding taxes - your tax rate utilized in theory represents effective tax rate which already incorporates income tax holiday or other abatements. Conceptually, you got the idea - just make sure your FCFF is pre-capital structure, including taxes - Just pretend there is no debt and model out FCFF on that assumption.
2) Project IRR would be as you indicated - pre-capital structure and Equity IRR would be to equity investors, which is after the impact of debt, correct. We still would not use FCFE since the interim periods before exit/terminal year, the equity holders do not receive the change in debt which is the downside to using FCFE. Model out ACTUAL cash to equity holders for Equity IRR, which usually takes the form of dividends and not crappy FCFE. Recall from class that FCFE should be banned from existence.
3) TEV/EBITDA for entry and exit = correct. Keep in mind one should not incorporate the premium in the purchase price upon entry. This also varies for project finance / infrastructure projects.
4) There is no way to mathematically reconcile Project IRR and Equity IRR as the calculation of the cash flow streams are clearly laid out (should be clearly laid out) in your derivations. Read More
2) Project IRR would be as you indicated - pre-capital structure and Equity IRR would be to equity investors, which is after the impact of debt, correct. We still would not use FCFE since the interim periods before exit/terminal year, the equity holders do not receive the change in debt which is the downside to using FCFE. Model out ACTUAL cash to equity holders for Equity IRR, which usually takes the form of dividends and not crappy FCFE. Recall from class that FCFE should be banned from existence.
3) TEV/EBITDA for entry and exit = correct. Keep in mind one should not incorporate the premium in the purchase price upon entry. This also varies for project finance / infrastructure projects.
4) There is no way to mathematically reconcile Project IRR and Equity IRR as the calculation of the cash flow streams are clearly laid out (should be clearly laid out) in your derivations. Read More
Re: Cash
Thank you. Why is premium not included? which may represent goodwill or brand or concession if gov't contract project?
Re: Cash
Is FCFE/Net Profit a good indicator of cash conversion ratio? or Operating cash flow / Operating Profit instead (pre-tax)? since net profit may not contain changes in debt while FCFE contained debt so is it apple to apple?.
Re: Cash
Premium should not included because once private, there is a lack of liquidity discount. In addition, if IPO'ing as an exit, the markets are priced without control premium.
What is the point of "cash conversation ratio"? To calculate actual cash generated vs Net Income? For sure, we are skeptical...
Premium should not included because once private, there is a lack of liquidity discount. In addition, if IPO'ing as an exit, the markets are priced without control premium.
What is the point of "cash conversation ratio"? To calculate actual cash generated vs Net Income? For sure, we are skeptical about using FCFE because it is still accrual concept of accounting; ditto for Operating Profit (whether pre- or post-tax).
Read More
What is the point of "cash conversation ratio"? To calculate actual cash generated vs Net Income? For sure, we are skeptical about using FCFE because it is still accrual concept of accounting; ditto for Operating Profit (whether pre- or post-tax).
Read More
Re: Cash
The point of cash conversion ratio is to check how much the target can convert and generate cash from its net income to free cash flow.
on the premium, understand and agree. although in this case, the target is also a private or subsidiary of a big company so there is also no direct public marke...
The point of cash conversion ratio is to check how much the target can convert and generate cash from its net income to free cash flow.
on the premium, understand and agree. although in this case, the target is also a private or subsidiary of a big company so there is also no direct public market so to speak. Thank you again. Read More
on the premium, understand and agree. although in this case, the target is also a private or subsidiary of a big company so there is also no direct public market so to speak. Thank you again. Read More
