Tesla had an amazing ride in 2013 – its shares rose more than 300 per cent. But has Elon Musk’s electric carmaker really become a larger company than Italian automaker Fiat as many headlines have asserted? Its market capitalisation of $17bn, compared with Fiat’s of less than $10bn, indicates so. But investors should recognise that equity value gives an incomplete picture of a company’s worth. It does not account for all the claims on a company’s assets and profits that would collectively give the correct indication of the business’s size.
Enterprise value – the value of the equity plus total debt, preferred stock and non-controlling interests, less cash and equity investments – is a superior measure. Fiat’s enterprise value is $27bn, according to S&P Capital IQ, while Tesla’s comes in at $21bn. (The latter company’s net debt is, in effect, zero.) Not only is Tesla smaller by this measure, but investors should note that it will sell only 20,000 cars in 2013 while Turin-based Fiat will sell a vastly larger 5m vehicles. A higher proportion of Fiat’s revenues and operating profits “belong” to holders of instruments that are not common equity – the Italian manufacturer has net debt of $15bn. This results from managers loading the company with borrowings and from the movement of its share price. Fiat has a market value/book value ratio of 1.1. By sharp contrast, Tesla’s market value/book ratio is 35.
This distinction between enterprise value and equity value goes to the heart of the objective of managers. Should they maximise enterprise value or equity value? The answer is nuanced. They should maximise equity returns. Fiat could issue equity in order to reduce debt. Enterprise value would be unchanged, but equity value would rise. But Fiat’s equity value per share would fall due to the dilutive nature of the newly issued equity.
In similar vein, Tesla could raise debt to buy back shares. Its total equity value would fall, but earnings per share accretion could boost its share price – and thus returns to the US carmaker’s shareholders. Financial engineering does not sell cars. But capital structure tweaks can nicely supplement the returns for shareholders.
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