Company Valuation for Businesses with High Capital Costs

May 19, 2024

by a searcher from Seattle Pacific University in Shoreline, WA, USA

I am evaluating several equipment rental companies and seeking perspective.

The spread between SDE and Net Income for these types of companies is wide, because high capital costs create large amounts of depreciation. The equipment is paid for with debt, and the rental income more than offsets. This dynamic blesses the owner with low taxable income, but cash flow.

I'm interested in a clear-eyed perspective on this type of capital-intensive company and how to think about valuation multiples on SDE, EBITDA, and actual Income.

What is a fair multiple on any of those three metrics for such a company? Has anyone recently been a part of a purchase/sale of a similar company, and might be willing to provide an example, or share perspective? If a company is showing a loss but still kicks out cash to the owner, in most years, how do you think that should affect valuation?

There are a couple examples in the BVR database. It's spotty, outdated, and not exactly apples to apples, but valuations for those similar businesses is 2x - 3x SDE.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

Your largest challenge in valuing a company such as this is going to be the future CAPEX need. Even though the company can borrow to support future CAPEX, you still need to make a large adjustment for future CAPEX to adjusted EBITDA to verify what the true cash flow is. Without including future CAPEX in the adjustment EBITDA you can easily over-pay for the business. Looking at the historical increase in gross fixed assets from year-to-year is a good way to determine on average how much the business spends on CAPEX each year.

The problem with many of these businesses is that the sellers think they have a really high value based on EBITDA with depreciation added back but they do not take into account future capital needs when they complete their own valuation. They have been able to leverage the business historically to support new equipment purchases but you will not be able to do that to the same degree once you have all of the business acquisition debt on the books. Due to the large on-going capital costs many of these businesses do not have a lot of value. In fact, I have seen cases where there really is no goodwill value to these businesses or a very minimal goodwill value to the business because there is not much value beyond the equipment value. So in essence the business produces enough cash flow to cover the equipment cost and pay the owner a salary and benefits, but does not really generate enough cash flow to provide much of a value beyond that. In these cases even just financing the business for the equipment value can make it hard to get the deal to cash flow.

Please let me know if you would like to discuss this in more detail of if you need help determining what type of debt these businesses can support. You can reach me here or directly at redacted Good luck.

Reply by a searcher
from University of Pennsylvania in Seattle, WA, USA

I have looked at several rental companies in the past that were all priced at basically FMV of the equipment. The only ones that I saw made much money had owners that were really good at buying used equipment, doing repairs in house, and selling used equipment at a profit. The main rental business wasn’t a huge cashflow generator. I would be concerned that these skills are not the best match for typical searchers - how often do you really want to haggle over a used forklift and know what to look out for?

I think there is a cap on goodwill for this type of company because it would be relatively easy to enter the market at just the cost of equipment. After evaluating several of these companies, I added them to my list of industries that don’t make sense for me personally.

Take a look at how much cash the previous owner was actually able to take out of the business over the past few years.

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