Can Enterprise Value be negative?
We know that Enterprise Value = Market Cap + Debt – Cash
Now the only way this equation can give a negative value, is if Cash Value is greater than Market Cap and Debt.
Assuming Debt to be zero (there is usually no need for the company to have debt when they have so much cash) – this would mean Market Cap is less than Cash.
Now this is a rare situation, that can occur if the company is undervalued, or if it has a lot of cash that may not be dispensable.
When can Enterprise Value be negative?
Situation 1 – Cash is free cash, that is dispensable. In this case, we can say that the company is usually undervalued. In market panics you sometimes see cash rich companies trading below market cap. I remember briefly in 2009 Hindustan Zinc was trading at a market cap below cash levels. MOIL’s market cap was also below cash in 2020 if my memory serves me right.
Situation 2 – Cash not dispensable – Many times the cash on the books is due to stuff like customer advances. This is not exactly free cash. Here the company is not necessarily undervalued. Example – Mazagon Dock had this situation about 6 months back.
A rare third situation can be where the company actually has cash, but investors do not have confidence in the ability of the management to use this effectively. They expect the management to waste this away.
So yes, Enterprise Value can be negative. As analysts or investors, we do need to analyze carefully if this is an undervaluation situation. Or just a scenario where the company has received a lot of cash due to customer advances.
Video of Maruti Valuation Modelling Session
We conducted a webinar on building a fully linked Valuation model for Maruti. You can access the video here.
You can also download the excel file used in the session here
Till next week. Keep Learning!