Top Reasons Why EBITDA Valuations Suck
. . . . and why no one seems to be doing anything about it even though EBITDA Multiples are entrusted with trillions of asset valuations each year.
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- EBITDA Multiples are opaque. The assumptions inside an EBITDA Multiple are not directly identifiable for analysis.
- The knowledge to transform EBITDA Multiples into an investment valuation is non-transparent. The knowledge comes not from formal education, objective analytical experience or a fundamental valuation concept but rather the summoning of voodoo sorcery and reading of tea leaves. The practice of transforming a peer group Multiple into an investment valuation fosters an environment of EBITDA gurus and wizards—flying by the seat of their pants.
- Peer group Multiples are based on the peer group’s economic value (EV) and their historical EBITDA. Market based EV is forward looking in nature and historical EBITDA is obviously not. Remedying the anticipatory and historical aspect of Multiples is fraught with subjectivity (#2).
- Investment opportunities have legal, consulting, financing and other start-up costs not present in a peer group Multiple. In addition, the effect of learning curves are also not present in the peer group Multiple. All else being equal, an investment opportunity's initial EBITDA amount should be below the corresponding relative peer group amount. However, in today's valuation practice, little adherence is made to a peer group's relative EBITDA amount. Usually, when fashioning an investment opportunity's initial EBITDA amount (#2), estimates and assumptions germane only to the investment opportunity are used to determine an investment's initial EBITDA amount.
- Adjusting a peer group's Multiple for the difference between the peer group's imbedded debt structure and cost and an investment's incremental debt structure and cost is a subjective process (#2).
- Using a peer group's EBITDA Multiple implies the investment opportunity and the peer group have a high degree of similar assets. The asset useful life imbedded in an EBITDA Multiple is ascertainable from peer group asset details used to generate the 'DA' portion of their EBITDA amount. However, investment opportunities fashion their own EBITDA asset useful life (#2). Non-accounted for differences in asset useful life between the peer group and the investment opportunity can have a significant impact on an investment's valuation.
- Necessary by default, an EBITDA periodic growth rate (beyond period one) is captured in a peer group Multiple. However, no one exactly knows how it gets there or how to delineate the EBITDA growth rate for its consideration. Instead, investment opportunities fashion their own EBITDA growth rate (#2). The unidentified EBITDA growth imbedded in an EBITDA Multiple and the EBITDA growth rate used to generate an investment’s prospective financial statements cannot be compared for reasonableness. Ideally, EBITDA peer groups would add their market-based EBITDA growth guidance to prospective EBITDA investment valuations, but they can't.
- Weighing EBITDA and DCF valuations is the practice used to reach today's investment ‘go/no go’ decisions. The intent of considering both EBITDA and DCF valuations is to instill investment decision makers with a level of comfort derived from the fact that no single wrong valuation outcome is being used, but rather weighing multiple wrong outcomes will somehow create the correct valuation answer. Reaching investment ‘go/no go’ decisions, through the practice of weighing EBITDA and DCF valuations (# 2), is a subjective, unsubstantiated mystic ‘smoke’ and ‘mirror’ process—“Pay no attention to that man behind the curtain”.
- The subjective aura surrounding 'go/no go' investment decisions promotes an EBITDA consulting paradigm of “Well, since everybody is right, then nobody is wrong.” Within this setting the ‘big dog’ at the negotiating table usually holds sway. The practice of EBITDA valuation consulting becomes choosing negotiating tables where you are that dog.
- Valuation consulting fees are not based on a reconciliation of actual results with expected—a fiduciary benchmark. Rather, sell-side consulting fees are based on achieving the highest valuation generated by the EBITDA/DCF consultant they hire. In addition, as a standard part of valuation engagements, both sell-side and buy-side valuation consultants contractually distance themselves from accountability of their work product—buyers of valuation consulting beware.
- Pertaining to asset valuation bubbles, the market based economic value (EV) aspect of generating EBITDA Multiples fuels a self-perpetuating valuation effect. With no purposeful validation feed-back mechanisms, EBITDA valuations have an incentivized (#10) self full-filling market value effect—that no one is either capable or wanting to acknowledge.
- Academia and business practice's propensity for top-down driven change initiatives and their NIH Syndrome hinders EBITDA's shortcoming acknowledgement—“We've got a good thing going here. Why would we want to rock this boat?"