Forget Adjusted EBITDA, welcome Modified EBITDA!

Just was browsing around random websites when I came across a story by Frank Quattrone, the well know tech banker. FT had this piece regarding one of the metrics his bank used for the LinkedIn Deal called the Modified EBITDA.

"Qatalyst is still using its seemingly unprecedented “dilution factor”, but now the earnings projections used in the valuation have been “adjusted” in novel way. Or, rather, “modified”. If Adjusted EBITDA isn’t offensive enough to you, LinkedIn wants to test your patience with Modified EBITDA.

Adjusted EBITDA adds back stock compensation expense. (Qatalyst would argue it already accounts for the economic cost of shares issued to employees through its dilution factor.) Modified EBITDA takes another leap by subtracting out charges for “capitalised software and website costs”. (note this sentence has been updated as it mistakenly said “capitalised software and website costs” were being added back not subtracted).

If that spending is a genuine capital expenditure — and the company is indeed amortizing the cost over two years and running that expense through the income statement — it is strange the company would want to lower EBITDA on the P&L rather than, more conventionally, just have the charge only appear in the cash flow statement. On the other hand, lowering LinkedIn’s reported EBITDA could imply lower theoretical values for LinkedIn.

(The actual deal price was $196 per share in cash. The discounted cash flow range derived by Qatalyst was $156 to $238.)

The terminal value in the DCF relies on an EBITDA exit multiple, which you can get by comparing LinkedIn to comparable companies currently traded in the market. Similarly, you can compare the multiples of EBITDA paid on previous acquisitions against the multiple Microsoft was willing to pay to buy LinkedIn.

When Qatalyst compared LinkedIn to similar companies, earnings were, presumably, modified to account for capitalised software costs. However, interestingly, for precedent transaction multiples Modified EBITDA was not used. Instead, Qatalyst used Adjusted EBITDA multiples because capitalised software costs were likely unavailable.

LinkedIn and Qatalyst could argue the lower earnings in Modified EBITDA should be offset by higher multiples. But if the net impact was negligible, why go to the trouble of moving from Adjusted EBITDA to Modified EBITDA in the first place?"

here's the link: http://ftalphaville.ft.com/2016/07/06/2168351/modified-ebitda-brought-to-you-by-frank-quattrone/