There are occasions when a group of companies are valued on a consolidated basis as a faster alternative than a sum-of-the-parts business valuation. This begs the question: how does one treat the presence of non-controlling interests in the group?
Before we get started, it is important to note that the non-controlling interest in a group does not mean the minority shareholders in the holding company, it in fact means the non-controlling interests on a subsidiary level and can comprise different stakes in different subsidiaries.
So then, how would these aggregated non-controlling shareholders, also known as minority interests, affect the valuation of the group? Let us consider the impact of the minority interest on both the enterprise value and the equity value.
When calculating the enterprise value by applying DCF valuation method, the net present value of free cash flows is calculated. The subsidiary minority shareholders have a right to share in those subsidiaries’ profits and will expect payment thereof in time. Therefore, the portion of the cash flows due to the minorities needs to be set-aside for payment in the future. That portion of the cash flows must thus be excluded from the free cash flows when calculating the enterprise value.
If a group comprises more than one subsidiary with minority interests, the most consistent way to forecast the minority interest is to apply a formula in the forecast that aligns with minority interests in the past, e.g. % of EBITDA or % of profit after tax.
The minority interest in the consolidated balance sheet represents a portion of the reserves earmarked for distribution to minorities in subsidiaries in the future. These reserves may be distributed in the short to medium term in a group where cash is frequently swept to the holding company as dividend distributions. This represents the character of an obligation to minorities in subsidiaries. When calculating the equity value, non-operating assets and liabilities are taken into account. Non-controlling interest should also be regarded as an obligation and as such included in liabilities to be deducted from the enterprise value.
It is vital that non-controlling interest are taken into account correctly when doing a group business valuation. Skipping over the minority interest will result in inflated valuations based on cash flows and reserves to which shareholders in the holding company are not fully entitled. Care should be taken to avoid this obvious mistake.
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