Total Enterprise Value (TEV)
What Is Total Enterprise Value (TEV)?
Total enterprise value (TEV) is a valuation measurement used to compare companies with differing levels of debt. Total enterprise value includes a company's equity value as well as the market value of its debt while deducting out endlessly 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.
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 huge impact on a company's financial health and value.
TEV is calculated as follows:
- TEV = market capitalization + market value of debt + preferred stock - endlessly cash equivalents
Market capitalization is added to the company's total amount of debt. Preferred stock is likewise 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. Additionally, preferred shares are repaid like debt in the event of an acquisition.
Endlessly cash equivalents are subtracted from the formula because it reduces the cost of gaining the company. Cash equivalents might comprise of short-term investments, commercial paper, money market funds, and marketable securities with a maturity date of 90 days or less.
Total enterprise value is helpful when companies engage in mergers and acquisitions. On the off chance that a securing firm is interested in a company, it would need to know how much debt the target company has on its balance sheet. The procuring firm could need to pay off the debt as part of the takeover. Additionally, assuming that the obtaining firm likewise 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 versus Market Capitalization
Often, two companies that seem to have comparative market capitalizations have very different total enterprise values.
For example, in the event that a company was attempting 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 however has $50 million in debt. The company leading the comparison could likewise have a market cap of $100 million yet could instead have no debt and $10 million cash close by. Based on TEV, the competitor's value would be $150 million while the company leading the comparison would have a value of $90 million.
Let's express that instead of a comparison to a competitor, the company was hoping to acquire the competitor. Utilizing the market capitalization value, we would agree that that the takeover price for getting 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 notwithstanding the $100 million market cap.
It's important to remember that the getting company would be buying the target company's debt as well as its assets. As a result, TEV is a more accurate measure for esteeming 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.
Utilizing the TEV to Normalize Values
The TEV, as well as being a metric for comparing potential takeover candidates, likewise permits a company or financial analyst to normalize the valuation of a company. Numerous 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 esteeming a company that measures its current share price relative to its earnings per share (EPS). However, a company's P/E ratio does not necessarily in all cases provide a complete picture since it just 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 probably won't 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 permits 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, like profits and market capitalization, as well as each of the components in the TEV calculation like total debt.
Features
- TEV helps with valuations of potential takeover targets and the amount that ought to be paid for the acquisition.
- TEV is used to derive the overall economic value of a company.
- TEV is calculated as follows: TEV = market capitalization + interest-bearing debt + preferred stock - cash
- Total enterprise value (TEV) is a valuation measurement used to compare companies with changing levels of debt.
