Valuation: Adjusted net debt - Debt like items

Valuation: Adjusted net debt – Debt like items

Joris Kersten, Place: Uden/ Netherlands, March 2nd 2020

Consultant & Trainer Joris Kersten

I am an independent M&A consultant and Valuator from The Netherlands.

In addition, I provide training in “Financial Modelling”, “Business Valuation” and “Mergers & Acquisitions” all over the world (New York, London, Asia, Middle East). This at leading (“bulge bracket”) investment banks, corporates and universities.

I also provide inhouse training on request (globally). Email for availability to: [email protected] 

And I have open training programs in business valuation in The Netherlands and different places in the world (e.g. New York, Mumbai, Dubai, Amsterdam and Uden).

My full training calendar can be found at the very end of this article.

And my next upcoming training is: Business Valuation & Deal Structuring @ Uden/ The Netherlands @ 18, 19, 20, 21 and 23, 24 March 2020.

Visit for all info and registration: www.joriskersten.nl

In addition, I write blogs and articles on business valuation related issues, earlier blogs can be found at the very end of this article.

Adjusted net debt: Debt like items

This is a sequence of 4 blogs on the concept “net debt” in for example M&A transactions.

3 blogs have been published already and this is the 4th, and last, one.

The previous 3 blogs can be found below:

Article 1: Valuation: Introduction to "net debt" (cash & debt free)

https://www.dhirubhai.net/pulse/valuation-introduction-net-debt-cash-free-joris-kersten-msc-bsc-rab/

Article 2: Valuation: Net debt (cash & debt free)

https://www.dhirubhai.net/pulse/valuation-net-debt-cash-free-joris-kersten-msc-bsc-rab/

Article 3: Valuation: Adjusted net debt – Cash like items

https://www.dhirubhai.net/pulse/valuation-adjusted-net-debt-cash-like-items-kersten-msc-bsc-rab/

In this 4th one I will talk about “adjusted net debt” and then specifically about the “debt like items”.

For these blogs I have used the following book as a source:

• Book: “Investeren & Financieren: 2nd edition” of Taco Rietveld (2017). Publisher: Vakmedianet.

This is one of my favorite books on valuation, and the two chapters on “net debt” are amazing and very detailed and practical. I have the book all the time on my desk.

And it proved itself very handy multiple times already, when I had discussions on “net debt” in M&A transactions.

The only downside is that the book is written in Dutch, so I can only encourage my Dutch colleagues to read and study the book!

Adjusted net debt - Debt like items: Introduction

Before I will jump into the “debt like items” of the “adjusted net debt” in detail, let’s first review what the following concepts mean:

1.     Cash like items;

2.     Debt like items;

3.     Adjusted net debt.

I have given this introduction already in the previous blog on this topic (blog 3). But it is important that everybody understands the basics.

So let’s take a look at these basics shortly:

Cash like items are assets which the company does not use for its operating activities.

So these non-operating assets do NOT generate any EBITDA or (operating) Free Cash Flow. But they do generate a positive (non-operating) free cash flow.

An example of a cash like item is an unused piece of machinery.

These cash like items actually represent a value, so we subtract them from net debt.

Debt like items are liabilities also separated from the operating activities of a company.

And these non-operating liabilities can lead to negative (non-operating) free cash flows.

And these are not shown in the EBITDA or (operating) free cash flows.

And the value of debt-like items need to be added to net debt.

So adjusted net debt adjusts “net debt” for “cash like” and “debt like” items.

The formula is:

·       Adjusted net debt = net debt + debt like items – cash like items

And after that we get to the “equity value” as follows:

·       Equity value = Enterprise value – adjusted net debt.

(Taco Rietveld, 2017)

Debt like items

I have looked at “cash like items” already in detail in blog 3.

And in this 4th blog I will look at the “debt like items” in detail.

Let’s first sum up the “debt like items” and let’s then take a look at them in more detail:

1.     Future exceptional expenses;

2.     Overdue investments;

3.     Inadequate net working capital;

4.     Deferred revenues;

5.     Tax payable;

6.     Deferred tax liabilities;

7.     Pension liabilities;

8.     Non-operating provisions;

9.     Off balance liabilities.

(Taco Rietveld, 2017)

Future exceptional expenses (item 1) & Overdue investments (item 2)

A company can have future exceptional expenses coming forth out for example claims of third parties against the company.

This is a debt like item (one needs to estimate chance, size, and timing do).

And concerning overdue investments: When a company has overdue investments in fixed or intangible assets (or marketing or R&D), then this will result in more CAPEX in the future.

A valuation method like DCF or LBO analysis will take this into account.

But when one purely values based on multiples this is not taken into account. And we can then add a debt like item for this.

