F&A Advisor: Multiple personalities

By Hobson Hogan EBITDA can be measured in different ways, and confusion over it sometimes leads us to wonder if we are speaking the same language. I often hear people make statements like “I heard that XYZ Corp was bought for 5.0x,” or “I had a broker tell me my business is worth 5x EBITDA.” My response is “5x what? Is that adjusted EBITDA, is it forward EBITDA, is it trailing 12 months EBITDA? 5.0x what?” I usually do not get any answers in return because most people do not know. There is no standard way of expressing EBITDA multiples. Finance guys like me use them; however, we tend to use them differently and that leads to confusion. As I stated in my previous article (Issue 893, Jan. 10), EBITDA multipliers are not a method of valuation. They are more of an expression of value that is used primarily to compare a transaction to publically traded firms and other completed M&A transactions. A perfect case in point is Willbros Group’s acquisition of InfrastruX Group. In March of last year, Willbros paid over $878 million for InfrastruX, which had trailing 12 months’ (TTM) EBITDA of $16 million. That is an EBITDA multiple of approximately 54.0x TTM EBITDA, which was significantly higher than the approximately 4.0x Willbros was trading for at the time. On the surface, it appears that Willbros overpaid for InfrastruX. However, the EBITDA multiple does not tell the whole story. Remember that EBITDA multiples are backward looking; they take the value of the enterprise value of the deal (value of the equity and debt) and divides it by the TTM EBITDA. The thing that we do not know is what InfrastruX’s next 12 months was going to look like after the deal. Based on the economics of the deal, it is likely that InfrastruX’s future was brighter than its immediate past. As an investment banker, I always make sure that my clients are viewed in the best possible light in an acquisition. In this transaction, InfrastruX’s investment bankers no doubt painted the firm in the best possible light. In preparing a firm for sale, extraordinary costs and costs that will not survive a transaction are added back to the firm’s earnings. “Addbacks” are common in M&A, however, they are not handled consistently in reporting. Often a firm’s owner will only speak about multiples of his reported EBITDA, not the adjusted EBITDA. You can ask me the multiple of a deal I worked on and get a different (and usually lower) multiple than you would hear from the owner. (As an aside— my experience is that EBITDA multiples are like fish stories, they tend to get bigger as the night wears on and more drinks are consumed.) Seasoned deal makers think in terms of adjusted EBITDA; however, a business operator is more likely to use the non-adjusted EBITDA as basis for his multiple, resulting in a higher multiple, even though the economics of the deal have not changed. If a firm is coming out of a period of poor performance, but has turned the corner, typically I will use the forward EBITDA multiples as a basis of comparison, rather than the TTM values. The reason is that multiples are best expressed in terms of the sustainable earnings of the firm. How a firm will perform in the future can have an impact on the deal multiple that is reported. To illustrate this, let’s look at two hypothetical deals. Both deals involve the same TTM EBITDA; the only difference is the future of their earnings and the purchase price. If you were analyzing this deal based on TTM EBITDA, you would say that clearly the buyer in Deal A got the better contract because they only paid 5x EBITDA for the business. The problem with that statement is that a buyer is buying the future, not the past. The buyer in Deal A paid 5.0x for a declining business, whereas the buyer in Deal B was able to buy an improving business for 5.0x. The above example clearly shows the dangers of simply using a multiplier to value your business. If your business has stable earnings and you use multiples from deals in an environment of strong growth or decline, you are likely to produce misleading values. So where does this leave us? The fact is that every firm, every deal, is unique and has to be valued as such. There are no shortcuts to good old fashioned financial modeling. Of course, the answers will be compared to other deals and the public markets, but only as a basis of evaluation to ensure that your modeling assumptions are sound. W. HOBSON HOGAN is a ZweigWhite principal specializing in mergers and acquisitions, finance and strategic planning. Contact him at hhogan@zweigwhite.com.