Debt free cash free to shares value with surplus cash
Training course provider: Here we go. I was describing a situation, the simplest case… I was imagining a situation where the fairy godmother waves her wand over the business with debt, and that’s the debt free cash free basis. Marcos what we could also do in valuation terms is go… as well as going from right to left, we could also go from left to right. We could go from left to right.
And of course this is the situation you guys are in isn’t it? This is your offer, this is your heads of terms, and you have to work out often what the seller of the business is going to get. This is often the value that is written in the sale and purchase agreement. If we’re going this way [left to right] we’d subtract the net debt from our debt free cash free offer that’s in the offer letter to work out what the seller gets. And certainly in the UK that’s what tends to be written in the sale and purchase agreement.
Now Marcos goes to the top of his class because he has asked me a very pertinent question to do with what happens if the business has a situation where cash is greater than debt. What if cash, or surplus cash, is greater than debt?
Debt free cash free is our view of underlying business value
And this is what I’m going to say Marcos, although you’ve probably already worked this out. This is our debt free cash free which equals our underlying… or debt free cash free is our view of underlying business value. So we’ve got a business over here [left hand side] in our offer letter, where we’ve got a view…
We could talk about how we form that view. How is valuation determined? When we get into valuation what we’re talking about is how we form that view of underlying business value. Marcos our debt free cash free… there are a number of ways of thinking about it. Remember we’ve explained the fairy godmother. That’s one way: free of debt and cash. Another way of thinking about debt free cash free Marcos is that it’s our view of underlying business value.
If you’re wanting to know why this debt free cash free term gets used at all, it’s because it’s a view of underlying business value. So here’s our view of underlying business value. We need to find out how we come up with that view, but I want to imagine Marcos’s situation where we’ve got a business that has lots of surplus cash.
Surplus cash is a non core asset
In that case, where surplus cash is greater than debt, what we’ve got is a business where we’ve got some view of its underlying value, but also that business, if you like, has got an asset. It’s got an asset which is not core to the business. What’s that asset called? Surplus cash.
I want you to imagine a business where you’ve got the underlying view of the business’s value, you’ve got that underlying view. Let’s imagine that business instead of surplus cash its got a corporate jet, or it’s got a diamond sitting in its vaults somewhere. This is a real case by the way. There’s a UK company that has got into trouble on the stock market because it had a diamond… one of its assets… it was a construction company. Anybody think a construction company needs a diamond in its vaults? No of course it didn’t, but it had this diamond it was supposed to be worth something like… I don’t know… millions of pounds. It turned out it was worth £300 or something. It wasn’t really… it was a rough cut diamond. Anyway, there’s a business in the UK that people know about it had this non core asset suddenly it didn’t turn out to be worth that much.
With surplus cash a buyer will pay more for the shares
Let’s imagine a business, it could be construction, but its got some kind of asset: a race horse, a corporate jet, a diamond. What are we going to pay for that business? In Marcos’s case that business has surplus cash. Marcos what I’m going to say to you, in the case where we’ve got surplus cash greater than debt, it’s a slightly unusual case and as a buyer what you’d be prepared to do is pay not only for the underlying business but you’d be prepared to pay for the surplus cash.
And I think you kind of knew that because you’re talking in terms of paying cash for cash. When you’re paying here [RHS] this is what the seller gets. Again, this is what the seller gets. He’s getting something for the underlying business, plus he’s getting paid out for his cash. So this is the case, this is the case where we’ve got surplus cash greater than debt. Surplus cash. And over here [RHS] what the seller gets.
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And of course this is the situation you guys are in isn’t it? This is your offer, this is your heads of terms, and you have to work out often what the seller of the business is going to get. This is often the value that is written in the sale and purchase agreement. If we’re going this way [left to right] we’d subtract the net debt from our debt free cash free offer that’s in the offer letter to work out what the seller gets. And certainly in the UK that’s what tends to be written in the sale and purchase agreement.
Now Marcos goes to the top of his class because he has asked me a very pertinent question to do with what happens if the business has a situation where cash is greater than debt. What if cash, or surplus cash, is greater than debt?
I want you to imagine a business where you’ve got the underlying view of the business’s value, you’ve got that underlying view. Let’s imagine that business instead of surplus cash its got a corporate jet, or it’s got a diamond sitting in its vaults somewhere. This is a real case by the way. There’s a UK company that has got into trouble on the stock market because it had a diamond… one of its assets… it was a construction company. Anybody think a construction company needs a diamond in its vaults? No of course it didn’t, but it had this diamond it was supposed to be worth something like… I don’t know… millions of pounds. It turned out it was worth £300 or something. It wasn’t really… it was a rough cut diamond. Anyway, there’s a business in the UK that people know about it had this non core asset suddenly it didn’t turn out to be worth that much.
