Investment Banking Q&A
VALUATION:
Why does Warren Buffett prefer EBIT multiples to EBITDA
multiples?
Warren Buffett once famously said, "Does management think the
tooth fairy pays for capital expenditures?” He dislikes EBITDA
because it excludes the often-sizable Capital Expenditures
companies make and hides how much cash they are actually
using to finance their operations.
EBIT is often closer to Free Cash Flow (FCF) for a company,
defined as Operating Cash Flow (OCF)– CapEx, because both
EBIT and FCF reflect CapEx in whole or in part. EBITDA is often
closer to OCF because both metrics completely exclude CapEx.
EV / EBIT includes Depreciation & Amortization whereas EV /
EBITDA excludes it – you’re more likely to use EV / EBIT in
industries where D&A is large and where capital expenditures
and fixed assets are important (e.g. manufacturing), and EV /
EBITDA in industries where fixed assets are less important and
where D&A is comparatively smaller (e.g. Internet companies).
How do you apply the 3 valuation methodologies to actually get
a value for the company you’re looking at?
You take the median multiple of a set of companies or
transactions and then multiply it by the relevant metric from the
company you’re valuing.
Example: If the median EBITDA multiple from your set of
Precedent Transactions is 6x and your company’s EBITDA is
$500 million, the implied Enterprise Value would be $3 billion.
Would an LBO or DCF give a higher valuation?
In most cases the DCF will give a higher valuation than the LBO.
Here’s the easiest way to think about it: with an LBO, you do not
get any value from the cash flows of a company in between Year
1 and the final year – you’re only valuing it based on its terminal
value. With a DCF, by contrast, you’re considering both the
company’s cash flows in between and its terminal value, so
values tend to be higher.
How do you value a private company?
You use the same methodologies as with public companies:
public company
comparables, precedent transactions, and DCF. But there are
some differences:
VALUATION:
Why does Warren Buffett prefer EBIT multiples to EBITDA
multiples?
Warren Buffett once famously said, "Does management think the
tooth fairy pays for capital expenditures?” He dislikes EBITDA
because it excludes the often-sizable Capital Expenditures
companies make and hides how much cash they are actually
using to finance their operations.
EBIT is often closer to Free Cash Flow (FCF) for a company,
defined as Operating Cash Flow (OCF)– CapEx, because both
EBIT and FCF reflect CapEx in whole or in part. EBITDA is often
closer to OCF because both metrics completely exclude CapEx.
EV / EBIT includes Depreciation & Amortization whereas EV /
EBITDA excludes it – you’re more likely to use EV / EBIT in
industries where D&A is large and where capital expenditures
and fixed assets are important (e.g. manufacturing), and EV /
EBITDA in industries where fixed assets are less important and
where D&A is comparatively smaller (e.g. Internet companies).
How do you apply the 3 valuation methodologies to actually get
a value for the company you’re looking at?
You take the median multiple of a set of companies or
transactions and then multiply it by the relevant metric from the
company you’re valuing.
Example: If the median EBITDA multiple from your set of
Precedent Transactions is 6x and your company’s EBITDA is
$500 million, the implied Enterprise Value would be $3 billion.
Would an LBO or DCF give a higher valuation?
In most cases the DCF will give a higher valuation than the LBO.
Here’s the easiest way to think about it: with an LBO, you do not
get any value from the cash flows of a company in between Year
1 and the final year – you’re only valuing it based on its terminal
value. With a DCF, by contrast, you’re considering both the
company’s cash flows in between and its terminal value, so
values tend to be higher.
How do you value a private company?
You use the same methodologies as with public companies:
public company
comparables, precedent transactions, and DCF. But there are
some differences:
