Top Reasons Why EBITDA Valuations Suck
. . . . and why no one seems to be doing anything about it
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- Business professionals entrust EBITDA Multiples with trillions of asset valuations, but business professionals are either clueless about or too reluctant to acknowledge EBITDA's valuation shortcomings.
- The assumptions inside opaque EBITDA Multiples are not all identifiable and therefore, how internal Multiple assumptions interact with each other is also not fully known. Not only are EBITDA Multiple assumptions not all identifiable, but any identifiable assumptions’ amounts are not verifiable.
- An initial EBITDA amount cannot be negative.
- Obtaining the business knowledge to transform a peer group’s information into a specific investment opportunity valuation is non-transparent. The knowledge comes not from formal education, objective analytical experience or a fundamental valuation doctrine but, years of divine intervention, summoning of voodoo sorcery and reading of tea leaves. The practice of transforming peer group EBITDA information into investment valuations fosters a culture of EBITDA gurus and wizards—flying by the seat of their pants.
- Peer group Multiples are based on a cursory relationship between a peer group’s current economic value (EV) and their historical EBITDA. Market based economic value is anticipatory in nature and historical EBITDA is obviously not. Remedying a Multiple's anticipatory and historical mix is fraught with subjectivity (#4).
- During inflationary periods, compensating (reducing) a peer group's Multiple for the difference between the peer group's imbedded debt cost and an investment's incremental debt cost is a subjective process (#4).
- Investment opportunities have legal, consulting, financing and other start-up costs not present in a peer group Multiple. Plus, the effect of management/operating 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 a peer group's relative EBITDA amount. Usually, when fashioning an investment opportunity's initial EBITDA amount (#4), estimates germane only to the investment opportunity are used to determine an initial EBITDA amount.
- An investment valuation's use of a peer group's EBITDA Multiple implies the investment opportunity and the peer group have some degree of similar assets. The asset useful life imbedded in an EBITDA Multiple is ascertainable from asset details used to generate the 'DA' portion of their historical EBITDA. However, investment opportunities fashion their own EBITDA asset useful life (#4). Any 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 (#5). However, no one exactly knows how it gets there (#2) or how to delineate the growth rate for its consideration. Instead, investment opportunities fashion their own EBITDA growth rate (#4). The unidentifiable EBITDA growth imbedded in an EBITDA Multiple and the EBITDA growth rate used to generate an investment’s prospective financial statements cannot help but be two different growth rates. 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 right valuation answer. Reaching investment ‘go/no go’ decisions, through the practice of weighing EBITDA and DCF valuations (# 4), is a subjective, unsubstantiated mystic ‘smoke’ and ‘mirror’ process—“pay no attention to that man behind the curtain”.
- The subjectivity surrounding 'go/no go' investment decisions promotes an EBITDA consulting paradigm and aura 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, consultants contractually distance themselves from accountability of their work product—buyer beware.
- Pertaining to asset valuation bubbles, the market based economic value (EV) aspect of generating EBITDA Multiples (#5) fuels a self-perpetuating valuation effect. With no purposeful validation feed-back mechanisms (#2, #3, #4, #5, #6, #7, #8, #9, #10, #11, #12), EBITDA valuations have only an incentivized (#12) self full-filling market value effect—that no one either sees or acknowledges (#1).
- Academia and business practice's propensity for top-down driven change initiatives hinders EBITDA's shortcoming acknowledgement (#1).