Hey all,
Some questions came up in my mind as I've been constructing a DCF and thinking a bit more about the assumptions I use.
1) CapEx and Depreciation vs. Intangible Assets and Amortization. Why is capex subtracted to get to FCF but purchases of intangible assets not? I would guess that it's because intangible assets aren't seen as being as essential as capex, but not entirely sure.
2) When we model out the FCF of a business for a DCF, we often have a "stabilized" FCF column where we take the last year FCF and do some adjustments like NWC = 0 (depending on business) and Depreciation = CapEx. Do we do this for purchases of intangibles and amortization as well? Like do we project out purchases of intangibles and set Amortization = Purchases of Intangibles?
It generally seems to me like businesses that are highly acquisitive often remain so for long periods of time unless they face unusual external shocks (e.g., Big Tech used to buy a ton of startups until Lina Khan took over the FTC). Should we not treat purchases of intangibles & amortization much like we treat capex and depreciation, and in perpetuity shouldn't we have our purchases of intangibles match our amortization?
Would appreciate any guidance here.
Thanks!
Hey there!
1) When it comes to CapEx and Depreciation vs. Intangible Assets and Amortization, it's a bit of a tricky area. You're right that CapEx is subtracted to get to FCF, but purchases of intangible assets aren't always. This is because CapEx is often seen as a necessary expense for maintaining the company's physical assets, while intangible assets can be a bit more discretionary. However, companies with significant intangible assets on their balance sheets will have material amortization expenses reducing operational income. These usually result from acquisitions.
2) As for your question about modeling out the FCF of a business for a DCF, it's not always the case that we set Amortization equal to Purchases of Intangibles. This is because the purchase of intangible assets and their subsequent amortization can vary greatly from year to year, depending on the company's strategy and the opportunities available to it.
In terms of businesses that are highly acquisitive, you're right that they often remain so for long periods of time. However, it's important to remember that each acquisition is a unique event that can have different impacts on the company's financials. Therefore, it might not be accurate to simply assume that purchases of intangibles will always match amortization.
I hope this helps! Let me know if you have any other questions.
Sources: 1st Yr Banking Analyst Open for Questions, Levered vs. Unlevered Free Cash Flow Difference, EBITDA vs. Operating Cash Flow vs. Free Cash Flow, Got asked this question in an interview
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