I'm given a CIM as part of an LBO case study. Should I use Adjusted EBITDA or EBITDA to get to Net Income (and then FCF)? Also I have mid-year financials (e.g. June) available, how should I structure my forecast (project off of mid-year financials or last fiscal year date?)?
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What is the delta between adj and non-adj ebitda? If the delta is small, it doesn’t matter. If it is large, take a closer look at the add-backs, and only use the ones you think are legit. And then footnote why you are only using those. Shows that you’ve thought about the add backs and are thinking about QoE.
As to your other question, I don’t really get it.
Just take the mid year, project out to year end based on historicals, and then forecast out annually.
Adjusted EBITDA: Adjustments typically don't continue into the forecast period so it shouldn't matter for FCF in the model. If there are pro forma addbacks in future periods associated with cost savings, those are inherently non-cash until the savings are realized (AKA you'd want to use EBITDA and not adjusted EBITDA).
Year: Modeling construct should always reflect annuals based on year end (AKA don't tweak your model to be 6/30/23, 6/30/24, etc.) if that's the question. Agree you can use 6/30 to inform where you think the full fiscal year will end.
Got it. So it sounds like the IS should just be Revenue - COGS - Operating Expenses = EBITDA, then EBITDA - D&A - interest - taxes to get to Net Income, then add back D&A and subtract changes in NWC and CapEx to get to FCF. It would be wrong to use Adjusted EBITDA margin as a driver for your forecast and plug operating expenses, correct (because that would mean you're including add-backs as part of your forecast). Also, when coming up with a valuation multiple and leverageable EBITDA (for debt assumptions), would you still use historical adjusted EBITDA?
Taking these in pieces...
(i) Your FCF bridge makes sense
(ii) For your forecast, I would actually keep the adjusted EBITDA margin in mind, because the addbacks are meant to normalize for anomalies (e.g., non-recurring fees associated with a sale process), so if the adjustments look reasonable, you can assume the normalized (adjusted) EBITDA profile is the right jumping off point.
(iii) From a valuation standpoint, it depends on the aggressiveness of the adjustments. Frequently sellers will expect you to price of adjusted EBITDA given the normalizing adjustments discussed above. You would usually incorporate these into your EV assuming they're reasonable.
Got it, that makes sense. They do look reasonable. In that case would I just make a note that EBITDA adjustments are embedded within operating expenses? So it would be Revenue - COGS - (Operating Expenses - Adjustments) = Adjusted EBITDA, then Adjusted EBITDA - D&A - interest - taxes to get to Net Income, then add back D&A and subtract changes in NWC and CapEx to get to FCF?
I'd echo Smoke Frog, I'd look at what the add-backs are. Let's say the business has stock-based compensation hitting the P&L, this would be non-cash and likely not materialize in terms of cash until some event, transaction, time vesting, etc. takes place. I definitely would back that out when walking to FCF.
Furthermore, depending on the type of business if they are adjusting EBITDA for deferred revenue where they are a high growth company burning cash (highly negative EBITDA) but are signing contracts that have cash paid upfront that allows them to be cashflow positive, I'd definitely include that adjustment until the business stabilizes.
If you use reported EBITDA for your valuation, you will not make it into second round. Bid the book and verify in due diligence!
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