LBO Question: EBITDA Multiple Expansion
Hi there -- I was hoping to get some clarification in regards to EBITDA Multiple Expansion
When textbooks (R&P) refer to "EBITDA Multiple Expansion", does that mean the EV/EBITDA multiple?
As well, when they talk about "EBITDA Multiple Expansion" does that mean another way for the IRR to increase is for the EV/EBITDA multiple to "increase" by having Enterprise Value increase
Essentially, my question is this:
Is EBITDA Multiple Expansion a concept that a Financial Sponsor hopes for the Enterprise Value to increase by Year 5 so that the EV/EBITDA multiple is higher and therefore when you multiply by Year 5 EBITDA you get a higher exit equity value and therefore greater IRR and Cash Return?
I am sorry if this question is confusing -- since I am myself a little confused it is difficult to articulate the question.
Thanks!
Lets say financial buyer (PE shop) buys a business today at 7x EBITDA. So if LTM EBITDA is $10m today, TEV is 7* $10m = $70m.
Multiple expansion refers 7x becoming 10x when the PE firm exit the business 3-5 years later. Lets say the company had no growth, so EBITDA is still $10m. 5 years later, when you are selling the business at now 10x, you "created value" ($70m vs $100m @ 10x * $10m EBITDA) by simply getting a higher multiple.
It really is as simple as attempting to buy low and sell high (after a period of value creation). Most analysis assumes that your exit multiple is the same as your entry multiple (in an effort to be conservative). As an example, I may purchase a retailer in a down economic cycle at 5x EBITDA. Maybe it trades at 5x because of the macro backdrop, high risk profile, poor management, etc. By driving operational efficiency, engaging in financial engineering, and taking advantage of market cycles I would attempt to exit the business at a higher multiple (multiple expansion).
Your statement is correct. A higher multiple would lead to a higher EV, equity value, and IRR.
Maybe just to close the loop, you would get multiple expansion either by 1) the industry becoming structurally more attractive, or 2) the growth outlook being materially better (I.e. putting a flat multiple on higher out year EBITDA). Both are tough to pull off, hence why the sponsor won't count much on it to meet its hurdle rate.
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