Company A has twice CapEx
Given at a bare minimum of information that company A has more CapEx than company B, what questions do you have for company A to make an investment decision? Please make as many assumptions as you need.
Next, you are now given 2 CIMs of these companies. What info would you look for in company A?
I would think of Free Cash Flow Conversion, but not sure if that is good enough to make an investment.
I’d want to know why Capex is higher. If it’s because of inefficient spending/poor management decisions then maybe there’s an opportunity to buy Company A cheaply (same FCF multiple effectively) and then turn it around. If it’s because Company A needs the capex because of its business model, then that can also mean that you can get it cheaply as no one else will be looking at it. Depends on what the capex is for, how discretionary it is etc. Have they just modernised all their facilities and therefore will throughout jump? Also important to look at how they’ve been funding it.
Thanks! If we were curious how they fund the CapEx, what would some concerns be? Given the amount of CapEx is huge, say they take out a huge equivalent amount of debt or raise equity to fund the CapEx purchase to grow the business, I am trying to think why that would be a potential concern, if any, from the investment perspective.
Kinda sounds like you want someone else to do your case study for you lol
If it’s seriously big do they even have any FCF?
Regarding funding it could become an issue if you hit leverage capacity on your buyout and then suddenly need to inject equity (bad for IRR/MoM) or you need to restructure (borrowing costs going forward will be horrendous and you may get diluted) or even potentially you need to sell a division (pressured sellers rarely get full value).
Thanks, Associate 1. Thinking through this, what if they need to external funding for their CapEx project and eventually improve the business? I am thinking from the company perspective. Shall I think about ROI metric to prove that management has a convincing rationale to raise capital to fund their CapEx project?
It is hard for me to wrap around the idea that management willy-nilly invested in the CapEx without evening rationalizing whether it would benefit the company or not. Bad apples are everywhere but I wanted to think through this a bit deeper.
There could be a million reasons why A and B have different Capex.
1) The could be different sizes. If you’re a manufacturing firm and have double the lines, then you have double the capex.
2) they’re in different industries
3) Company A is investing for growth
As it relates to capex, I would want to understand 1) what is for growth and what is maintenance and 2) what’s the return on growth capex (incremental revenue and GP), 3) current liquidity situation
Let's think through this. What about these two companies in the same industry, offering very similar products, similar financial profile (in terms of revenue, growth, EBITDA margin and profit margin). Would you have other thoughts why 2x CapEx would be a potential concern?
When I am thinking about this scenario, I do not always go with the perception that "2x CapEx is really high, hence it is an issue". It may not be an issue. I just need to think of different scenarios in which this is the case.
1) figure out capex as % of revenue and as % of ebit, d&a as well as pp&e
2) figure out how much of capex is growth vs maintenance
3) figure out if capex is cyclical for this business- what portion of pp&e undergoes a replacement cycle
4) if growth based capex figure out what roi it generates
based on this info you can figure out if the capex is really needed and this determines business qualify, growth curves, cash flow conversion, capital intensity level, and what multiple you’d pay
I appreciate the inputs here. I think from an investor perspective, I can see why one wants to see more growth CapEx versus maintenance. Personally, I may also want to look into what CapEx projects have been implemented and then determine whether it makes sense for company A to make such a decision.
I am just thinking out loud...
I think if this was asked in an interview setting I would think about how capex ties into competitive advantage. If they are basically competitors and one is spending a lot more I would assume they have an edge and are taking share from the other company and would view it as a positive sign. I was asked a similar question except replace "capex" with "growth rate" but they are intrinsically linked so same answer.
Biggest thing for interview questions is not to overthink things - find the simple answer holding other things constant. do NOT ramble with 5 different points like some other posters are suggesting (even if valid in real world setting)
I would want to know:
A) are cash flows steady? If this is a cyclical business with high Capex, a disruptive year could result in trouble, especially depending on how the CapEx is funded. If debt, that would be really not good
B) Is the Capex a good spend? Are returns high on the cash being spent. If so, could be a good opp to buy, as many firms may shy away. If the CapEx is not a good spend, could still be a good buy if room to turn around and growth
C) mentioned in A, but would want/need to know how this investment is being supported. Debt? Earnings/FCF?
D) Is this spending continuous or is it an upfront cost that you can leverage for margin improvement over time. (For example-If it’s customer specific can it be applied for other customers post-project/build)
E) Salvage life of the spend and it’s use of life, important depending on nature of business (cyclical vs steady business/cash flows)
Thank you, Michael.
All good inputs here. I have not seen enough various business models to understand these perspectives. I have not worked on a deal which the management irrationally invested in buying an equipment that has nothing to do with their business. But totally understand there are exceptions out there. Thanks!
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