The EV/EBITDA multiple

In some of my articles over the past few years, I explained the significance and uses of various financial metrics and valuation multiples.

In recent years, many international financial analysts regularly quoted the EV/EBITDA multiple when commenting on a company’s investment rationale. In fact, it has reportedly now become the second most popular valuation metric after the price to earnings ratio.

The Enterprise Value (EV) depicts a company’s total valuation and is calculated by adding the amount of net debt to a company’s market capitalisation. The enterprise value can be considered as the price or value at which a company is bought by an investor since in the hypothetical case of a takeover, the buyer will have to take into consideration the debt of the company as well when calculating the overall price that would need to be paid.

EBITDA is operating profit (i.e. earnings before interest and taxes – or EBIT) plus depreciation and amortisation charges (DA).

The EV/EBITDA multiple has become more commonly used for three main reasons: (i) it is a broad measure of cash flow and indicates a company’s capacity to invest and service its debt obligations; (ii) it can also be relevant for companies that report losses since EBITDA is often in positive territory even when earnings are negative; and (iii) EBITDA appears more applicable for companies that seek to minimise taxes by extending their ability to take on more debt.

EV/EBITDA ratios vary according to the nature of the sector. As such, as with several other multiples, the EV/EBITDA multiple should only be compared among similar businesses operating within the same industry. One would expect higher EV/EBITDA ratios for high growth industries such as technology and lower multiples in industries with slower growth rates such as utilities.

When one compares companies within the same industry and having similar characteristics, a low EV/EBITDA ratio may indicate that a specific company is relatively undervalued while a high EV/EBITDA may indicate that the company is relatively overvalued and it would therefore be best not to invest in that company.

The EV/EBITDA multiple is widely regarded to be best used for capital intensive businesses which have high depreciation figures.

If one were to review the companies on the Regulated Main Market of the Malta Stock Exchange, a few have high depreciation figures and as such, the EV/EBITDA multiple is a ratio that should be given due consideration especially in the context of other similar companies overseas. These companies are GO plc, Malta International Airport plc, International Hotel Investments plc and Medserv plc.

GO plc has a current market capitalisation of €405 million and the interim financial statements as at 30 June 2018 show that the overall net debt of the group was €61.5 million (including the consolidation of Cablenet) giving an indicative enterprise value of €466.5 million. Meanwhile, the GO Group generated €32.9 million in EBITDA in the first half of 2018. As such, GO’s EV to EBITDA multiple works out at just over 7 times (on an annualised basis, including the consolidation of Cablenet) which, in turn, is lower than the average of around 8 times for selected telecom companies in Europe. Moreover, it is interesting to note that in July 2018, Monaco Telecom agreed to acquire MTN Cyprus also at an EV to EBITDA multiple of around 8 times.

When taking into consideration the total issued share capital of the company, the market capitalisation of Malta International Airport plc is of €825.3 million – the largest capitalised company on the MSE. MIA is one of the very few companies with no debt. In fact, the 2018 interim financial statements reveal that during the first half of 2018 the company used a large chunk of its idle cash balance to also pay-off all of its bank borrowings amounting to €33 million (in addition to the early repayment of an €11 million fixed interest rate loan during 2017). Despite the repayment of all bank borrowings over the past two years, the company still had €8.9 million in cash as at 30 June 2018. As such, this figure must be deducted from the market cap of the company to arrive at its enterprise value. MIA’s enterprise value using the June 2018 interim financial statements thus amounts to €816.4 million. In July 2018, MIA revised upwards its financial targets. The company is estimating to achieve an EBITDA in excess of €53 million during 2018 which would translate into an EV/EBITDA multiple of approximately 15.4 times. One should compare this figure not only to the multiple of Vienna Airport (being the single largest shareholder of MIA) but also to other airport operators handling similar passenger traffic since the smaller airport companies usually trade at a premium to larger ones.

International Hotel Investments plc has a market capitalisation of €375 million and as at June 2018 it reported overall net debt of €510 million (on a consolidated basis, including the Corinthia London hotel) giving an indicative enterprise value of €885 million. IHI had estimated that in 2018 it would generate an EBITDA of €70 million and it would have an overall net debt of €525 million. This implies that IHI’s equity is trading on a forward EV/EBITDA multiple of just under 13 times. Generally, IHI’s equity is also analysed in the context of the overall asset value of the group’s vast property portfolio.

Medserv plc has a current market capitalisation of €54.8 million and the overall net debt as at 30 June 2018 amounted to €53 million giving an enterprise value of €107.8 million. Medserv reported that it generated an EBITDA of €3.4 million in the first six months of 2018 (representing an increase of 18.5% when compared to the previous corresponding figure) and the company had estimated that it will generate an EBITDA of €6.81 million for the current financial year ending 31 December 2018. Should this be achieved, the forward EV/EBITDA multiple would equate to 15.8 times. Additionally, the UK-based specialists Edison Investment Research is projecting that Medserv should generate an EBITDA of €10.5 million in 2019 which would represent a significant improvement in the EV/EBITDA multiple to 10.3 times.

Although the EV/EBITDA ratio is a useful and popular multiple, there are many investors and analysts who criticise the use of this multiple. This is mainly because the use of the EBITDA ignores charges related to depreciation and amortisation which, in turn, understates the capital intensity of a company. This criticism is mostly directed at companies that need to undertake major capital investments on a regular basis, such as hotel companies. In fact, one of these critics is Warren Buffett who had mentioned his reservations on the use of the EV/EBITDA multiple in the annual shareholders meeting of Berkshire Hathaway in 2003. He argued that “any management that doesn’t regard depreciation as an expense is living in a dream world”.

The important thing when referring to certain multiples is to understand what they represent and the limitations on their use. However, various ratios and multiples can highlight valuable insights and investors should not only look at certain ratios in isolation when contemplating an investment but rather also take stock of expected company developments, the industry outlook and overall economic conditions.

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