Noncontrolling Interest (“NCI”, formerly called “Minority Interest”) represents the portion of a company’s various consolidated subsidiaries that is owned by outside parties. The parent company shown below has two operating subsidiaries, A and B.
Subsidiary A is 100% owned by the parent and is therefore referred to as a wholly-owned subsidiary. All of the assets and liabilities of this subsidiary are recorded on the parent’s financial statements since the parent owns and controls the entire subsidiary. Any business activity of Subsidiary A will also be recorded on the parent’s financial statements. Thus 100% of revenues and costs will be included on the parent’s Income Statement. This is called Consolidation Accounting since under accounting rules there can only be one owner of assets recorded on a balance sheet (i.e. no double counting) so whoever controls the company will record everything.
This rule applies even when the parent owns less than 100%. Typically, if the parent owns more than 50% of a subsidiary, they are assumed to control the entity (note: there can be different tests for control, but ownership of more than 50% typically means the parent can control the subsidiary). Since control means that the parent will use consolidation accounting, the parent as the owner of record will put all the assets and liabilities on their balance sheet as well as include 100% of the subsidiary’s revenues and costs in their income statement.
Looking at the situation with Subsidiary B above, the parent will consolidate the subsidiary’s results and show 100% of income and costs and thus 100% of profit since it owns more than 50% (in this case 75%) of the subsidiary. So how do we account for the profits and equity interest owed to the minority partner in the subsidiary (i.e. the owner of the other 25% of the equity)?
This is where the NCI comes in. It is an account that keeps track of the minority partner’s share of earnings. It is a non-cash adjustment to net income that allocates a percentage of profit (in this case 25%) of Subsidiary B to the minority equity holders.
The following is an excerpt from a Nestle S.A. Annual Report.
The table shows that total earnings for all of the company’s various global consolidated businesses (i.e. subsidiaries) was $7.538 billion Swiss Francs. However, $355 mm of those earnings were attributable to shareholders of subsidiaries controlled, but not wholly-owned, by Nestle. In other words, these investors have minority, or noncontrolling, interests in these subsidiaries. This profit is allocated to these other shareholders shown in the row labelled “of which attributable to noncontrolling interests”.
The remaining earnings were then “…attributable to shareholders of the parent (Net profit)”. This is the earnings number used in the earnings per share (“EPS”) calculation because when we calculate EPS, we always want to look at the earnings attributable to the common shareholders of the reporting company.
When one company has a subsidiary, it just means that they own a stake in another company. As companies grow larger, they will begin to own other companies rather than assets directly. This may arise for a variety of reasons:
Whatever the reason, the parent company may own a series of other companies underneath the main corporate structure. In the case of a public company, such as Nestle S.A., it will consolidate the subsidiaries it controls as described in this note from its annual disclosure:
When a company exercises “control” over another company, it possesses sufficient voting power to control the governance of that company. With control of the company, the controlling shareholder (we refer to it as the parent company) can direct operations, arrange financing, control the distribution of income through dividends, etc. Since the “Controlling Shareholder” acts as if they own all the assets, they are the ones to consolidate the ownership onto their financial statements.
The general assumption is that ownership is proportional to voting power (i.e. one share, one vote) so that when someone owns greater than 50% of a company, they are assumed to have control. This means that if a parent company owns >50% but <100% they will control a subsidiary and a Noncontrolling Interest will appear on their financial statements to account for their partner in the subsidiary business (i.e. the owner of the 25% stake).
There are instances when the percentages may vary from these levels. In certain corporate structures, certain owners may have exceptional powers (such as a General Partner) or have multi-voting shares. In these circumstances’ consolidation may occur even if ownership is below 50%.
For example, George Weston Limited owns less than 50% of Loblaw, its largest operating subsidiary, yet still consolidates Loblaw into its financial statements:
An intangible asset is one that is not physical in nature. Some intangibles, such as licences or patents, have a finite life and therefore need to be capitalized and expensed over time just like a fixed asset. Companies will typically show the amounts spent to acquire intangibles as a separate item in the investing section of the cash flow statement. The periodic expense of the intangible is called amortization as opposed to depreciation.
Let’s suppose a parent company has two subsidiaries as shown below:
The financials for the parent company will reflect two things:
In the diagram above, everything is consolidated into the parent yet the income to the 25% shareholders of Subsidiary B must be accounted for. The adjustment to account for the noncontrolling partners’ income will be listed on the income statement as a “Noncontrolling Interest” (‘NCI”) and will appear at the bottom of the Income Statement as shown below in the sample calculations below:
The end result is that 25% of Subsidiary B’s stand-alone net income, or $2,500 ($10,000 * 25%), is “allocated” as NCI on the parent’s income statement to the minority shareholders of Subsidiary B.
