What is Total Enterprise Value (TEV)?
Total enterprise value (TEV) is a valuation measure used to compare companies with different levels of debt. Gross business value includes not only the value of a company’s equity, but also the market value of its debt, minus cash and cash equivalents.
Some financial analysts use market capitalization analysis to arrive at a company’s value. Market capitalization is the value of a company multiplied by the current stock price times the total number of shares outstanding. However, companies often have different financial and capital structures, making TEV a better measure of value when comparing companies.
- Total enterprise value (TEV) is a valuation measure used to compare companies with different levels of debt.
- TEV is calculated as follows: TEV = market capitalization + interest-bearing debt + preferred stock – cash
- TEV helps evaluate potential acquisition 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 a company’s overall economic value, and is often considered a more comprehensive metric because it takes into account 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 value + debt market value + preferred stock – cash and cash equivalents
Market capitalization is added to the company’s total debt. Preferred stock has also been added, as it is a hybrid security with characteristics of equity and debt. Preferred stock is considered debt because these stocks pay dividends and have a higher priority than common stock in claiming income. Also, in an acquisition event, preferred stock is repaid in a similar manner to debt.
Cash and cash equivalents are subtracted from the formula because it reduces the cost of acquiring a company. Cash equivalents may include short-term investments, commercial paper, money market funds and marketable securities with maturities of 90 days or less.
Total enterprise value is helpful when companies make mergers and acquisitions. If the acquiring company is interested in a company, it needs to know how much debt the target company has on its balance sheet. As part of an acquisition, the acquiring company may need to pay down debt. In addition, if the acquiring company also has debt on its balance sheet, it is critical to know the amount of outstanding debt of the target company, as this may affect whether the transaction closes.
Total enterprise value and market capitalization
Often, two companies with similar market capitalizations have very different total enterprise values.
For example, if a company is trying to compare its value to that of its competitors, it has to surpass market cap. Suppose a competitor has a market cap of $100 million but has $50 million in debt. The company being compared may also have a market cap of $100 million, but may have no debt and $10 million in cash on hand. According to TEV, the competitor is worth $150 million, while the company being compared is worth $90 million.
Suppose the company is not comparing with competitors, but looking to acquire competitors. Using market capitalization, we can say that the acquisition price for the company was $100 million. However, TEV shows that the acquisition cost was actually $150 million due to the $50 million in debt in addition to the $100 million market cap.
It is important to remember that the acquiring company will buy the debt of the target company and its assets. Therefore, TEV is a more accurate measure for evaluating a company’s price during mergers and acquisitions.
Total enterprise value can be used to compare two companies with different levels of debt and equity or to analyze potential acquisition targets.
Normalize values using TEV
In addition to serving as a metric for comparing potential acquisition candidates, TEV allows a company or financial analyst to standardize a company’s valuation. Many financial analysts use the price-to-earnings (P/E) ratio to arrive at a company’s value in excess of its market capitalization. The price-to-earnings ratio is a measure of the valuation ratio of a company’s current share price relative to its earnings per share (EPS). However, a company’s P/E ratio doesn’t always provide the complete picture, as it only includes the company’s market capitalization and profits (or earnings). A price-to-earnings ratio can make one company look expensive compared to another, but in reality, it’s not because one company may not have any debt and another company has debt on its balance sheet.
Instead, financial analysts can standardize a company’s valuation by matching EBITDA (earnings before interest, taxes, depreciation, and amortization) to enterprise value. EBITDA is a measure of enterprise value that better evaluates a public company’s stock price for investment purposes. The reason is that the calculation includes components of the P/E ratio, such as profit and market capitalization, as well as all components in the TEV calculation, such as total debt.