Enterprise Multiples

.

EV/SALES

Equational Form

$\frac {EV}{Sales} \,= \,\frac{ROIC\, -\, g}{ROIC\,(WACC\,-\,g)}\,(1\,-\,T)\,(M)$

g solution

$g\,=\,\frac{ROIC\,[(T'\, x\, EBIT)\,-\,(EV\, x\, WACC)]}{(T'\,x\,EBIT)\,-\,(EV\, x\, ROIC)}$

Inputs

 $EV\,=\,Mkt\,Cap\,Equity\,+\,Mkt\,Value\,Debt\,-\,Cash$ $EBIT \,=\,Earnings\,\,Before\,\,Interest\,\,\&\,\,Taxes$ $T\,=\, Avg\, \,Tax\,\, Rate\,\, on\,\, EBIT$ $T'\, =\, 1\,-\,T$ $NOPLAT \,=\,EBIT\,(1\,-\,T)$ $IC\, =\, Fixed\, Assets\, +\, \Delta\, NWC$ $ROIC\,=\,\frac{NOPLAT}{IC}$ $WACC\,=\,\frac{E}{V}\,R_{E}\, +\, \frac{P}{V}\,R_{P}\,+\,\frac{D}{V}\,R_{D}\,(1\,-\,T)$ $Sales\,=\, Total\,\, Operating\,\, Revenue$ $M\,=\,\frac{EBIT}{Sales}$

Description 1

• EV/sales is a crude measure, but least susceptible to accounting differences; it is equivalent to its equity counterpart, price to sales, where a company has no debt.
• EV/sales is useful when accounting differences among comparables are extreme, or where profit or cash flow figures are unrepresentative or negative. It is frequently used for unprofitable or cyclical firms where there are problems in measuring profit or cash flow further down the P&L. As a proxy for cash flow, sales has the virtue of being stable and relatively unaffected by accounting policies.
• EV/sales is also useful in identifying restructuring potential. Net margin is a key driver of this measure; low profitability (low net margin) would result in a low value for a given level of sales.
• Be careful that the sales figure is representative; generally EV/sales should not be used for companies with variable, periodic sales, such as property developers.

Caveats There are three caveats in using this multiple:

1. Sales volatility: EV/sales is frequently applied to technology firms, which are likely to have negative cash flow and/or earnings while they are in their initial growth phase. But these companies frequently have highly volatile sales as well.
2. Revenue recognition policies: Sales are not unaffected by accounting policies.
3. Sales can be substantially affected by different interpretations of accounting standards in such areas as:
— Use of gross versus net revenue in recording sales on agency transactions
— Treatment of sales where a customer has the right of return
— Long-term contracts accounted for under percentage of completion or completed contract methods

1 Suozzo et al (2001) Valuation Multiples: A Primer; NYU Sterns School of Business; UBS Warburg; Gobal Equity Research; pg. 28-29

EV/EBITDA

Equational Form

$\frac {EV}{EBITDA} \,= \,\frac{ROIC\, -\, g}{ROIC\,(WACC\,-\,g)}\,(1\,-\,T)\,(1\,-\,D)$

g solution

$g\,=\,\frac{ROIC\,[(T'\, x\, EBIT)\,-\,(EV\, x\, WACC)]}{(T'\,x\,EBIT)\,-\,(EV\, x\, ROIC)}$

Inputs

 $EV\,=\,Mkt\,Cap\,Equity\,+\,Mkt\,Value\,Debt\,-\,Cash$ $EBIT \,=\,Earnings\,\,Before\,\,Interest\,\,\&\,\,Taxes$ $EBITDA\,=\,EBIT\, +\, Depreciation\,\,\&\,\,Amortization$ $T\,=\, Avg\, \,Tax\,\, Rate\,\, on\,\, EBIT$ $T'\, =\, 1\,-\,T$ $NOPLAT \,=\,EBIT\,(1\,-\,T)$ $IC\, =\, Fixed\, Assets\, +\, \Delta\, NWC$ $ROIC\,=\,\frac{NOPLAT}{IC}$ $WACC\,=\,\frac{E}{V}\,R_{E}\, +\, \frac{P}{V}\,R_{P}\,+\,\frac{D}{V}\,R_{D}\,(1\,-\,T)$ $D\,=\,\frac{(D\,+\,A)}{EBITDA}$ $D'\, =\, (1\,-\,D)$

Description 1

• EBITDA is a proxy for operating cash flow, and EV/EBITDA – probably the most popular EV multiple – is a price to cash flow multiple. Its popularity stems from the fact that it is unaffected by differences in depreciation policy and appears unaffected by differences in capital structure.
• However, while EBITDA is closer to cash flow than other profit measures it is not a true cash flow, as it does not incorporate either asset depreciation or capital expenditure. Also, EBITDA is a pretax measure, whereas management can potentially add value through skilled tax management.
• EV/EBITDA is affected by a firm’s level of capital intensity (measured as depreciation as a percentage of EBITDA). All things being equal, higher capital intensity results in a lower EV/EBITDA multiple.
• EV/EBITDA is most useful in comparing companies with a selected peer group that has a comparable level of capital intensity; comparisons of a stock with a sector average can also be useful as long as there is not a large variation in capital intensity within the sector.
• On the other hand, comparisons of a stock with the market, comparisons across sectors and comparisons of a sector with the market are unlikely to be meaningful.

