How to value a company with high debt
Hi guys,
I have an interview question for you:
Could you please advise me on high to value a company which has high debt? Please mention which multiples you are going to use into your valuation and why.
Thank you in advance
Interesting question. EV/EBITDA is a capital structure 'neutral' multiple, as EBITDA is before interest, so that wouldn't be the best indicator for a heavily indebted company. That said, the company's added risk from their debt would logically be priced in to their value, so I don't believe this assumption really holds up. P/E would give you the cleanest look at after-interest earnings (and is more commonly used in highly leveraged industries), so that may be a more appropriate answer. However, P/E has its own short comings, and is more vulnerable to earnings manipulation (vs the clean assessment of EBITDA). The right answer is probably a mix of multiples, but those are some points to consider. Curious what others think?
High debt implies high credit risk. Naturally you'd place a discount to the value vs. comps with more normal or average cap structure. High debt would also tie up most of the company's cash flow for debt service, instead of investing in capex to drive growth. This would also warrant a discount vs. comps.
Depends on what industry it is and its growth profile. industry: usually placing debt requires tangible PP&E/hard asset collateral bases. growth: if the debt was being used for capex/growth then it makes sense. If it was just refinancing of existing debt over and over again, then bad idea. also need to consider that more debt implies less leverage to put on to boost levered equity returns. usually you'd be hesitant as a LBO investor to look into a SaaS/soft-tech company with >10% debt but you'd consider looking at some heavy manufacturing/industrials with higher debt.
Plenty of LBO in the SaaSsoft-tech space or asset-light businesses in general. From a lender perspective, you can lend on the basis of either cash flow (e.g. software company with good visibility and stability of cash flows) or assets.
Yes, obviously that's why Vista/Thoma Bravo/Silver Lake exists. What I said was none of these SaaS had existing debt to begin with. Of course post-LBO transaction they'd have a huge amount of pro-forma debt, sometimes up to 50%, and the justification was huge amounts of FCF.
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