How to determine if growth from acquisitions is good growth?
I am a consultant, not banker so I have some questions regarding valuation. I do a lot of CDDs of sponsor backed assets. In almost all of these cases the firms VDD / company presentation boasts about it strong growth (which is primarily due to acquisitions).
Reading financial statements becomes really skewed. You have jumps in revenue every year to add ons here and there.
My question:
Just because revenue/EBITDA increases does not necessarily mean that value is created. Acquistion cost shareholders equity/debt and there would need to be a proper assessment of acquisition price vs. return to judge whether the company is actually doing well.
How do you look as bankers on such assets? How do you determine the growth in i.e. a FCF model if the big jumps in revenue are mainly driven by acquisitions?
Why would I pay 15x for a business that 10x? Multiple is driven by risk, growth, etc. if I buy a business which is riskier (has less growth) why would an investor value that EBITDA at the same multiple?
I like to look at various metrics over time to gauge this, but main is ROIC over time. If they’re a serious serial acquirer with not just small roll ups/platform acquisitions, could be wise to adjust for goodwill. But ultimately in my view biz should be able to increase/recover ROIC post acquisition (ROIC accretive deals) might dip initially but should recover and grow after acquisitions.
Also generally checking if any synergies management mentioned actually played out or which synergies that were supposed to play out did (I.e were the missed synergies low hanging fruit or blue sky stuff). And lastly what type of multiples they’re acquiring for. If your biz is worth like 15 - 20x EBITDA and you’re acquiring businesses at like 7x they’re likely instantly accretive (you’re just adding these earnings to your biz)
Michael Mauboussin has written some great stuff on this. One example, if you Google "mauboussin calculating return on invested capital" you should see a link at Morgan Stanley.
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