How does IFRS 16 affect valuation multiples?
How does IFRS 16 affect valuation multiples? So I know it sits on the balance sheet opposed to an operating lease (which is essentially expenses similar to rent), and the lease essentially "amortizes" over time.
I would assume this would increase multiples because operating expenses would be lower, is this correct? Also how do you go about it when a company was using a different method before, do you just strip out the lease expense and capitalize it on the balance sheet? Wouldn't this be a fair chunk of work?
If someone could explain in detail I'd appreciate it.
more debt - leases are debt imo as they bear interest higher ebitda estimates due to lease expenses being classified as interest
Are you saying multiples would increase because the additional "debt"/lease would increase enterprise value more than it would increase EBITDA?
I know the multiples would increase, but having trouble understanding exactly why and how answer in an interview setting.
The new accounting method requires companies to capitalize operating leases, i.e. report them as debt on their balance sheets. So in simple interview friendly terms, debt is higher which means enterprise value is higher which means the multiple is higher. However, since you're adding operating leases to the numerator you need to also add back rent expense to the denominator (EBITDAR) to keep them apples-to-apples. (In practice we just exclude the operating leases from debt, tbh.)
It could also be helpful to think about the impact this has on different industries. Retailers, for example, have very high operating leases, so this rule change has a pretty material impact. Tech companies, on the other hand, not so much.
Very simple: Debt increases with lease liabilities (LL), EBITDA increases with lease expenses (rent).
So the new multiple becomes EV / EBITDA = [EV (old) + LL] / [EBITDA (old) + rent].
So the EV / EBITDA multiple will go up post IFRS 16 if the lease multiple (= LL / rent) is higher than the old EV / EBITDA multiple and vice versa if lower.
Something similar applies for the EV / EBIT multiple, it increases when the interest multiple (=LL / lease interest) is higher and vice versa if lower.
EV / Sales multiples will increase accross the board.
P / E multiples stay the same (but with a big caveat*)
*there can be temporary differences between net income pre and post IFRS 16 because the ROU asset depreciates straight line and the LL amortizes as an annuity. In general ROU asset depreciation is HIGHER than lease repayments in the beginning of a contract and LOWER than repayments near the end of a contract. So if a company has many "young" lease contracts net income (and thus PE multiples) can take a big hit moving to post IFRS 16, but this will reverse later on.
Source: I am a buy side equity analyst so have to deal with this IFRS 16 bullshit way more than I would like to.
By rent do you mean (depreciation of lease assets + interest on lease liabilities)?
Yes and no, I do mean the lease expenses (which I dubbed rent) that are removed from the P&L post IFRS 16. This is equal to ROU depreciation + lease interest only on average as stated under the caveat in my post above.
So a check I often do is see if the sum of ROU depreciation + lease interest over a long forecast period is similar to what I would expect if I would forecast and sum the pre IFRS 16 lease expenses over that same period. Then the model balances.
Here you go:
https://www2.deloitte.com/content/dam/Deloitte/za/Documents/finance/IFRS-1-brochure-V9.pdf
Yeah that doc gives a great overview, and contains most of what you would need.
For some nitty gritty stuff:
https://www.ifrs.org/-/media/project/leases/ifrs/published-documents/ifrs16-effects-analysis.pdf
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