Matt Bergman tweeted about the difference between enterprise free cash flow and equity free cash flow.

MB: « #investing #finance not profound, but confusion I often see:

  • Free cash flow to firm = unlevered free cash flow = enterprise free cash flow.
  • Free cash flow to equity = levered free cash flow = equity FCF
  • FCFF = free to all claimants
  • FCFE=levered [because] after all payments on debt »

AE : « Thanks for pointing out the distinction. Is your point that reported FCF is often inflated because it refers to the former rather than latter (essentially gross rather than net)? »

MB: « Oh my pleasure. I actually hadn’t thought much about your point – but I think it’s a very good one-& mostly, you won’t see it distinguished on financials or by stock data service, etc. (1/ »

MB: « The young folks who ask me usually a) confused due to intuition that cash flows before debt *should* be *levered* & b) easy way to kill valuation=mismatching discount rate-enterprise cash flows are discounted at cost of capital, equity at cost of equity (2/2 »

MB : « Virtually always, cost of debt is lower than cost of equity & debt has tax savings – so again, virtually always, cost of equity > cost of capital (as measured by WACC) – if you discount e.g. unlevered FCF at cost of equity, very likely to undervalue company & vice versa (3/ »

AE: « The devil is in the details with the inputs to your valuation formula. »

MB: « absolutely – and you see it real world. @AswathDamodaran very early in his courses will show published investment bank M&A projections that entirely mismatch, costing their clients huge $$ »

MB: « Re: any *inflation* – everything links back to either enterprise value (which includes debt) or equity value (which is after net debt, i.e +- debt + cash). Common stock prices are, of course, an equity metric (why P/EBITDA is meaningless multiple, equity metric/firm metric) »

AE: « Great points. Inflation is becoming a more relevant factor. »

AE: « I do think private companies are sometimes acquired based on a multiple of EBITDA, but then I assume buyer would subtract debt from the valuation when making offer… or just buy the assets rather than the stock. (As I recall, better tax-wise for seller to sell the stock.) »

MB: «No doubt – I’m agnostic on whether EBITDA is best candidate to serve as the multiple on which a transaction is priced, but no doubt common – in a genuine merger, “price” often means enterprise value, i.e. acquirer assumes target debt. »

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s