Monday, May 20, 2002

Enterprise-Multiple Bargains

NEW YORK - Considering the large number of companies with depressed stock prices and the weakened state of many industries, there has been a dearth of corporate takeovers or leveraged buyouts. If such activity heats up, however, one of the items many dealmakers will be looking at is the enterprise multiple. The ratio, a company's enterprise value to its operating income, often uncovers value where other metrics suggest the opposite.

Enterprise value is the price that Wall Street puts on business operations. It's the sum of the market value of common stock, the liquidation value of preferred stock and all debt, minus cash and equivalents. Operating income here is defined as profits before depreciation and amortization, interest and taxes.

To see the enterprise multiple at work, consider the case of two stocks in the computer services category: Computer Sciences and Electronic Data Systems. Measured by the price-to-earnings (P/E) yardstick, the latter company appears to be the better bargain. It sells for just 19 times latest 12-month earnings, while Computer Sciences has a trailing multiple of 24.

However, EDS' enterprise multiple is 8, a slender premium to Computer Sciences' 7.8. A glance at the two companies' balance sheets reveals the reason why: EDS' ratio of long-term debt to total capital stands at 39%, versus 34% for Computer Sciences. Anyone wishing to take over EDS would have to assume $4.6 billion in total debt.

Computer Sciences derives 25% of its business from technology projects for the U.S. government. With the prospects of more government spending on defense and security technologies, shares of the El Segundo, Calif.-based firm enjoyed an impressive bounce in the fall and winter. The stock has eased somewhat lately, though, and now trades 11% off its 52-week high.

The enterprise multiple can also come in handy when there aren't any earnings multiples to compare. Looking elsewhere in the computer services sector, Unisys (nyse: UIS - news - people ) has a net loss for its past four reported quarters. Hence, no meaningful price-to-earnings ratio.

But Unisys does have an enterprise multiple, 17.8, which looks awfully high compared to those of both Computer Sciences and EDS. The computer service sector as a whole has an average enterprise multiple of 11.4.

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