Financial driver evaluation

by a searcher from IE Business School

2 years ago

Hi all! Just want to understand when investors are open to undertake an acquisition laying an EBITDA below 12-14% (under what is normally expected at purchase in SF model) but in which there are some other interesting opportunities upon capital structuring or some operative improvement. What would you consider the most for analyzing this kind of deal?

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searcher from National University of Ireland, Galway

That is our target area. I think the most important consideration is what are you bring to the situation that will change the circumstances that caused the low EBITDA. Note that sometimes low EBITDA is deliberate. A low debt business with high working capital turns can be fully cash viable for years at say 8% EBITDA. The goal in those cases is to build market share as the value repository. A subsequence earnings focused strategy is simply remixing the allocation of expenses to reprioritize margin. However to do that IMO you have to understand the sector. It is not simple financial engineering with no market or customer understanding. Because so many PE investors are leverage focused and need higher EBITDAs it should be possible to buy "low" performers for a discount relative to the realizable performance within a reasonable period, say 5 years.. You need more cash but the ROI could be greater. and risk lower..

2 years ago | like reply | 1 like

intermediary from The University of Chicago - Booth School of Business

I am not sure if I understand the question. I think you are asking if a business with EBITDA <12% is a good business.

I consider EBITDA margin as a "guideline", not as a "financial driver". Anyone who teaches otherwise is missing the fundamentals of finance.

Example: A hawker goes to the bazar and buys fruits for 100. He sells them off at the end of the day nets 101. A profit margin of 1%. He repeats this every day. At the end of the year, he has his original investment of 100 plus profit of 365. His margin on sales is 1%, but ROI is 365%. Is this business bad or good?

I had heard this from my father at age 10 but did not appreciate it even though I had MBA (U of C) and Sr. management experience with a Fortune 500. It was after 10 years as an M&A Intermediary and teaching at Kellogg that I began to appreciate the wisdom of what my father said. I now analyze the fundamental "business model" of a business and not any specific metric.

Just like low margin business can be a good business, the opposite is also true. That is, a high margin business sometimes is more risky.

2 years ago | like reply | 3 likes

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