High EBITDA margin company. Concern for too high Price/Rev?

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10

Reply by an investor
from Illinois Institute of Technology in Pasadena, CA, USA

A few points: (1) a quality of earnings will flush out the answer###-###-#### what are the trends over the last 3 years? vs TTM margins when the seller wants to sell###-###-#### what margins do the competitors have, as a niche product business will typically have higher margins than commodities.

Reply by a searcher
from University of Pennsylvania in Indianapolis, IN, USA

If the margins are in-line with the industry, then there may be no cause for alarm.

As others have stated, go back several years on financials and if the high margins are a recent spike, check for the seller eliminating costs close to a sale that they previously ran through the business or one-time business. If the business is in manufacturing or some other high capex business, check to make sure they are not deferring maintenance or other capex to inflate EBITDA that a buyer would then have to make up post sale.

If you are really concerned and EBITDA plus the margins have peaked recently, a 3-to-5 year average could be used similar to cyclical industries.

The main question is do you, as the buyer, believe the margins are real and, more importantly, sustainable post-close? If not, then you should use a normalized EBITDA. If you think they are sustainable, use them and maybe include an escrow, seller note or earnout based on those margins being sustainable.

Sometimes they are real. I originated an acquisition of a large industrial scrap processor that had 15% plus EBITDA margins in an industry of 10% or below, which was due to their operational efficiency. The company made a great platform for an industry consolidation where there was a large amount of value created from valuation arbitrage and their operational approach immediately improved the profitability of each of their add-on acquisitions.

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