Corporate Finance in Atlantic Canada

Commentary on corporate finance issues for small- & mid-market private companies in Atlantic Canada

Archive for October 2012

Too much focus on EBITDA multiples?

leave a comment »

EBITDA = Earnings before interest, taxes and depreciation/amortization.

In the mid-market M&A space, ‘everyone’ loves to quote valuation or price as a multiple of EBITDA, but in my experience, this has become too simplistic.

First, some entrepreneurs (and even some of their advisors) forget that EBITDA multiples translate into the ‘enterprise value’ of the business (“EV”), and not directly into share (or equity values).  Because EBITDA is before interest, that means the result of applying a multiple is before debt.  EV less debt equals share/equity value.  I often explain the concept to clients as:  your business (the collection of working capital, real estate, equipment and goodwill) is owned by your company (which has any debt owed by the business), so if you have no debt, then the value of your business can be the same as the value of your company shares.

Second, EBITDA has become a ‘proxy’ for business cash flow, but it is really only a partial measure of operating cash flow … since it doesn’t factor in financing, capital asset purchases and income taxes (all very important things to the cash flow management of a business!).   Over time, the EBITDA multiples have come to recognize that EBITDA is an incomplete proxy for cash flow, but I regularly see entrepreneurs forgetting this reality when planning.

Third, the major challenge with people quoting EBITDA multiples is the range … 3 to 5 times is often quoted.  That is a very wide range, and fails to account for differences in capital intensive businesses versus (say) service businesses.  Since EV includes equipment, then an acquisition of an equipment-intensive business at 3 times is not going to financially ‘work’ (either for the purchaser or the vendor), but the market dictates the multiples, so not all capital intensive businesses trade at sufficiently high multiples to justify the investment.  Yet some folks still quote higher multiples for capital intensive businesses.

While the use of EBITDA multiples in M&A and valuation has come a long way, some forget that its origins come from the first leveraged buyout ‘craze’ of the ’80s (RJR Nabisco, etc), hence the failure sometimes of the ‘big company’ EBITDA metrics being adaptable to the small and mid-market sector.

Written by Dan Jennings

October 31, 2012 at 2:15 pm

Posted in CF Musings

Tagged with ,

MEG sells

leave a comment »

http://www.thechronicleherald.ca/business/149955-ns-company-bought-by-us-giant

SNL Financial, a large research firm based in Virginia., announced the acquisition of Metals Economics Group, the Halifax consulting company that focuses on mining intelligence and data.  The price tag was not disclosed.  Michael Chender was the vendor.

Another example of a strategic buyer consolidating an industry.

Written by Dan Jennings

October 18, 2012 at 7:49 pm

Posted in Announced Transactions

Tagged with

Mills retail store sold

leave a comment »

http://thechronicleherald.ca/business/146259-new-owners-eye-rejuvenated-mills

Mickey MacDonald has sold Mills, the venerable ladies fashion boutique in Halifax.  The buyers are three Halifax lawyers and a friend, who intend to keep the existing management team.  The deal did not include the high profile real estate on Spring Garden Road, so the purchasers will be moving the store further down the street in the new year.

Another example of the long list of financial buyers who are interested in acquiring local small businesses …

Written by Dan Jennings

October 11, 2012 at 8:37 am

Posted in Announced Transactions

Tagged with

Pent-up Demand for Deals

leave a comment »

http://valuationspeak.com/the-personal-side/where-is-the-mergers-and-acquisitions-tsunami/

Interesting blog post from Chris Mercer (one of the US valuation gurus) on the ‘M&A tsunami’ still to come.  He lists various reasons — from the availability of capital to baby boomer demographics — some of which apply to Atlantic Canada as well.  In particular, the amount of capital that is sitting on the sidelines is huge in our local marketplace.  Month after month, we are approached by acquirers and lenders, who have both debt/equity capital available for M&A but can’t find enough deals to utilize all this capital.  Private equity funds especially have capital they need to place in order to generate the returns promised to their investors and pay the managers bonuses (and holding cash in money market funds doesn’t cut it).

The question, of course, is if/when this pent-up demand will cause prices for small and local business M&A to rise?  I believe that eventually buyers and capital providers will be willing to accept lower returns and this will drive multiples and prices higher.  We saw the same thing happen in real estate over the last twenty years — the demand for real estate has driven cap rates to unheard-of lows, meaning that real estate owners/investors have come to accept relatively lower rates of return (higher prices) in exchange for an asset class they believe is relatively lower risk.  Many investors are also skeptical of the equity stock markets and the low rates of return expected there in the coming years.

In addition, Mercer makes a valid point below, i.e. the sellers largely (but not all) ‘paused’ in 2008-2010, but the baby boomers still eventually need to sell, even if they do expect to work longer past an expected retirement age.

“Baby Boomer Transition Bubble just got kicked down the road?
In essence, the bubble is still there – it just got kicked down the road.  Now, the backlog of sellers is bigger and the situation may become more urgent.  It is true that most business owners have adjusted their retirement expectations and it has been estimated that retirement ages have been pushed out about 3 years on average.  Since very few businesses sold during the 2008-2011 timeframe, there is an enormous backlog of business owners who would sell given the right circumstances.”

Written by Dan Jennings

October 5, 2012 at 3:57 pm

Posted in CF Musings

Tagged with