Editda Vs Ebit For Valuation Purposes

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08/28/2021 Redacted Redacted

searcher Columbia University

EDITDA VS EBIT FOR VALUATION PURPOSES

I'm looking at a deal for which depreciation and capex are material each year, and want to exclude them from the valuation calculation. I believe my seller expects to use an EBITDA multiple for his business, and is waving his hand at his annual capex. Have you guys seen structures or discussion patterns that have successfully climbed over this bump? For context, depreciation is nearly half of EBITDA each year.

1 like 155 views 20 comments

professional Ohio University Cleveland State University - 08/28/2021

High growth firms need CAPEX to support growth, so it probably makes sense to value using DCF analysis if you have significant Depr and CAPEX. Professor Damodaran compiles annual Capex/Depr studies by industry sector, http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/capex.html which might be useful for your analysis.

like reply | 1 like

searcher Camosun College - 08/28/2021

Makes sense if depreciation and amortization is a significant part of earnings.

like reply | 0 likes

intermediary Wake Forest University - Schools of Business Emory University - Goizueta Business School - 08/28/2021

If you are using a multiple of EBIT or EBITDA as one of your valuation inputs (perhaps in addition to DCF as ^[redacted]‌ points out) just make sure you are using EBIT * EBIT multiples and EBITDA * EBITDA multiples. so that there isn't any mixing and matching. In a perfect world with quality comparables from the same industry, the result should be similar.

like reply | 3 likes

intermediary Boise State University - 08/28/2021

I second Ron Buck's comments.

like reply | 1 like

searcher Harvard University - Harvard Business School - 08/28/2021

Generally, they're basically the same unless the company has significant capex. If the company has high capex requirements then an even better metric than EBIT might be EBITDA - go forward capex. At the end of the day what you, your investors, and your lender care about is cash flow. The challenge is getting your seller and their broker on the same page.

If the seller/broker expects you to use a capex-light industry multiple for a capex-heavy business that's a good sign to walk away.

like reply | 0 likes

intermediary Wake Forest University - Schools of Business Emory University - Goizueta Business School - 08/29/2021

Agree - the comps should be, well, comparable (relative size, industry, economics, etc.). But as ^[redacted]‌ points out below, all companies in the same industry are not created equal at the same point in time. Recently sold a high-end manufacturer with a lot of potential capex, but they had recently replaced and upgraded all of their CNC milling centers, so only minimal capex was needed for several years. Looked at another one that was facing heavy capex.

like reply | 1 like

professional University of Ljubljana - Faculty of Economics NEOMA Business School St. Petersburg State University - 08/28/2021

If the firm is not really comparable with its peers, DCF might be a better option. CapEX gap differences may truly be significant in such cases. Mind also the fact that some industries invest in longer-term cycles, so perhaps a longer period might be considered. Benchmarking ratios (PPE / Net sales, Net CapEX/D&A, D&A / Net sales, etc.) may also be a good way to gain a better understanding of a current situation (capex gap - yes/no) and future capex needs. If you are not really familiar

like reply | 0 likes

intermediary The University of Chicago - Booth School of Business Illinois Institute of Technology Cleveland State University - 08/29/2021

1. This question arises when a business is CapX intensive, and being more general, when the business is Asset intensive. By the way, CapX does not just mean tangible assets; it also includes anything that is capitalized.
Also, there are many growth businesses that do not need high CapX.
2. Industry comparison is good, but should not be relied upon. Of the many businesses that I have sold, there have been many manufacturing businesses with no CapX (except for some computers and phones).
like reply | 3 likes

searcher Columbia University - 08/31/2021

Very helpful, Mike. Thank you.

like    reply | 0 likes

lender University of Utah - 08/29/2021

I would look at the depreciation schedule for the equipment and determine the useful life of the equipment, replacement costs, and maintenance schedules and create meaningful maintenance CAPX number. I would reduce this figure from depreciation to determine what is an ongoing expense of the business.

like    reply | 0 likes

searcher Drexel University Villanova University - 08/29/2021

can use a multiple of FCF

like    reply | 0 likes

searcher Columbia University - 08/31/2021

Do you have examples or stories on this? I think this would be the best multiple to use, but most commonly see sellers expect to use EBITDA. I understand the rationale for that -- though most often don't imagine I'm going to do very much to affect taxes/depreciation.

like    reply | 0 likes

professional Bishop's University - 08/30/2021

This video may be helpful for you: https://youtu.be/_S2m1dieX6w

like    reply | 0 likes

searcher The University of Chicago - Booth School of Business Azusa Pacific University - 08/30/2021

Thanks

like    reply | 0 likes

searcher University of Texas at Austin - 08/30/2021

Thanks

like    reply | 0 likes

searcher Harvard University - Harvard Business School Copenhagen Business School Hong Kong University of Science and Technology - 08/31/2021

Hi Vik, Depends on 3 main factors: (1) whether the company's accounting policy includes accelerated depreciation, as per IFRS rules; (2) the level of "Cash-to-EBITDA" the business has and (3) the amount of maintenance booked as cost in the P&L vs. booked as capex-maintenance in the balance sheet.

I recommend doing 3 simple checks:

(1) Ask the seller: "Do you accelerate depreciation as per IFRS rules, relative to the lifetime value of the asset? Or is the annual depreciation in

like    reply | 1 like

searcher Columbia University - 08/31/2021

This is very helpful. On your number #2 above -- what's the best way at getting an honest split between 'maintenance' capex and 'expansion' ? This is where the dispute is going to be. All the Capex is booked as Capex (off-P&L).

like    reply | 0 likes

searcher Harvard University - Harvard Business School Copenhagen Business School Hong Kong University of Science and Technology - 08/31/2021

The company should report this split transparently, or alternatively you can assume a level of maintenance CAPEX in line with the actual depreciation of equipment (not the accelerated depreciation).

like    reply | 0 likes

searcher Columbia University - 08/31/2021

All these comments are extremely helpful. The firm in question has some heavy equipment that the depreciate as per the standard rules, and also replace as they break down. Over a few-year time horizon, annual capex and depreciation are pretty similar. Certainly the seller wants to take credit for the depreciation but wave his hand at the capex, though he seems like a reasonable and intelligent person. I have attempted to lay this out clearly for him, and have opted for an EBITDA-CapEx multiple t

like    reply | 0 likes

searcher Northwestern University - Kellogg School of Management Universitat Pompeu Fabra - 09/01/2021

Hi Vik, an EBITDA - Capex multiple may make sense in this case. But beware of potential "spikes" in capex in the coming years: replacement of machinery, etc.
At the end of the day, you should have a dollar price that is fair (and accounts for the capex, as well as changes in WC). Whether you "translate" that dollar number into a multiple of EBITDA or EBITDA-Capex or EBIT, shouldn't make a big difference. A business is worth what it's worth in dollars and not multiples

Good luck!

like    reply | 1 like

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