EV/EBITDA vs EV/EBIT vs EV/(EBITDA-capex)? Please help?

Hi guys,

Could someone please help explain the difference of when to use EV/EBIT vs EV/(EBITDA-capex)? I know you generally use EV/EBIT for companies with high capex, why though? Because of the high D&A, but don't you want to account for that? like EBITDAR for airlines, gaming/casinos, etc? I guess I am generally confused on capex here. Is the capex here MCX? What's the thought process of capex's relationship with D&A? And what about growth capex?

I am just starting to learn this, so if someone could be patient and explain this clearly, I would really appreciate it!! Thanks in advance. :)

 

I could be wrong so someone can correct me. I got a variation of this question in an interview at Evercore... but here it goes:

Backing out capex will essentially make an analysis of different companies in the same industry apples-to-apples. So if Company A & B are automakers and Company B is 10 years older than Company A, then Company A would have newer equipment. So if we measure value on EBITDA alone then we aren't taking an equal look at the two because B has less Depreciation & Amortization so all else equal they will have higher EBITDA (think of it as all else equal you're adding back lower D&A for B because it has spent less capex in the last few years).

To equalize the two companies we back out the average annual capex of each company. The result should be that Company A has less avg capex (all else equal) than Company B. Why? Because Company B is older and needs to replace its equipment.

Using EBIT is different than EBITDA less capex because the latter is based on future capex while the former is based on past capex.

 

I don´t mean to be rude and to be honest I am just getting started in the industry so I might go wrong but in your example I understand you are assuming that D&A is a reflection of Capex, which it is true for most mature companies but not necessarilly for the rest. So if I had to compare two companies with considerably different D&A I would rather use EBITDA which will give me a better picture of the cost effectiveness and the margins that both companies have, basically its cash generation. Subtracting D&A would be distortive because of the huge difference among them. What do you think?

 
dukebanker12:

EBITDA - Capex is a proxy for FCF, a more accurate measure of the cash generating capabilities of a business

why not just calculate fcf if you're already doing the math to calculate ebitda-capex

 
dukebanker12:
couchy:
dukebanker12:

EBITDA - Capex is a proxy for FCF, a more accurate measure of the cash generating capabilities of a business

why not just calculate fcf if you're already doing the math to calculate ebitda-capex

calculating FCF for each comp would take too long

That doesn't make much sense. FCF is a pretty straight forward formula and just 2 more steps to calculate. If you're spreading comps, you just link a few extra cells. If you're not picky about, the morningstar and yahoo wesbites already calculate FCF for you.

EBIT + DA - capex vs. EBIT*(1-tax) + DA - capex - dWC

its just 2 extra steps!

 
lifeishard:

Hey NYU,

Thanks for your help on this. On your last comment, just to clarify, when you say the past capex for EBIT, that's based on D&A on the balance sheet for the past year/LTM, and the capex you are backing out of EBITDA is forward looking? But isn't it still the average annual capex that you said?

I mean EBIT adds back D&A to EBITDA. So you're adding back the amortized portion of past capex. Whereas EBITDA less capex will take the average capex and back it out which is forward looking because large corporations understand what maintenance capex they will need as well what capex they will need to upgrade and stay with the competition. As an analyst its tougher to make the call on what figure to use but it can be done with enough knowledge of the industry.

 
couchy:
dukebanker12:
couchy:
dukebanker12:

EBITDA - Capex is a proxy for FCF, a more accurate measure of the cash generating capabilities of a business

why not just calculate fcf if you're already doing the math to calculate ebitda-capex

calculating FCF for each comp would take too long

That doesn't make much sense. FCF is a pretty straight forward formula and just 2 more steps to calculate. If you're spreading comps, you just link a few extra cells. If you're not picky about, the morningstar and yahoo wesbites already calculate FCF for you.

EBIT + DA - capex
vs.
EBIT*(1-tax) + DA - capex - dWC

its just 2 extra steps!

The formula is simple. Being able to accurately forecast future capex and net working capital isn't always that easy.

 

I believe FCF uses Change in Net working Capital?? Which in itself is a formula, so its not so straight forward as pulling the number from the statements (although, if it is in your model, it shouldn't make any difference I'd think).

"History doesn't repeat itself, but it does rhyme."
 
streetwannabe:

I believe FCF uses Change in Net working Capital?? Which in itself is a formula, so its not so straight forward as pulling the number from the statements (although, if it is in your model, it shouldn't make any difference I'd think).

So I've actually asked myself this question many times, and i've concluded that it's because ebitda, even ebitda - capex is less volatile than FCF. That's partly because it removes the working capital cycle, so in effect your normalizing your nuumber just as scrubbing out 1-time costs does too.