(Taco Rietveld, 2017)

Inadequate net working capital (item 3)

When we sell a company it should contain a normal level of working capital.

But what is a normal level of working capital ?

Here for we look at the last three years. But we first “clean” the net working capital for:

1.     Cash like an debt like items in working capital, as mentioned in the previous blog (article 3*) in this sequence;

2.     Debt items, as mentioned in the previous blog (article 3*) in this sequence;

3.     And “one offs”, as mentioned in the previous blog (article 3*) in this sequence;

After that we calculate the average working capital over the last twelve months (LTM).

Due to seasonal impact working capital fluctuates around the average working capital.

So when you sell a company with balance sheet date 31st December, and working capital is higher than the average, than we have another “cash like item” in the deal.

And obviously, when working capital at 31st December is lower than the average, than we have another “debt like item” in the deal.

(Taco Rietveld, 2017)

*Article 3: Valuation: Adjusted net debt – Cash like items

https://www.dhirubhai.net/pulse/valuation-adjusted-net-debt-cash-like-items-kersten-msc-bsc-rab/

Deferred revenues (item 4)

Deferred revenues are revenues from goods or services that are paid already, but still need to be delivered to the client.

Some professional argue this is a debt like item, and some professionals argue it should be modeled in the operating working capital. Therefore it should be assessed case by case, so M&A deal by M&A deal. This depending on the business model of the specific company.

When the deferred revenues are qualified as a debt like item, technically the debt like item consists only out of the COGS (costs of good sold) and OPEX (operating expenses).

(Taco Rietveld, 2017)

Tax payable (item 5) & Deferred tax liabilities (item 6)

A payable of corporate tax is generally seen as a debt like item.

So in other words, it belongs to the seller, cause it is an effect of the past (pre take over).

And DTLs (deferred tax liabilities) are tax liabilities that likely need to be paid in the future.

We need to estimate when we expect to pay these liabilities. And we need to discount them with a discount rate (e.g. WACC). And then it is a debt like item.

(Taco Rietveld, 2017)

Pension liabilities (item 7) & Non-operating provisions (item 8) & Off balance liabilities (item 9)

Pension liabilities are non-operating provisions. So they are separated from EBITDA or free cash flow.

This is why we need to value them separately, and then they can be seen as debt like items.

The same goes for other non-operating provisions.

Remember that just “operating provisions” are already taken into account in the “free cash flow” calculations of a “discounted cash flow valuation”.

But for “non-operating provisions” this is not the case. So they should be valued separately as a debt like item.

Off balance liabilities like “earn outs” and “guarantees” should be valued separately as well as debt like items. Obviously, one needs to estimate chance, size, and timing of the expected payments of these liabilities.

(Taco Rietveld, 2017)

Source used for this blog

• Book: “Investeren & Financieren: 2nd edition” of Taco Rietveld (2017). Publisher: Vakmedianet.

I am quite sure that right now this is one of the most complete handbooks on valuation and M&A. The level of detail in the book is amazing and the book is extremely practical! ??

Unfortunately the book is only available in Dutch, but definitely worth it to read for any Dutch finance & accounting professional involved in valuation and/ or M&A.

Earlier blogs on “net debt” (cash & debt free)

Article 1: Valuation: Introduction to "net debt" (cash & debt free)

https://www.dhirubhai.net/pulse/valuation-introduction-net-debt-cash-free-joris-kersten-msc-bsc-rab/

Article 2: Valuation: Net debt (cash & debt free)

https://www.dhirubhai.net/pulse/valuation-net-debt-cash-free-joris-kersten-msc-bsc-rab/

Article 3: Valuation: Adjusted net debt – Cash like items

https://www.dhirubhai.net/pulse/valuation-adjusted-net-debt-cash-like-items-kersten-msc-bsc-rab/

Article 4: Valuation: Adjusted net debt – Debt like items

Will be published in week of 2nd March.

Earlier blogs on “various topics”

Financing a M&A transaction: An introduction

https://www.dhirubhai.net/pulse/financing-ma-transaction-introduction-joris-kersten-msc-bsc-rab/

Earlier blogs on “bonds”

Article 1: Bonds - An introduction

https://www.dhirubhai.net/pulse/corporate-finance-bonds-introduction-joris-kersten-msc-bsc-rab/

Earlier blogs on the “cost of capital”

Article 1: Valuation & Betas (CAPM)

https://www.dhirubhai.net/pulse/valuation-betas-capm-joris-kersten-msc-bsc-rab/

Article 2: Valuation & Equity Market Risk Premium (CAPM)

https://www.dhirubhai.net/pulse/valuation-equity-market-risk-premium-capm-joris-kersten-msc-bsc-rab/

