Adjusting EV for Operating Lease Liabilities?
Bankers,
How are you handling this in comps / presentations now that operating lease liabilities are considered debt? CapIQ now includes this in the numbers, now drastically increasing EV in some cases. Are you adjusting EV to exclude lease liabilities, or netting the right of use asset against it? Or no adjustment at all, with multiples just increasing? Or using new EV/EBITDAR where it wouldn't have been used previously?
For EV / EBITDA (most common) calculations do not add operating lease liabilities to EV since your rent expense is already removed from EBITDA (in essence you already accounted for it).
For EV / EBITDAR calculations you should add operating lease liabilities to EV since EBITDAR is before rental expense.
I really hate that CapIQ started adding operating leases to EV. It makes sense that it can be treated as debt, but for EBITDA multiple purposes it screws things up.
Yep I also hate it. I wonder if Factset has done the same.
The new FASB rule ASC 842 require: all leases over one year in duration to be capitalized for GAAP reporting. For EV calculations capital leases should be treated as debt. 2019 is the first year that all companies are required to capitalize leases over 1 year.
As a result of this accounting change, it is now easier to compare companies that tried to mask asset intensity of their operations by treating lt operating leases as off balance sheet liabilities. ebitda adjustments such as EBITDAR will be obsolete on a go forward basis.
I suppose whether this is captured in analyses may have varied Bank by Bank / transaction by transaction historically, but on a go forward basis I think the best practice is to treat them as debt.
If you do a google search you can find white papers from the big 4 on how to account for the change. But all public companies started reporting this way in calendar Q1 of this year.
Yep. Good background.
It'll be interesting to see if buyers try to get it treated as part of indebtedness. We just sold a subsidiary and the buyer did not try to have the operating lease liabilities included, although they weren't very material in this case. In this scenario, I don't think they should be included since the company isn't getting any earnings credit.
Why would EBITDAR be obsolete going forward? Wouldn't it be more relevant? Granted I'm not a retail guy, but that doesn't seem right.
My guess is most banks haven't really adjusted their multiples to account for the change, although conceptually they should be adjusting the numerator or denominator.
Great response and post. I am an incoming SA and wanted to piggy back off your approach. When creating trading comps, you'd, like you said use EV( Including operating lease liabilities)/ EBITDAR, or debt( Including operating lease) to ebitadr... However, for a DCF, would you exclude operating lease from your net debt calculation when going from EV to equity value?? I'd assume you would if you use a standard adj. ebitda metric for your forecast or if you are able to adjust it for imputed interest on the operating lease, then you would include the operating lease in the calculation for net debt??? thanks again
Thanks for the response! I guess that's one of those areas where I would leave a toggle in, use standard adj. ebitda( No addition of imputed interest) and let my associate dictate! Cheers! Happy New Year ( if it's not too late)
CapIQ is releasing an update in February 2020 to correct the TEV/EBITDA calculation as it was previously not "apples to apples" increasing the EV by the capitalized leases, but no change to EBITDA.
Does this mean that in comps adjustments these days, people are having to adjust EV and EBITDA to be apples to apples with 2019 accounting changes (i.e. - capitalized leases from NOPAT, and add them into EV)
bump--anyone?
Google: "ASC 842 and the Impact on Business Valuation - Stout"
Yes, you do need to calculate EBITDAR.
TEV = Market Cap. (Total equity value) + Interest bearing debt - Cash
See, on the asset side, creation of a new item, here "right-of-use lease assets" is taken care by Depreciation in EBITDA.
But there's also the liability side, where creation of the new item "lease liabilities". Here, lease liabilities are being treated as interest bearing debt, because rental expenses are perceived as interest expenses. It demands that Rental expenses be added back to EBITDA.
Now the TEV/EBITDAR multiple would make sense. That's how we can compare apple to apple.
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