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EBITDA Exit Multiple
 

slickmac's picture
IB
 
Points)
 on 4/5/08 at 12:31am

How exactly do you determine an appropriate EBITDA exit multiple for a given firm. Obviously you look at comps, but where exactly does one derive the exit multiple from?

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........ (not verified)
(Chimp, 0
 
Points)
 on 2/20/09 at 12:14pm

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Alex_Kap's picture

Not sure who compares

IB
 
Points)
 on 4/5/08 at 1:42am

Not sure who compares Cap/EBITDA, its EV/EBITDA, as Cap would look at equity holders, but ebitda goes to debt and equity so it its likeing EV/NI, doesn't make sense either.

Easiest way to get an exit is to find comparable exits and use that as an analysis. Comparable is what's hardest to find at times. If you want to see what market places comps firm vaue then you would have to compare equal terms or LTM to make it comparable.

Alphaholic's picture

Don't Forget!

CO
 
Points)
 on 4/5/08 at 2:07am

EBITDA multiples are terrible to use in the first place if the firm has lots of CAPEX, NWC needs or pays an unusual amount of taxes!

dosk17's picture

Generally you assume the same

IB
 
Points)
 on 4/5/08 at 4:46am

Generally you assume the same exit multiple and purchase multiple. The purchase multiple would be either:

1) Based on public seller premiums if it's a public company, as well as other valuation metrics such as comps, DCF, etc.

2) Just based on comps if it's a private seller.

Some PE firms have made a lot of money by buying companies in cyclical industries during "down" times and then selling on the upswing. And it's likely the exit multiple won't in fact be the same as the purchase multiple.

But that's still the safest assumption; sometimes we are actually more conservative and assume a lower exit multiple if, for example, the growth rate slows by the end of the investment period.

mlamb93's picture

multiples

IB
(Orangutan, 271
 
Points)
 on 4/5/08 at 10:30am

What dosk said is true. One important thing to note is that multiples (in general) fluctuate with the health of the market. Back when the LBO boom was in its prime, multiples that PE firms paid for targets were borderline absurd. Think about it - if you bought a company for 9x EBITDA all-in (assuming no earn out) you really don't have much room to create value in the form of multiple expansion. EBITDA growth is really the only other long-term option. Without both, it's difficult to produce the 30%+ IRR most PE firms shoot for. This is even harder in today's world with the debt markets in their current condition.

All in all, if you're doing an LBO analysis, I would recommend you run a few scenarios (i.e. selling at same multiple with higher EBITDA, selling at higher multiple with higher EBITDA, etc.) This will help you determine how much value creation comes from each.

Quick note: if you're looking at multiples for private firm transactions, make sure you take each with a grain of sand. I saw this because - sometimes these reported multiples aren't off proforma EBITDA. They also may contain an earn out, that can make 6x look like an 8x.

GenghisKhan's picture

From a theoretical perspective

IB
(Gorilla, 518
 
Points)
 on 4/5/08 at 10:49am

the EBITDA exit multiples method is badly flawed, because it is predicated upon the "greater fool" theory. I bought it for 8x, and I am basing my returns on the assuming that a bigger fool will pay 8x for it in five years.

The practitioners' mental shortcut makes this method more common than the perpetual growth basis, but never mistake common for correct. You typically see bankers run 5-year DCFs with exit multiple approximating entry multiples or cycle average multiples. This is so that you don't get any "juice" from multiple expansion or contraction in your assumption. But it's flawed because of that inherent assumption that someone else will be as silly as you are.

Here are some things you should think about: why a five year DCF? Why should the terminal value be a year 5 multiple? If it is, does a company continue to grow at 20% in perpetuity - ever? History tells us no. In fact, evidence would point you to the fact that all companies converge upon GDP growth (or lower, given the entry of new fast growing firms), over time.

So terminal value should be based on an EBITDA multiple or perpetual growth rate that approximates GDP, no? Absolutely, from a theoretical basis. But will Google be GDP in 5 years? Unlikely. So the right argument is that terminal value should reflect the steady state of the business, that portion that occurs when it does become a GDP-type company. And the interim period DCF should go as long as it takes to get there (10 years, perhaps).

At that point, capex and D&A should not impact the EBITDA versus ULFCF question because the two should converge in a steady state business, right?