So for distressed companies, or companies where working capital is a large/unique portion of the business model, you should just forcast the FCF.. and do EV/FCF? I dunno...

just my guess ... I think the forcasting WC is tough comment is true as well. But then again, forecasting EBITDA is just as big a crapshoot....

Was cool to hear a different take on it.

 
couchy:
streetwannabe:

I believe FCF uses Change in Net working Capital?? Which in itself is a formula, so its not so straight forward as pulling the number from the statements (although, if it is in your model, it shouldn't make any difference I'd think).

So I've actually asked myself this question many times, and i've concluded that it's because ebitda, even ebitda - capex is less volatile than FCF. That's partly because it removes the working capital cycle, so in effect your normalizing your nuumber just as scrubbing out 1-time costs does too.

So for distressed companies, or companies where working capital is a large/unique portion of the business model, you should just forcast the FCF.. and do EV/FCF? I dunno...

just my guess ... I think the forcasting WC is tough comment is true as well. But then again, forecasting EBITDA is just as big a crapshoot....

Was cool to hear a different take on it.

Yep, I think the same way regarding working capital cycle - it can be really difficult to get a handle on what a 'normalised' level of working capital is (especially for companies that are growing significantly).

Since EV / Whatever multiples are just a quick discounting of future earnings, my logic of not going to a EV/FCF multiple is kinda like: (1) there's uncertainty about whether today's FCF is really representative e.g. in terms of cash conversion, so the multiple might not make sense vs. comparables; and (2) that's okay because run-rate WC levels will probably revert to somewhere around the sector average in the long term, and the long term is where most of the value is.

By the same logic, for a distressed company, you'd care a lot more about WC (if significant) at the present / near future, because the value could be impacted a lot more significantly in the short term vs. a non-distressed company, since issues like covenants actually begin to matter.

And I think for companies where WC is really significant - I would say the onus is on the company to give investors comfort / visibility around their WC levels, otherwise they can probably expect a chunky discount on their multiples?

 
jamieoliver:

I don´t mean to be rude and to be honest I am just getting started in the industry so I might go wrong but in your example I understand you are assuming that D&A is a reflection of Capex, which it is true for most mature companies but not necessarilly for the rest. So if I had to compare two companies with considerably different D&A I would rather use EBITDA which will give me a better picture of the cost effectiveness and the margins that both companies have, basically its cash generation. Subtracting D&A would be distortive because of the huge difference among them. What do you think?

The original question, in the form I've received it, usually assumes that both companies have the same EV. The interviewer will then ask about the multiples they trade at given one has older equipment and the other has newer.

So EBITDA essentially adds back D&A which is a reflection of past capex, not future. So with equal EV the older equipment company would have a higher multiple due to having lower EBITDA (because lower D&A is being added back). This doesn't feel right intuitively because we know that the older equipment needs to be replaced at some point so, all else equal, the newer equipment company should trade at a higher multiple. Remember the crux of the question in the interview would revolve around everything else being equal except for the state of the new equimpent.

So your point regarding EBITDA and margins and efficiency would be correct if everything was equal except for EBITDA, but the question I was referencing from my interview at Evercore was that the only difference was the age of the equipment with EBITDA being the same for both companies. Hope that clears things up. Your post is correct. Im just trying to point out how the interviewer tried to make me think and confuse me.

 
NYU:
jamieoliver:

I don´t mean to be rude and to be honest I am just getting started in the industry so I might go wrong but in your example I understand you are assuming that D&A is a reflection of Capex, which it is true for most mature companies but not necessarilly for the rest. So if I had to compare two companies with considerably different D&A I would rather use EBITDA which will give me a better picture of the cost effectiveness and the margins that both companies have, basically its cash generation. Subtracting D&A would be distortive because of the huge difference among them. What do you think?

The original question, in the form I've received it, usually assumes that both companies have the same EV. The interviewer will then ask about the multiples they trade at given one has older equipment and the other has newer.

So EBITDA essentially adds back D&A which is a reflection of past capex, not future. So with equal EV the older equipment company would have a higher multiple due to having lower EBITDA (because lower D&A is being added back). This doesn't feel right intuitively because we know that the older equipment needs to be replaced at some point so, all else equal, the newer equipment company should trade at a higher multiple. Remember the crux of the question in the interview would revolve around everything else being equal except for the state of the new equimpent.

So your point regarding EBITDA and margins and efficiency would be correct if everything was equal except for EBITDA, but the question I was referencing from my interview at Evercore was that the only difference was the age of the equipment with EBITDA being the same for both companies. Hope that clears things up. Your post is correct. Im just trying to point out how the interviewer tried to make me think and confuse me.

