Corveta: Auditing an EV-to-Equity Bridge and a Terminal Value
You are reviewing a junior analyst's valuation of Corveta, a European industrial. Her DCF gives an enterprise value of EUR 4,850 million; she subtracts net debt of EUR 1,200 million and divides by 120 million shares to reach EUR 30.42. Her comparable analysis applies a 7.5x peer EV/EBITDA multiple to 20X6E EBITDA of EUR 600 million. The DCF uses an 8.2% WACC and 2.0% terminal growth, and a terminal value of EUR 3,400 million that she describes as 7.0x 20X9 EBITDA of EUR 700 million. The notes reveal: a EUR 300 million minority interest in a 60%-owned subsidiary; a EUR 450 million unfunded pension deficit (tax rate 25%); EUR 250 million of cash trapped in a country with repatriation controls, included in the EUR 1,200 million net debt figure; annual operating lease rent of EUR 180 million (peers report under IFRS 16); and 8 million options struck at EUR 18. The shares trade at EUR 27.50.
1. Rebuild the enterprise-value-to-equity bridge and compute the corrected value per share.
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Principle. Enterprise value belongs to all capital providers. Every claim ranking ahead of, or alongside, the ordinary shares must be deducted, and every asset not generating the forecast cash flows must be excluded from the operating business.
Adjustments.
| Item | Amount | Treatment |
|---|---|---|
| Net debt as stated | 1,200 | Deduct |
| Restricted cash | 250 | Deduct again: it was netted in arriving at 1,200 but is not available to shareholders, so adjusted net debt is 1,450 |
| Minority interest | 300 | Deduct: the DCF captures 100% of the subsidiary's cash flows but only 60% belongs to Corveta |
| Pension deficit | 450 pre-tax | Deduct 450 x (1 - 0.25) = 337.5 post-tax, because contributions are tax-deductible |
Equity value = 4,850 - 1,450 - 300 - 337.5 = EUR 2,762.5 million
Options. Treasury stock method: 8m x EUR 18 = EUR 144 million of proceeds. Pre-option value per share = 2,762.5 / 120 = EUR 23.02. Shares repurchased = 144 / 23.02 = 6.26m. Diluted shares = 126.26m.
Value per share = 2,762.5 / 126.26 = EUR 21.88 (equivalently 2,618.5 / 120).
Conclusion. The analyst's EUR 30.42 overstates value by about 28%. Even her own comparable value of EUR 27.50 is above the intrinsic figure, which tells you the peer multiple is doing too much work - see the lease issue below.
2. Test the terminal value for internal consistency with the WACC and growth assumptions.
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Check 1 - is the stated multiple even the multiple used? 7.0x on EUR 700 million of 20X9 EBITDA would be EUR 4,900 million, not EUR 3,400 million. The implied multiple is 3,400 / 700 = 4.86x. Either the label or the number is wrong; in a valuation this is not a typo, it is a 30% swing in value and it suggests the DCF was built by plugging the terminal value.
Check 2 - does the terminal value survive the Gordon test?
- Implied terminal FCFF = 3,400 x (0.082 - 0.020) = EUR 210.8 million
- Terminal NOPAT at a 25% tax rate = 700 x 0.75 = EUR 525 million
- Implied reinvestment rate = (525 - 210.8) / 525 = 59.8%
- Implied return on new capital = g / reinvestment rate = 2.0% / 0.598 = 3.3%
A 3.3% return on new capital against an 8.2% WACC means the terminal value is capitalising growth that destroys value. That is economically inconsistent: if Corveta truly reinvests 60% of NOPAT, it should earn at least its cost of capital, and if it earns only 3.3%, the correct terminal growth is close to zero and the terminal value should be built as NOPAT/WACC with minimal reinvestment.
Check 3 - is 70% of EV in the terminal value plausible? For a mature industrial with 2% growth, 60-75% is normal, so the proportion itself is not the red flag. The red flag is that a low-growth, capital-intensive business has been given a terminal value derived from neither a defensible multiple nor a defensible reinvestment economics.
Recommendation. Rebuild the terminal value explicitly from NOPAT, a sustainable reinvestment rate and an ROIC converging to WACC; then sanity-check the result against the 4.86x implied multiple and the peer set. If the two methods disagree by more than 15%, the forecast period assumptions are wrong.
3. Her comparable analysis yields EUR 27.50. Is the multiple applied consistently, and what does a corrected comparison imply?
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The inconsistency. Corveta's reported EBITDA of EUR 600 million is struck after EUR 180 million of operating lease rent. The peer multiple of 7.5x is derived from peers reporting under IFRS 16, whose EBITDA excludes lease depreciation and whose enterprise value includes lease liabilities. Applying a post-IFRS 16 multiple to a pre-IFRS 16 EBITDA double counts the leases in Corveta's favour.
Correction A - capitalise the leases and convert Corveta to the same basis.
- Capitalised lease liability at roughly 7x rent: 180 x 7 = EUR 1,260 million
- Adjusted EBITDA: 600 + 180 = EUR 780 million
- Adjusted EV at 7.5x: 780 x 7.5 = EUR 5,850 million
- Equity value: 5,850 - 1,450 - 1,260 - 300 - 337.5 = EUR 2,502.5 million
- Per share before options: 2,502.5 / 120 = EUR 20.85; after the treasury stock method, about EUR 19.9
Correction B - or leave the leases out on both sides. Use a peer multiple derived from pre-IFRS 16 EBITDA, which is lower than 7.5x, and deduct nothing for leases. The two approaches should converge; they do not in her note, which is how the error survived review.
Other comparability debts in the bridge. The peer multiple was applied to EBITDA that consolidates 100% of a subsidiary that is only 60% owned. Either apply the multiple to an EBITDA that has been reduced by the minority's share, or deduct the EUR 300 million minority interest in the bridge - not neither, and not both.
Verdict. The EUR 27.50 comparable value is not a cross-check; on a consistent basis the peers point to roughly EUR 20, closer to the corrected DCF of EUR 21.88. Both methods now say the shares at EUR 27.50 are expensive, which is a far more defensible conclusion than the analyst's original EUR 30.42.