That's the correct way to do a DCF. That's what our guys get from me when I sit on their fairness committee.

Still, I know that's not typically the way firms do DCFs. One, because it's hard to get good projections for more than a few years. Two, because bankers like the EBITDA exit multiple method (most firms are not particularly academic in their approach to finance).

Regardless, that's not an excuse not to be able to argue the point fluently. At some point you'll be in a board meeting, and some finance geek will grill you on why you used the arithmetic versus the geometric equity risk premium, or the abbreviated period versus since-inception, or raw versus unadjusted beta, or used a size premium or not. And you'll either stare at him like a deer in the headlights, or you'll calmly but forcefully say: "You raise a good point, but let me explain why that's not the appropriate approach for this type of analysis..."

jajaja's picture

don't want to sound flippant

PE
(Baboon, 100
 
Points)
 on 4/5/08 at 10:54am

but in the real world, you determine the exit multiple by looking at the entry multiple, and making some finger in the air adjustment up or down depending on where you are guessing the cycle is going, and whether you are getting the company at a steal.

this is a terrible method, as the multiple can give huge swings to your valuation and make/break the deal. However i would argue it does at least as well as slaving the whole night to get 40 comps / prev transactions. reality is, the future is hard to predict, all you can do is build in as much cushion as you can afford

In reply to GenghisKhan
boredom's picture

Approach to finance

O
 
Points)
 on 4/5/08 at 11:50am
GenghisKhan:

Still, I know that's not typically the way firms do DCFs. One, because it's hard to get good projections for more than a few years. Two, because bankers like the EBITDA exit multiple method (most firms are not particularly academic in their approach to finance).

That last part about most firms not being particularly academic in their approach to finance has me curious. Are there some firms that are generally more likely to have people whipping out the Damodaran books? If so, could you name which ones have a reputation for taking a more academic approach, and which ones are known not to? Perhaps it depends more on which group you're part of?

On that same note, I've been wondering about where the technical judgment or knowledge resides in the hierarchy. Is it up to associates and analysts to come up with what's considered a solid valuation (i.e. make decisions on how certain premiums are calculated, etc.), or who runs the show there? I've heard conflicting things on the involvement (or lack thereof) of VPs/SVPs/MDs in the process.

CDNmonkey's picture

Genghis, while I agree with

PE
(Orangutan, 348
 
Points)
 on 4/5/08 at 9:01pm

Genghis, while I agree with your technical approach to the DCF method, I would argue the bigger problem is the projections. You mentioned this is why banks tend to use the 5 year + perpetuity model - since good projections aren't available.

I have confidence in a 5 year to perpetuity DCF model for companies like Wal-Mart, Home Depot, P&G, J&J, etc. It is not hard to see where these companies will approximately be 10-20 years. A few years of projections with EPS growing at (ROE * re-investment rate) to perpetuity is reasonable. (or EBIT/NOPLAT growth = ROIC * re-investment rate).

However, in banking we apply the DCF model to every company under the sun. Every company seems to have rising earnings and 3% perpetual growth rates. Unless a business has a durable competitive advantage, perpetual growth probably has zero value as capital expenditures are required to fund future growth. For a business without a long-term competitive advantage, returns on incremental capital deployed will probably equal WACC. There are plenty of exceptions of course...natural resources, non-asset based businesses, etc. As a corollary, I would also argue that for business without a strong competitive advantage, it is also tougher to predict if current earnings can be maintained far into the future. I'm not suggesting there is a better way - just that our industry seems to be very optomistic (as we are paid to be).

Based on my very limited experience and insight, it seems that bankers add far more value selling mediocre businesses than great ones. It is far easier to sell the future prospects of Allison Transmission than Jaguar Cars. Would this be a fair conclusion about M&A banking or am I way off?

slickmac's picture

Thanks for all of the input

IB
 
Points)
 on 4/5/08 at 10:19pm

Thanks for all of the input thus far. Let me pose an example so I can really determine whether I understand the concept. Suppose for example I am valuing Lockheed Martin (LMT). Let us assume that by some miracle, I have made accurate assumptions for short term growth rates and FCF projections. I then pull some of LMT's traditional comps and analyze their current EV / EBITDA multiples.
BOEING CO: 7.87
TEXTRON INC: 13.3
ROCKWELL COLLINS INC: 10.09
etc.