1 Suozzo et al (2001) Valuation Multiples: A Primer; NYU Sterns School of Business; UBS Warburg; Gobal Equity Research; pg. 29-31

EV/NOPLAT

Equational Form

$\frac {EV}{NOPLAT} \,= \,\frac{ROIC\, -\, g}{ROIC\,(WACC\,-\,g)}$

g solution

$g\,=\,\frac{ROIC\,\,x\big[NOPLAT\,\,-\,\,(EV\,\,x\,\,WACC)\big]}{NOPLAT\,\,-\,\,(EV\,\,x\,\,ROIC)}$

Inputs

 $EV\,=\,Mkt\,Cap\,Equity\,+\,Mkt\,Value\,Debt\,-\,Cash$ $EBIT \,=\,Earnings\,\,Before\,\,Interest\,\,\&\,\,Taxes$ $T\,=\, Avg\, \,Tax\,\, Rate\,\, on\,\, EBIT$ $T'\, =\, 1\,-\,T$ $NOPLAT \,=\,EBIT\,(1\,-\,T)$ $IC\, =\, Fixed\, Assets\, +\, \Delta\, NWC$ $ROIC\,=\,\frac{NOPLAT}{IC}$ $WACC\,=\,\frac{E}{V}\,R_{E}\, +\, \frac{P}{V}\,R_{P}\,+\,\frac{D}{V}\,R_{D}\,(1\,-\,T)$

Description 1

• NOPLAT is a more sophisticated and complete form of EBIT that allows for differences in tax efficiency and effective tax rates. If the company were all equity-financed, NOPLAT would equal earnings.
• However, the calculation of NOPLAT introduces a measure of subjectivity. This makes it harder to compare to other parties’ calculations of NOPLAT.
• The NOPLAT multiple is effectively a degeared PE and is a perfectly reasonable statistic to use provided it is measured on a consistent basis across companies.
• EV/NOPLAT can be used as a substitute for EV/EBIT.

1 Suozzo et al (2001) Valuation Multiples: A Primer; NYU Sterns School of Business; UBS Warburg; Gobal Equity Research; pg. 32

EV/FCFOPS

$\frac {EV}{FCF_{OPS}} \,= \,\frac{ROIC\, -\, g}{ROIC\,(WACC\,-\,g)}\,(1\,-\,T)$

g solution

$g\,=\,\frac{ROIC\,[(T'\, x\, EBIT)\,-\,(EV\, x\, WACC)]}{(T'\,x\,EBIT)\,-\,(EV\, x\, ROIC)}$

Inputs

 $EV\,=\,Mkt\,Cap\,Equity\,+\,Mkt\,Value\,Debt\,-\,Cash$ $EBIT \,=\,Earnings\,\,Before\,\,Interest\,\,\&\,\,Taxes$ $FCF_{OPS} = EBIT$ $T\,=\, Avg\, \,Tax\,\, Rate\,\, on\,\, EBIT$ $NOPLAT \,=\,EBIT\,(1\,-\,T)$ $IC\, =\, Fixed\, Assets\, +\, \Delta\, NWC$ $ROIC\,=\,\frac{NOPLAT}{IC}$ $WACC\,=\,\frac{E}{V}\,R_{E}\, +\, \frac{P}{V}\,R_{P}\,+\,\frac{D}{V}\,R_{D}\,(1\,-\,T)$ $NWC\,=\,Current\,Assets\,-\,Current\,Liabilities$ $T'\, =\, 1\,-\,T$

Description 1

• Core EV/FCFOPS (Free Cash Flow from Operations). ROIC is calculated using FCFOPS in the numerator.
• FCFOPS is core EBITDA less charges for capital usage and for the effect of inflation on working capital needs. FCFOPS should be measured before goodwill amortization. A calculation of operating free cash flow is shown below.
• EV/FCFOPS is a price to cash flow measure similar to EV/EBIT. FCFOPS is not a true cash flow, however, as it does not include actual capital expenditure or change in working capital; it is a normalized EBIT or a smoothed cash flow.
• FCFOPS is more comparable than EBITDA and less susceptible to accounting distortions than EBIT, and is therefore a more suitable basis for valuation multiples. FCFOPS does, however, add another layer of subjectivity via the calculation of maintenance capital spending and net working capital inflation.
• EV/FCFOPS is preferable to EV/EBITDA for comparing companies within a sector, or for comparing companies across sectors or markets where companies have widely varying degrees of capital intensity.
• Operating free cash flow is a smoothed measure of free cash flow to the firm, for which historical figures can be highly volatile. Because of this, multiples using FCFOPS can be easier to interpret than those using free cash flow.
• This multiple cannot be used when current cash flow is negative. Use normalized FCFOPS or a forward-priced multiple instead.