Cash Flow Statement
Cash Flow Statements reflect the total change in cash within a company during a reporting period. When a company has a subsidiary that it consolidates, the parent shows 100% of the subsidiary’s cash flows on the parent’s Cash Flow Statement, even if it doesn’t own 100% of the subsidiary. This is because according to consolidation accounting, the parent will always show 100% of the subsidiary’s assets on the parent’s Balance Sheet, and Cash is one of asset accounts.
As a result of this, a parent company does not deduct NCI from their Cash Flow Statement.
On the parent company’s Income Statement, NCI is an allocation of a subsidiary’s earnings to the minority shareholder in that subsidiary. It is not a cash transfer to the minority shareholder.
As an example, an individual who owns 100 shares of IBM benefits from the earnings that IBM produces but the only way this individual can get cash is through dividends or share buy-backs. The same is true for noncontrolling interests – it is a non-cash allocation of income. Non-controlling partners only get cash through dividends or share buy-backs.
There are two ways to construct the Cash Flow Statement to account for the non-cash impact of a noncontrolling interest amount on the Income Statement:
However, both approaches arrive at the same operating cash flow number:
Because the parent’s cash balance will consolidate the cash balance of Subsidiary B, the cash flow statement needs to include 100% of the net income of all consolidated subsidiaries.
However, if Subsidiary B paid a dividend, that dividend would be distributed to shareholders (the parent and the noncontrolling shareholders) in proportion to their respective ownership. So, if a $10 mm dividend was paid by Subsidiary B, the parent would receive 75% of the dividend, or $7.5 mm. Since this cash is moving from a consolidated subsidiary to the parent, it would not affect the parent’s consolidated cash balance. However, the $2.5 mm (25%) of the dividend paid to the noncontrolling shareholders of Subsidiary B would leave the parent group and therefore reduce consolidated cash. This would be shown in the Financing section of the parent’s cash flow statement as “Dividends paid to noncontrolling shareholders” or some similar type of disclosure.
NCI accumulates in the equity section of the Balance Sheet (or sometimes in between the Total Liabilities and Equity sections). The NCI on the Balance Sheet will increase by the amount of NCI on the Income Statement (i.e. the net income attributable to the minority shareholders). In the example below, the NCI increases from $10,000 to $12,500 on the balance sheet to account for the minority shareholders’ accumulated equity in the subsidiary.
Other items that will cause the NCI to change include:
Note that it is possible for NCI to appear as a long-term liability depending on the contractual arrangements between the parent company and the other noncontrolling shareholders. As an example, if there is an agreement that could force the parent to buy out the noncontrolling shareholders under their shareholder agreement, then the NCI might show up as a long-term liability since the parent will have a potential liability to fund the purchase of the noncontrolling shareholders in the future.
Other arrangements, such as franchisee interests and other equity-like ownership, may also show up as long-term liabilities but are for all intents and purposes the same as NCI.
Adjusting Enterprise Value for Noncontrolling Interest
The value of Noncontrolling Interests (“NCI”) should be added to Enterprise Value (“EV”) when calculating a multiple such as EV / EBITDA.
When a multiple is calculated, it is essential that both the numerator and denominator present the same collection of assets so that the multiple can be applied or compared to another company.
Since subsidiaries that cause NCI are consolidated for financial statement purposes, 100% of their operating results (i.e. revenues or EBITDA) will be included in the parent’s financials. However, without any adjustment, the EV of a company will include only the share of the equity owned by the parent in the subsidiaries which have outside shareholders who show up as NCI on the balance sheet – i.e. this will be priced into the stock because the market will only give credit for the stake owned by the parent. The EV will also include all of the debt of these subsidiaries since the financial statements of these subsidiaries are consolidated with the parent. Therefore, to make the numerator and denominator of the EV / EBITDA multiple consistent, we must add the value of the NCI.
For example, in the case of a 70% owned consolidated subsidiary, the equity market will only recognize the value of this 70% stake in the stock price (and not the 30% NCI since this is owned by other investors). This creates a mismatch between Enterprise Value and EBITDA. Assuming ownership of 70% of a subsidiary company, this can be demonstrated as follows:
Ideally, the market value of the NCI should be added since the market is trying to price in market value into the stock price. In practice, if market value is not readily available, an estimate is made or, where the amount is not material, the accounting carrying value is used.