Please explain in detail the mechanisms behind accretion / dilution when speaking about EV/EBITDA multiples and why a company would not want to acquire another one with a higher multiple.
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I'll try to explain.
Say there's a company trades at an EV/EBITDA multiple of 10. Now let's say there's a company you can buy with an EV/EBITDA multiple of 20.
That means that for a company that produces the same amount of cash flow from operations (roughly, because EBITDA =/= Cash Flow), you will pay an EV that is double what the first company costs which makes the exact same EBITDA. That's like buying two house investments that both make $100 per year in cash flow for you, and you can choose to buy one house for $100 or the other house that is $200 and they both give you the same cashflow. The $200 one is the company that has the multiple of 20 whereas the $100 house is the company with a multiple of 10.
Now for Accretion and Dilution - if your personal company has a multiple of 15. Buying the company with a multiple of 10 will be accretive to your company, because it will lower your overall multiple. If you buy the company with a higher multiple, like 20, then your company will become diluted, and your multiple will rise and your company will become more expensive for the same cash flow.
Let me know if that makes sense and if it doesn't I'd be happy to expand or try to explain it in a different way for you.
Thank you.
However, wouldn't a company want an EV/EBITDA multiple as high as possible?
Yes, investors would see it as less of a bargain, but at the same time it would indicate greater prospect and, eventually, a higher selling price for the owners.
Not an expert by any means but..
I don't think company owners necessarily want their company to be expensive, rather, they'd like their company to maximize profits for investors - I don't believe the two equate.
Here's a fantastic thread on WSO that covers this subject more thoroughly.
https://www.wallstreetoasis.com/forums/why-low-evebitda-good-target
Thanks for your reply. However, the thread focuses on a low EV/EBITDA multiple, rather than the dilution concept behind a multiple that is lower than that of the acquiring company
I get what you mean btw!
Sorry for my aggressive response above but we see threads like this one pop every week or so and looking for past threads should do the job.
Now onto your question: While yes some could argue that buying a company with greater EV/EBITDA has better prospects, others will argue that you are overpaying for said asset.
On the other hand, buying an asset for a lower ratio and putting it back in shape before selling it will often be a more profitable strategy. With the house example, it would be renovating the house for instance. That's pretty much what PE firms do, they buy assets at 'low' multiples, cut costs, grow the company a bit, and flip the company at higher multiples with the support of bankers running a competitive bidding process/IPO making their ~3x MOIC.
Thanks. I know, of course, that a low EV/EBITDA paid, translates into a cheaper acquisition and the possibility to extract greater value. What I don't get is the dilution concept of acquiring a company that has a lower multiple than the acquiring company. Could you explain this concept?
Do you understand accretion dilution from a EPS perspective because thats the same.
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