Oh great! I got your point then. Great stuff btw; I have an interview tomorrow and this will definitely come in handy, even if not asked to actually bring it up because it would be a good think to talk about. Thanks again NYU

 

NYU, if everything including EV & EBITDA is the same for two companies except the state of the equipment, you can use EV/EBIT which will also give the company with newer equipment a higher value.

Envision, create and believe in your own universe, and the universe will form around you. -- Tony Hsieh
 

First you guys over think it. It doesn't help you get rich, who cares. But let's say you cared, you can't even get it right.

The newer company would obviously have the higher multiple because it's depreciating more since it's new. The company with older equipment has nothing left to depreciate...

 
Katter:

First you guys over think it. It doesn't help you get rich, who cares. But let's say you cared, you can't even get it right.

The newer company would obviously have the higher multiple because it's depreciating more since it's new. The company with older equipment has nothing left to depreciate...

This is not true at all. If the newer company is depreciating more, than its EBITDA would be higher, thus making the multiple lower since you are adding back that D&A which makes your denominator higher than the older company.

What the other user posted is exactly right. The older company would be trading at higher multiple because its D&A is lower than the other, which makes the denominator lower in your multiple when you add it back...

"An investment in knowledge pays the best interest." - Benjamin Franklin
 
Best Response

Bump. Couldnt bare to watch this discussion without adding my ideas to it...

1) @StudentLoan, your argument of higher D&A causing higher EBITDA does not make any mathematical sense. Lets say Revenue - COGS - SG&A - D&A = EBIT --> EBIT+D&A = EBITDA Doesn't matter if D&A was 5 or 500, it's added back, so NOTHING changes if D&A was lower or higher to begin with: EBIT was X-5 in the first situation, and X-500 in the second situation --> adding back accordingly (X-5)+5=X and (X-500)+500=X --> X is X whatever the value of D&A was. In other words, the height of D&A has NO effect at all on EBITDA

2) why would a newer company be depreciating more than an older company? - if both companies depreciate straight line, depreciation remains the same throughout the life of its assets - if one company is an old(ER) steel factory it will still economically depreciate more than a young consulting firm (probably both in case of straight line as well as accelerated depreciation)

3) fact is, EBITDA and EBIT are both proxies for cash flow but one important consideration to take into account is the capital intensity of the firm. if a firm has long-lived assets with low depreciation, EBITDA is a better measure. However, when it is a fast growing firm, with high capital intensity where Capex (at least) equal to depreciation are required to sustain the firm's operations, you might as well take EBIT. thats what one of the posters further up meant with taking D&A as a proxy for Capex. if you measure a firm using EBITDA, but 50% of EBITDA is depreciation (which then needs to be matched by Capex), you rather take EBITA, or EBIT if amort is very small, as EBITDA will be be distorted and missing a large amount of Capex implied by Depreciation.

There are more considerations, but capital intensity is a factor which varies quite a lot across industries, which is why you often see analysts differ in their use of EBITDA, EBITA, or EBIT as a figure for multiples across different industries

 

Bump. Agree with point (2). Don't understand why a company with older machinery than another company in the same industry but with newer machinery would have higher D&A, ceteris paribus,if they are using straight line depreciation. Unless you are talking about accelerated depreciation, then the older company would have depreciated more and thus face lower depreciation expense now; while the newer company would have higher depreciation expense since the machinery is earlier on its useful life.

Hopefully I didn't forget what I learnt in accounting lol..

 

I did not take time to read everything, but just in case somehow googles this I think the previous posts did not understand the following...

D&A is a proxy for maintenance capex and maintenance capex only, i.e. disregarding growth capex. The reason to look at maintenance capex in particular is that a) growth capex a discretionary whereas maintenance capex are not, b) growth capex will decline / stop eventually as a business matures, which becomes relevant when modelling periods further down the road (esp. terminal FCF), whereas maintenance capex continue in perpetuity to "make up" for the wear down of the machinery (=> D&A).

With respect to higher / lower D&A for older / newer company, I agree with crusader12.

 

Reading through the comments, seems like you guys are overthinking it. This is what I thought:

EV/EBITDA is just the normal, quickest multiple to use to determine valuation for any (most) company.

EV/EBIT would be for companies that do not have any substantial D&A/Capex needs, so therefore you can basically ignore D&A altogether. This would be companies that buy and sell a finished product where the operation margin is most important in determining profitability because every cent above cost matters.

EV/(EBITDA-Capex) is when industry capex is too high/normal to not take it into account, example would be companies issuing large debt with required annual Capex for ongoing business.

The point is, D&A and Capex are both important to determining the business' ongoing investment needs, thus affecting it's ability to generate cash flow, which affects valuation.

 

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