Top Reasons Why EBITDA Valuations Suck
. . . and need the help of an affirming DCF valuation.
Given the nature of EBITDA valuations why is there seemingly no one doing anything about them when they are entrusted with trillions of asset valuations each year?
Complete the Contact form to send your questions, comments and suggestions to Peer Inside.
- EBITDA Multiples are opaque. The assumptions inside an EBITDA Multiple are not directly identifiable for analysis.
- The knowledge to edit an EBITDA Multiple 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 subjective adjustments.
- Investment opportunities have legal, consulting, financing and other start-up costs not present in a peer group Multiple. In addition, the effect of an investment's 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 relative peer group amount. However, in today's valuation practice, little adherence is made to the peer group's relative EBITDA amount once a Multiple is calculated.
- Adjusting a peer group's Multiple for the difference between the peer group's imbedded debt structure and debt cost and an investment's debt structure and incremental debt cost is a subjective process.
- 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 embedded 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. 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.
- By default, the 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. The unidentified EBITDA growth embedded in an EBITDA Multiple and the EBITDA growth rate used to generate an investment’s financial statements cannot be compared for reasonableness.
- If an investment opportunity generates an initial unsatisfactory EBITDA amount a separate rudimentary non-specified valuation analysis determines whether the investment opportunity could be deemed viable. If deemed viable, transfers of EBITDA to period one from later periods occur until a time when an arbitrary satisfactory EBITDA amount (valuation) is reached.
- The practice being used to reach today's investment ‘go/no go’ decisions weighs an EBITDA and a DCF valuation. 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, 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 the 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 valuation feed-back mechanisms, EBITDA valuations have an incentivized self-full filling market value effect—that valuation decision advisors are either not technically capable of or willing to acknowledge.
- Capitalistic valuation business practice and academia's supposedly countering influence have created independent valuation cultures focusing on limiting change initiatives to top-down and embracing the NIH Syndrome. These are defensive traits necessary to defend today's subjective status quo of investment valuation. The traits hinder acknowledgement of EBITDA's shortcomings and thus hinder any progress to address its shortcomings. —“There is no doubt we've got a good thing going here. Why would we want someone to rock this boat?"
Peer Inside An EBITDA Multiple
. . . and match what you find with an affirming DCF valuation to begin the journey of creating purposeful valuation feed-back mechanisms.