Capex in valuation
Hi guys,
Say your target has likely under invested in capex and a buyer will have to renew some of the assets.
1. How do you test for this hypothesis?
2. How do you quantify the level of under investment?
3. How do you adjust valuation to reflect the amount that will have to be invested in capex?
Thanks!
You can use industry benchmark such as capex as % of revenue or some other relevant metric.
Compare the company’s metric relative to the industry.
You can build in the additional cash outflows in your LBO and solve for an entry price that generates the target return for your fund.
The above is all high level, outside in. There can be business model differences that explain variations.
Example:
Let’s say I’m evaluating a trucking company. The company owns a fleet of 100 trucks. I give them an initial valuation indication of $10 million. However during diligence, I find out most of their trucks are older than industry average and nearing the end of their useful life, and a buyer would need to spend significant capex (let’s say $2mm) to repair / replace these trucks. But, I do like the company and I think they have a great reputation in the market, blue chip customers, and a good operational footprint.
I would revise my valuation and use the capex I would need to fund as a purchase price reduction and offer $8mm. The premise here is that I’m taking the responsibility of the trucks so the seller won’t have to. A reasonable buyer would expect the trucks to be repaired or replaced, whether the seller spends their own $2mm or the buyer does later (so the net proceeds to the seller should theoretically be the same).
This is obviously a very simple example and deals usually have more nuance.
Work on a lot of asset intensive deals and this is correct. Think of it is another 'debt like' item where you are indifferent to 1) the company taking on additional debt prior to close to buy the trucks or 2) you paying less for the company and buying them post-close. Either way, you come out to the same spot.
I cover healthcare, and so this could include 'real assets' or healthcare IT
The approach to valuation is as GrandJury described (i.e., basically remove the catch-up capex required from the consideration, because we will need to put that money in).
I typically review through a mix of things e.g., site visits for real assets and surveyors to analyse what is needed. For more IT type businesses, look at the technical debt (use a Tech DD firm). At the earlier stage, gauge through looking at historical capex and peer benchmarks.
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