Business valuations – part 5

October 2, 2017

I have already discussed the shortcomings of using EBITDA in business valuation, despite its prevalence in financial markets and company announcements.

My preference is not to ignore depreciation. Depreciation is often considered a proxy for capital expenditure. You know, the money that needs to be spent to grow your business or replenish capital assets.

The relationship between depreciation and capital expenditure for ASX listed companies was 103% in the last two years, so not far off the mark.

Let’s say we really, really want to use multiples of EBITDA. To use this information, we need to understand the relationship between EBIT, depreciation and EBITDA.

So how does depreciation impact multiples.

ASX listed companies in the Consumer Staples and Telecommunication Services industries have broadly similar EBIT multiples (on average).

Can we convert these to EBITDA multiples?

Yes, quite easily. The simplest is to use the relationship between depreciation and EBIT (Depreciation Factor), as described by Chris Mercer from Mercer Capital.

Industry EBIT multiple Depreciation as % EBIT Implied EBITDA multiple
Consumer staples 14.0x 14% 12.2x
Telecommunication services 14.0x 31% 10.7x

We can see that Consumer Staples companies have higher EBITDA multiples because of lower capital intensity. Put another way, less profit is used to fund capital expenditure.

If we assume all ASX listed companies have an EBIT multiple of 13.0x (roughly the average), we can identify relative capital intensity and the impact on EBITDA multiples.

Industry Depreciation as % EBIT Implied EBITDA multiple
Financials 11.7% 11.6
Consumer staples 14.4% 11.4
Healthcare 16.4% 11.2
Containers and Packaging 17.2% 11.1
Consumer discretionary 20.1% 10.8
Industrials 20.3% 10.8
Information Tech 21.7% 10.7
Chemicals 27.9% 10.2
Telecommunication services 30.9% 9.9
Utilities 42.8% 9.1

Source: CapIQ

Financials companies have higher EBITDA multiples as typically they are less capital intensive than Utilities and Telco’s, that clearly need to re-invest in infrastructure assets.

The more capital intensive, the higher the depreciation, the lower the EBITDA multiple, all other things equal.


Because these companies are spending less of their profits on replenishing capital equipment and have more money for other things – like paying dividends to shareholders.

What is the relevance to private business?

Let’s say buying and selling businesses in the retail industry happen at an implied EBITDA multiple of 4x, on average. IBISWorld tells us that the depreciation factor is 27% for this industry.

If a private business has normalised EBITDA of $1 million, then our business value would be $4 million.

What if that business is less capital intensive than the industry, say with a depreciation factor of 15%?

Let’s adjust for the differences in capital intensity and see what happens.

Industry EBITDA multiple 4.0x
Depreciation factor 27%
Implied industry EBIT multiple 5.1x
Private business dep. factor 15%
Adjusted EBITDA multiple 4.4x
EBITDA ($m) 1,000
Business value 4,400
Original value 4,000

Using the industry EBITDA multiple would have under-valued the business. Alternatively, we could have applied an EBIT multiple and avoided this situation.

Just because you heard business transactions happened at 4x EBITDA does not mean that is relevant to your business.

By the way, my son and I fixed that toy combustion engine.

Lachie McColl