Adjusting Comps for leases
How do i adjust comps for leases in IFRS (IFRS 16) and US Gaap?
My understanding: If Capital leases are added to equity value as bridge to EV, the denominator should be EBITDA (so before lease interest and amortization on right of use asset). Is this correct?
IFRS 16 is about operational leases that will be capitalised (converted into capital leases).
From a DCF/LBO point of view: enterprise value will remain the same in any case (company / cash flows don't change).
If you start with equity value (for instance share price * shares outstanding) you indeed add the obligation as a debt like item to arrive at enterprise value. However, EBITDA will also be adjusted as the rent expense is now converted in in interest and depreciation which are both below EBITDA.
Thank you! Meaning you would have to add interest expense and depreciation to EBITDA
What previously was EBITDAR is now EBITDA. So EBITDA will increase because rent expense is taken out. In return interest and depreciation (both below EBITDA) will increase.
Although EV shouldn't change (cash flows don't change as you say), would it possibly increase as Net Debt increases? In the equ value --> EV bridge, I would add newly capitalised leases as a debt eqivalent item.
Why shouldn't it EV change? You're including another investor group in the numerator (likely a large amount as it's the full life of the lease) and removing only 1 year lease expense from denominator - this would increase EV.
Wouldn't the key with comps just be keeping it apples to apples?
Look, it depends :) If you take the capital leases in your WACC, EV will go up actually, because both FCF go up and WACC down (more leverage in general means lower WACC). Equity value however should remain exactly the same. See simple examlpe below:![Example](a href="https://i.ibb.co/4MWqG87/Simple-calc.png">https://i.ibb.co/4MWqG87/Simple-calc.png</a)
Anything excluded from decreasing EBITDA needs to be added to EV. With the recent accounting changes IIRC all leases including operating are now excluded from EBITDA, so EBITDA is now actually EBITDAR. Because it's excluded from decreasing EBITDA, you would need to add the lease liability as a debt-like item in your EV build.
How you add the lease liability is a point of debate among bankers - historically a 7x rent multiple was used so that has precedent. Additionally, the balance sheet liability now being reported under the new accounting rules only takes into account the liability of leases the company currently has, and not leases as they are renewed, which may understate the liability (the argument being that leases should be assumed to be renewed as they come due). For example, within that aggregate liability there may be a lease that expires within the year - this lease would actually be reflected as quite a low liability amount in the aggregate balance sheet figure. However, the lease is expected to be renewed which implies a much higher liability than is being reported in the balance sheet figure. For this reason, it may be argued that continuing to use the 7x rent expense method is superior and more reflective of the true liability position of the company's leases.
UBS had a report on this you should be able to find if you're interested ("LatAm Airlines: Our approach to IFRS 16 for airline valuation").
Thanks for the useful comment. Do you know where to find the report, by any chance ? I searched online for a while but couldn't find it.
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