Yeah right! I hear you say. Don’t believe me eh?

If you had your own airline, you can go anywhere for free right? I’m not kidding! Just buy over MAS and give yourself a free ticket, that simple!

Sounds ridiculous but it’s not. It won’t cost you billions or even millions.

Now you can buy the whole company lock stock and barrel for NOTHING. And here’s the good news… you also get paid some RM100 million for taking it.

Don’t believe me!!!???

OK let’s do the numbers…

Malaysian Airline System Berhad or MAS has a total of 1,671 million shares issued. Multiply that by its share price of RM2.56 and you get a total value of RM4,278 million or RM4.3 billion. That’s the value that the market puts on MAS.

As at 31 December 2007, MAS had around RM4.4 billion in cash (net of its borrowings). So in theory, if you bought the whole company for RM4.3 billion, you could just take out the RM4.4 billion to pay for your purchase. And guess what? You own the whole airline and pocket a cool RM100 million.

You can’t be serious! So what’s the catch?

OK, I know I can’t fool you. You’re too smart for this. Yes there’s a problem with this analysis:

1. You can’t buy all the shares in MAS for RM2.56
When you start buying in a big way, obviously the share price is going to go up and you’ll end up paying too much for it. Besides there are some big wigs in there who control more than 50%.

2. Cash position changes every day
Actually as at 30-Sep-08, MAS Net Cash has reduced to less than RM4.0 billion. Businesses have cycles and sometimes cash is up, sometimes it’s down.

3. You will need a few billion first
Before you can get your hands on the RM4.4 billion cash kitty, you need to find the money to mop up all the shares first. Imagine the look on your banker’s face! Please don’t come looking for me if your name gets blacklisted in the CTOS system

So why am I wasting my time reading this article?
OK wait, before you get upset with me, there’s a lesson here and it’s called Enterprise Value. This is actually a useful concept in company valuation.

Enterprise Value
When you buy shares in the stock market, you are buying the business assets, cash, goodwill, systems, borrowings and whatever else in there. What are really necessary to make money are the business assets, for example:

• Premises & Equipment
• Trade Secrets
• Inventory
• Systems
• Customer Goodwill

We are trying to value the business here. Cash is just cash. A dollar of cash is just that… one dollar. No more, no less. The same goes with borrowings.

So to work out the value of the business, you need to work out this thing called Enterprise Value, which is:

EV = Net Assets – Cash

(No rocket science…  just strip out cash from the business assets, that’s all)

If the business does not have cash but has borrowings, then:

EV = Net Assets + Borrowings

If the business is a listed company, then replace “Net Assets” with the Company’s Market Value (also called Market Capitalization).

EV = Market Capitalization – Cash + Borrowings

So as in the example of Malaysian Airlines:

EV = RM4.3 billion – RM4.4 billion (which gives negative value)

This means the stockmarket places a negative value on the net business assets of MAS – in other words you get paid for buying over this whole company.

So what so Great about this EV concept?
Basically cash and borrowings distort business valuation. There are companies out there sitting on bucket loads of cash way in excess to what they need for their business, for example Resorts World and Petronas Dagangan.

When you look at the PE Ratio of Resorts for example, it’s around 8.6x currently. But the underlying business assets is cheaper than that.

Why? Because Resorts has heaps of cash… around RM3 billion. Cash distorts the valuation. How do I know that? OK let’s do the sums for Resorts…

Market Value = 5,902 million shares x RM2.27 per share
= RM13.4 billion

If in theory you bought the whole company and take out the RM2.9 billion net cash, you are effectively paying RM10.5 billion for it.

EV/EBIT
Instead of PE Ratio, we now use something called EV/EBIT – Enterprise Value divided by Earnings Before Interest and Tax.

EV/EBIT is similar to PE Ratio except we take out the cash element.

Instead of using the Net Profit as in the calculation of PE Ratio, we take out Interest Income because we took out the RM2.9 billion cash when calculating EV. So we will no longer earn interest as there is no cash.

We also take out tax expense because it is another distortion.

So in the case of Resorts, EBIT for 2007 works out to be RM1.8 billion. If we are paying net RM10.5 billion for it, the true Price to Earnings Ratio works out to be 5.9x only. This is called EV/EBIT.

When you work out PE Ratio, just cross check it with EV / EBIT so you get a better feel for how the market values a company’s business assets.

Has this post been helpful to you? Easy? Hard? Interesting? Boring? Would appreciate your feedback so I can better gauge how to write in future.