Now I simply average out the multiples (I used 20 comps that averaged to approximately 10) and apply it to the last year's projected EBITDA and discount at WACC.

Feedback? Criticisms of comps? Direction? Thanks in advance.

slickmac's picture

Sorry for the bump, but I

IB
 
Points)
 on 4/6/08 at 10:04am

Sorry for the bump, but I spent a decent amount of time pulling the comps and would love feedback from someone who can critique the process. Thanks in advance.

slickmac's picture

Gotta bump it sorry.

IB
 
Points)
 on 4/6/08 at 11:26pm

Gotta bump it sorry.

ash37's picture

The issue with using trading

PE
(Monkey, 31
 
Points)
 on 4/7/08 at 12:27am

The issue with using trading multiples to project your perpetual growth is that firms often pay a premium over trading comps (to account for en bloc, synergies, forward tax credits, etc). Therefore, if exit multiple = initial multiple, then it does not equal your trading multiple for reasons stated earlier (unless the company you are looking at is another Bear Stearns and you can buy it for a fraction of its market price).

With respect to how you determine that multiple itself, try looking to see if there are any precedent transactions and look to apply their multiples.

In reply to boredom
GenghisKhan's picture

As requested by PM

IB
(Gorilla, 518
 
Points)
 on 6/24/08 at 7:44pm
boredom:
GenghisKhan:

Still, I know that's not typically the way firms do DCFs. One, because it's hard to get good projections for more than a few years. Two, because bankers like the EBITDA exit multiple method (most firms are not particularly academic in their approach to finance).

That last part about most firms not being particularly academic in their approach to finance has me curious. Are there some firms that are generally more likely to have people whipping out the Damodaran books? If so, could you name which ones have a reputation for taking a more academic approach, and which ones are known not to? Perhaps it depends more on which group you're part of?

On that same note, I've been wondering about where the technical judgment or knowledge resides in the hierarchy. Is it up to associates and analysts to come up with what's considered a solid valuation (i.e. make decisions on how certain premiums are calculated, etc.), or who runs the show there? I've heard conflicting things on the involvement (or lack thereof) of VPs/SVPs/MDs in the process.

Boredom, yes, there are firms that I believe are more "academic" in their approach. JPM is a good example of this. From their insistence upon mid-period discounting to their establishment of an M&A Research department (sort of a b-school finance professor type group) to their use of "risk factors" in lieu of a traditional beta, JPM has always been in my mind more cerebral than the typical M&A group.

The question you ask about WHERE the institutional knowledge resides is actually an enormously important question. In my opinion it's why it is a terrible mistake to disband M&A as a stand-alone group. The knowledge that resides among specialist practitioners fertilizes the entire firm. Things that tech groups never see may be second nature to, say, chemicals bankers. M&A branches across those and helps ensure that expertise crosses group boundaries.

That "guru" effect is why every firm has senior M&A professionals. The issue with integrating M&A into the industry groups is how you develop those future gurus without stand-alone M&A (unless you just intend to poach them from firms who have M&A groups).

In reply to slickmac
onepercent's picture

slickmac: Thanks for all of

CF
 
Points)
 on 8/2/12 at 11:53pm
slickmac:

Thanks for all of the input thus far. Let me pose an example so I can really determine whether I understand the concept. Suppose for example I am valuing Lockheed Martin (LMT). Let us assume that by some miracle, I have made accurate assumptions for short term growth rates and FCF projections. I then pull some of LMT's traditional comps and analyze their current EV / EBITDA multiples.
BOEING CO: 7.87
TEXTRON INC: 13.3
ROCKWELL COLLINS INC: 10.09
etc.

Now I simply average out the multiples (I used 20 comps that averaged to approximately 10) and apply it to the last year's projected EBITDA and discount at WACC.

Feedback? Criticisms of comps? Direction? Thanks in advance.

Make sure that the comps have multiples within a reasonable range. It seems that 10 is within the spread, but any outliers would skew the average and a median would be more appropriate. Also, make sure that the multiples are from the same time frame (e.g. if one comp has a different year end than the company you value, be sure you are using the same LTM).

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