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Caterpillar Inc. (CAT), Rowan Companies PLC (RDC), Merck & Co., Inc. (MRK): Finding More Opportunities Based on Enterprise Value

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Enterprise value is a measure of a company’s value. Often thought of as the theoretical takeover price, enterprise value is an alternative to straightforward market capitalization and is a “sum-of-the-parts” calculation. Enterprise value is based on the fact that in the event of a take-over an acquirer would have to take on the company’s debt but would pocket the cash.

To calculate enterprise value, the following calculation is used:

Common equity at market value (the current market cap.)

+ Preferred stock at market value

+ Minority interest at market value

+ Debt at market value

+ Unfunded pension liabilities and other debt liabilities

– Associates at market value

– Cash and equivalents.

How this useful?

For investors looking for value investing opportunities, enterprise value can be a useful method of finding companies that are undervalued or prospective takeover targets.

Enterprise value can also be used in-place of the price-to-book ratio. Indeed, a discount to enterprise value is a more realistic valuation of a company’s worth than the price-to-book ratio as the price-to-book ratio includes cash in its calculation, but ignores the value of the company’s debt and in a takeover attempt, the debt would have to be acquired.

Obviously, a company that is consistently trading below its enterprise value is a very attractive takeover target, and presents an opportunity for value investors.

But in this strong market surely there are no opportunities?

Surprisingly, there are still plenty of companies that are trading below their enterprise values and most of them are not in the basic materials sector (which is currently trading on a stupidly low valuation.) However, each company does have a reason for being cheap and undervalued, but in my opinion, as they are trading below their enterprise values, the downside is limited.

The world’s largest mining equipment manufacturer

Caterpillar Inc. (NYSE:CAT)

Like mining companies, equipment manufacturer Caterpillar Inc. (NYSE:CAT) has fallen out of favor with the market recently due to worries over slowing Chinese growth. However, at its current price the company is trading way below its enterprise value — 63% below its indicative enterprise price to be exact.

Company Enterprise Value Market Cap. Shares Outstanding Enterprise Price Current Price Potential Upside
Caterpillar $89,675 $55,070 655.048 $136.90 $82.70 65.5%

Figures in $US and millions where applicable

The calculation:

Metric Value
Common equity (market value) $54,972
Add: Noncontrolling interests (per books) $50
Total equity $55,022
Add: Short-term borrowings (per books) $5,287
Add: Long-term debt due within one year (per books) $7,104
Add: Long-term debt due after one year (per books) $27,752
Total equity and debt $95,165
Less: Cash and short-term investments $5,490
Enterprise value $89,675

Figures in $US millions

Adding debt and removing cash from Caterpillar Inc. (NYSE:CAT)’s market cap leads to an enterprise value of $89.675 billion or an indicative value of $136.9 billion. Overall, this is not a completely unrealistic valuation for the company. Indeed, the company’s share price hit a high of $116 at the beginning of 2012.

Oil & gas drilling

Rowan Companies PLC (NYSE:RDC) has not been a market favorite for some time, and has been trading below the value of its assets for the majority of the past year. This presents an opportunity, as Rowan Companies PLC (NYSE:RDC) is a relatively small drilling company which has been the subject of much takeover speculation. As the company is currently trading at a discount to its enterprise value, a buyout could be a very real possibility.

Company Enterprise Value Market Cap. Shares Outstanding Enterprise Price Current Price Potential Upside
Rowan Companies $5,344 $4,190 123.22 $43.37 $34.21 26.77%

Figures in $US and millions where applicable

The calculation:

Metric Value
Common equity (market value) $4,212
Add: Noncontrolling interests (per books) $142
Total equity $4,354
Add: Loans payable and current portion of long-term debt (per books) $0
Add: Long-term debt, excluding current portion (per books) $2,009
Total equity and debt $6,363
Less: Cash and cash equivalents $1,019
Less: Short-term investments $0
Enterprise value $5,344

Figures in $US and millions

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