Hacker News Reader

Comment by devoutsalsa | Hacker News Reader

If you acquire the company, you assume it's debt, too. So that's a liability you assume, meaning you have to pay that on top of paying for the market cap of the company. You also get the cash, which is a reward for buying the company. So to buy the company and pay off all the debts.

Example:

- Company Stock is worth market cap of 2 billion.

- Company has 2 billion in debt.

- Company has 1 billion in cash.

2B (acquiring all the stock) + 2B (paying off all the debt) - 1B (cash in the bank) = 3B (enterprise value, aka the effective price to buy the company w/ no debt).

Some people call the enterprise value the true price of the company.

View on HN

I think the confusion lies in the word "value". To use your example of Company, imagine another company (Company2) exactly the same as Company but without the debt. Enterprise value of Company is 3B, enterprise value of Company2 is 1B. But Company2 would clearly be preferential to acquire, because it has no debt, despite the much lower enterprise value. So enterprise "value" is not a useful measure of "value". Am I misunderstanding something here?

The part you're missing is that the 3 variables aren't independent of each other or of the underlying company. You'll never have two 'identical' companies that only differ in one of those variables.

If company 2 has the same market cap with zero debt as company 1 has with huge amount of debt, then that implicitly means that the market values what company 2 does less. Perhaps they're in a market with lower growth or have a smaller market share or have a product with less upside potential or have huge lawsuit hanging over them.

If company 1 and company 2 did the same thing and had the same profits and sales, but the only difference is that company 1 had a lot more debt, then the market cap of company 2 would almost certainly be higher than the market cap of company 1. In fact you could then use the Enterprise Value formula to work out what the market cap of company 2 'should' be.

Ok I understand what you're saying, but this is still treating debt as a negative despite the fact it has a positive influence on the enterprise value.

Imagine this example. I'm CEO of Company2 and I take out a 1B loan. Enterprise value is still 2B, because 1B debt is cancelled by the 1B I now have in cash. I then waste all the cash on whatever. My company's enterprise value is now 3B, because the debt has increased it without being cancelled by the cash.

Depends on what you did with your cash. If you wasted it on something (perceived as) 'stupid' then your stock price would go down, lowering your market cap and your enterprise value would stay the same. If however you invested that cash into something perceived as 'smart' then your company will now be better off in some dimension, and thus it makes sense that your company will be worth more.

Equally if you are able to take on a lot of debt without it lowering your stock price then that means that the market thinks you're going to use that new money in a smart way to grow your companies value and thus your company is more valuable. If the market didn't believe you would use the debt wisely, taking on debt will lower your stock price.

In the real world you effectively cannot change the amount of cash or debt you have without it affecting your market cap in some way, as all three are tied together in complex ways and this model doesn't offer any insight into how changing one value will affect the others or the overall value going forwards. Think of Enterprise Value just as the price tag of a company at any given moment in time.

Gotcha. To go back to the article, it compares Tesla vs Toyota's market cap (558 vs 329) and then their enterprise value (553 vs 466) and concludes that if we look at EV then Toyota has almost caught up. What this reveals is that the market has decided that Toyota is in a good position ("valuable") because they have a market cap reasonably close to Tesla despite a lot more debt, so there is inherently some extra value in Toyota (according to the market) not captured by just looking at the diff between Tesla and Toyota market cap. It also reveals that Toyota believes they're undervalued which is why they're using debt financing instead of shares, whereas Tesla thinks the opposite.

Reply on news.ycombinator.com