1 Suozzo et al (2001) Valuation Multiples: A Primer; NYU Sterns School of Business; UBS Warburg; Gobal Equity Research; pg. 32

EV/EBIT

Equational Form

$\frac {EV}{EBIT} \,= \,\frac{ROIC\, -\, g}{ROIC\,(WACC\,-\,g)}\,(1\,-\,T)$

g solution

$g\,=\,\frac{ROIC\,[(T'\, x\, EBIT)\,-\,(EV\, x\, WACC)]}{(T'\,x\,EBIT)\,-\,(EV\, x\, ROIC)}$

Inputs

 $EV\,=\,Mkt\,Cap\,Equity\,+\,Mkt\,Value\,Debt\,-\,Cash$ $EBIT \,=\,Earnings\,\,Before\,\,Interest\,\,\&\,\,Taxes$ $T\,=\, Avg\, \,Tax\,\, Rate\,\, on\,\, EBIT$ $T'\, =\, 1\,-\,T$ $NOPLAT \,=\,EBIT\,(1\,-\,T)$ $IC\, =\, Fixed\, Assets\, +\, \Delta\, NWC$ $ROIC\,=\,\frac{NOPLAT}{IC}$ $WACC\,=\,\frac{E}{V}\,R_{E}\, +\, \frac{P}{V}\,R_{P}\,+\,\frac{D}{V}\,R_{D}\,(1\,-\,T)$

Description 1

• EBIT is a post-goodwill figure. However, we believe that goodwill amortization is not an economic charge and should properly be added back to operating profit.
• EBIT is a better measure of ‘free’ (post-maintenance capital spending) cash flow than EBITDA, and is more comparable where capital intensities differ.
• EBIT is, however, affected by accounting policy differences for depreciation.
• EV/EBIT is most useful where there are relatively small differences in accounting treatment of depreciation among comparables.
• Alternatively, you can normalise depreciation.
• Note that the goodwill adjustment does not apply to financial statements reported under US GAAP. Recently-published Financial Accounting Statement 142, Goodwill and Other Intangible Assets, stipulates that effective 1 January 2002 (for calendar year companies), goodwill is no longer to be amortized.

1 Suozzo et al (2001) Valuation Multiples: A Primer; NYU Sterns School of Business; UBS Warburg; Gobal Equity Research; pg. 31

EV/IC

Equational Form

$\frac {EV}{IC} \,= \,\frac{ROIC\, -\, g}{WACC\,-\,g}$

g solution

$g\,=\,\frac{NOPLAT\,-(EV\,x\,WACC)}{IC\,-\,EV}$

Inputs

 $EV\,=\,Mkt\,Cap\,Equity\,+\,Mkt\,Value\,Debt\,-\,Cash$ $IC\, =\, Fixed\, Assets\, +\, \Delta\, NWC$ $EBIT \,=\,Earnings\,\,Before\,\,Interest\,\,and\,\,Taxes$ $NWC\,=\,Current\,Assets\,-\,Current\,Liabilities$ $T\,=\, Avg\, \,Tax\,\, Rate\,\, on\,\, EBIT$ $NOPLAT \,=\,EBIT\,(1\,-\,T)$ $ROIC\,=\,\frac{NOPLAT}{IC}$ $WACC\,=\,\frac{E}{V}\,R_{E}\, +\, \frac{P}{V}\,R_{P}\,+\,\frac{D}{V}\,R_{D}\,(1\,-\,T)$

Description 1

• Invested capital, measured from the asset side of the balance sheet, is the sum of net tangible and intangible assets and net working capital. Invested capital excludes non-core investments and other assets, and to ensure comparability these must also be excluded from enterprise value.
• Alternative calculations are possible:
1. Total capital employed: Total capital employed is invested capital plus investments and associates. Return on total capital employed differs from return on invested capital in that the numerator for return on total capital employed includes income from non-core operating investments and other assets. To ensure comparability, enterprise value must also include the value of these assets.
2. Adjusted capital employed: This is total capital employed adjusted to bring book capital closer to economic capital. These adjustments (to assets; from Stern, Stewart) include adding back accumulated goodwill amortization, LIFO reserve and cumulative write-offs of special items, among others.
3. Replacement capital employed: Capital employed at replacement value, intended to better approximate the cost of replacing the capital base at current prices and therefore the return on assets at market value. This can be roughly approximated by adding back accumulated depreciation in addition to making the other adjustments noted above.
• The enterprise equivalent of price to book value, EV/invested capital is equal to EV/NOPLAT × ROIC (whereas price to book is equal to PE × ROE).
• Note that invested capital measures only operating assets whereas net book value includes the value of the firm’s cash holdings. Net income includes return on cash, but NOPLAT does not. NOPLAT is in this respect a better indication of core profitability than net income.
• This is a useful measure for sectors where tangible assets are key. Because of its close linkage to return on capital, it is useful to view this measure together with return on capital.
• Items included in invested capital or total capital employed must be consistent with items included in enterprise value.

1 Suozzo et al (2001) Valuation Multiples: A Primer; NYU Sterns School of Business; UBS Warburg; Gobal Equity Research; pg. 34-35