Article 3: Is the Capital Asset Pricing Model dead ? (CAPM)

https://www.dhirubhai.net/pulse/capital-asset-pricing-model-dead-capm-joris-kersten-msc-bsc-rab/

Article 4: Valuation & the cost of debt (WACC)

https://www.dhirubhai.net/pulse/valuation-cost-debt-wacc-joris-kersten-msc-bsc-rab/

Article 5: Valuation & Capital Structure (WACC)

https://www.dhirubhai.net/pulse/valuation-capital-structure-wacc-joris-kersten-msc-bsc-rab/

Article 6: International WACC & Country Risk – Part 1

https://www.dhirubhai.net/pulse/valuation-international-wacc-country-risk-part-1-joris/

Article 7: International WACC – Part 2

https://www.dhirubhai.net/pulse/valuation-international-wacc-part-2-joris-kersten-msc-bsc-rab/

Article 8: Present Values, Real Options, the Dot.com Bubble

https://www.dhirubhai.net/pulse/valuation-present-values-real-options-dotcom-bubble-joris/

Article 9: Valuation: Different DCF & WACC techniques

https://www.dhirubhai.net/pulse/valuation-different-dcf-wacc-techniques-joris-kersten-msc-bsc-rab/

Article 10: Valuation of a company abroad

https://www.dhirubhai.net/pulse/valuation-company-abroad-joris-kersten-msc-bsc-rab/

Article 11: Valuation: Illiquidity discounts, control premiums and minority discounts

https://www.dhirubhai.net/pulse/valuation-illiquidity-discounts-control-premiums-joris/

Article 12: Valuation: Small firm premiums

https://www.dhirubhai.net/pulse/valuation-small-firm-premiums-joris-kersten-msc-bsc-rab/

Earlier blogs on “Business valuation to Enterprise Value”

From June until August I have written the following blogs on valuation:

1)    Leveraged Buyout (LBO) Analysis:

https://www.dhirubhai.net/pulse/leveraged-buyouts-lbos-joris-kersten-msc-bsc-rab/

2)    M&A Analysis – Accretion/ Dilution:

https://www.dhirubhai.net/pulse/ma-model-accretion-dilution-joris-kersten-msc-bsc-rab/

3)    Discounted Cash Flow Valuation:

https://www.dhirubhai.net/pulse/discounted-cash-flow-valuation-dcf-joris-kersten-msc-bsc-rab/

4)    Valuation Multiples 1 – Comparable Companies Analysis:

https://www.dhirubhai.net/pulse/valuation-multiples-1-comparable-companies-analysis-joris

5)    Excel Shortcuts & Business Valuation:

https://www.dhirubhai.net/pulse/excel-shortcuts-business-valuation-joris-kersten-msc-bsc-rab

6)    Valuation Multiples 2 – Precedent Transaction Analysis:

https://www.dhirubhai.net/pulse/valuation-multiples-2-precedent-transaction-kersten-msc-bsc-rab

Earlier blogs on Wall Street

Article 1: Wall Street – A general introduction

https://www.dhirubhai.net/pulse/wall-street-general-introduction-joris-kersten-msc-bsc-rab/

Article 2: Wall Street – The Federal Reserve banking system

https://www.dhirubhai.net/pulse/wall-street-federal-reserve-banking-system-kersten-msc-bsc-rab/

Earlier blogs on Financial Modelling

Scoping a financial model built primarily for business valuation:

https://www.dhirubhai.net/pulse/scoping-financial-model-built-primarily-business-joris/

Training agenda Joris Kersten:

• Financial Modelling in Excel (5 days): 2, 3, 4, 5, 6 February 2020. Location: Riyadh/ Saudi Arabia;
• Business Valuation & Deal Structuring (6 days): 18, 19, 20, 21 and 23, 24 March 2020. Location: Uden/ The Netherlands;
• Financial Modelling in Excel (4 days): 20, 21, 22, 23 April 2020. Location: Uden/ The Netherlands;
• Business Valuation & Deal Structuring (5 days): 22, 23, 24, 25, 26 June 2020. Location: New York City/ United States.
• Business Valuation & Deal Structuring (5 days): 19, 20, 21, 22, 23 July 2020. Location: Dubai/ United Arab Emirates.
• Business Valuation & Deal Structuring (5 days): 3, 4, 5, 6, 7 August 2020. Location: Mumbai/ India.
• Business Valuation & Deal Structuring (6 days): 28, 29, 30, 31 October 2020 + 2, 3 November 2020. Location: Amsterdam/ The Netherlands.
• Financial Modelling in Excel (4 days): 16, 17, 18, 19 November 2020. Location: Amsterdam/ The Netherlands.

All info on these open training sessions can be found on: www.joriskersten.nl 

And 130 references on my training sessions can be found on: www.joriskersten.nl