Value/EBITDA Multiples

VALUE/EBITDA MULTIPLE

What is it?

Value: Market Value of Equity + Market Value of Debt + Market Value of Other Securities

EBITDA: Earnings before interest, taxes and depreciation

The No-Cash Version

Value: Market Value of All Securities - Cash & Marketable Securities

EBITDA: Earnings before interest,taxes and depreciation - Interest Income from Cash & Marketable Securities

Reasons for Increased Use

1. The multiple can be computed even for firms that are reporting net losses, since earnings before interest, taxes and depreciation are usually positive.

2. For firms in certain industries, such as cable, which require a substantial investment in infrastructure and long gestation periods, this multiple seems to be more appropriate than the price/earnings ratio.

3. In leveraged buyouts, where the key factor is cash generated by the firm prior to all discretionary expenditures, the EBITDA is the measure of cash flows from operations that can be used to support debt payment at least in the short term.

4. By looking at cashflows prior to capital expenditures, it may provide a better estimate of ìoptimal valueî, especially if the capital expenditures are unwise or earn substandard returns.

5. By looking at the value of the firm (inclusive of debt) and cashflows to the firm (prior to debt payments) it allows for comparisons across firms with different financial leverage.

The Determinants of Value/EBITDA Multiples: Linkage to DCF Valuation

The value of a stable growth firm can be written as follows:

The numerator can be written as follows:

FCFF = EBIT (1-t) - (Cex - Depr) - D Working Capital

= (EBITDA - Depr) (1-t) - (Cex - Depr) - D Working Capital

= EBITDA (1-t) + Depr (t) - Cex - D Working Capital

From Firm Value to EBITDA Multiples

Now the Value of the firm can be rewritten as,

Dividing both sides of the equation by EBITDA,

Determinants of Value/EBITDA Multiples

Determinant
Effect on Value/EBITDA mulitple
Implications

1. Tax Rate As tax rate increases, multiple decreases.

Firms with large net operating losses should sell for higher Value/EBITDA multiples.
As tax rates increase, Value/EBITDA multiples should go down.

2. Cost of Capital As cost of capital increases, multiple will decrease.

Firms which are riskier and use lower leverage should have lower Value/EBITDA multiples.

3. Depreciation/EBITDA As depreciation increases as a proportion of EBITDA, Value/EBITDA multiples will increase.

For a given level of capital expenditures, firms which report higher depreciation will have higher multiples.

4. Growth and Capital Expenditures/EBITDA For a given growth rate, firms with higher capital expenditures will sell for lower Value/EBITDA multiples.

Firms which generate growth more efficiently (i.e., by taking projects with higher returns or from existing investments) will sell for higher Value/EBITDA multiples.

Expected Growth, Capital Expenditures and Value/EBITDA Multiples

For a given growth rate, firms with higher capital expenditures will have lower Value/EBITDA multiples

Determinant	Effect on Value/EBITDA mulitple	Implications
1. Tax Rate	As tax rate increases, multiple decreases.	Firms with large net operating losses should sell for higher Value/EBITDA multiples. As tax rates increase, Value/EBITDA multiples should go down.
2. Cost of Capital	As cost of capital increases, multiple will decrease.	Firms which are riskier and use lower leverage should have lower Value/EBITDA multiples.
3. Depreciation/EBITDA	As depreciation increases as a proportion of EBITDA, Value/EBITDA multiples will increase.	For a given level of capital expenditures, firms which report higher depreciation will have higher multiples.
4. Growth and Capital Expenditures/EBITDA	For a given growth rate, firms with higher capital expenditures will sell for lower Value/EBITDA multiples.	Firms which generate growth more efficiently (i.e., by taking projects with higher returns or from existing investments) will sell for higher Value/EBITDA multiples.