EBITDA multiples are one of the most often used business valuation indicators. Appraisers can evaluate a subject company’s performance and value to those of similar firms using these multiples. We’ll look at what EBITDA multiples are, how they may be used in valuation, the benefits and drawbacks of using EBITDA multiples for determining value, and some examples of typical EBITDA multiples by industry in this post.
EBITDA Multiples: What are they?
(EBITDA) is an abbreviation for earnings before interest, taxes, depreciation, and amortization. EBITDA is a financial performance statistic that is frequently used by investors and potential purchasers to assess a company’s financial performance.
The formula for calculating EBITDA is straightforward:
Operating profit + Depreciation + Amortization = EBITDA
This formula removes the non-operating impacts that are unique to each company. EBITDA permits comparisons of organizations across different sectors and tax levels since it focuses on profitability before depreciation and amortization (which can vary dramatically between industries).
The use of multiples to compare EBITDA values across industries allows organizations of varied sizes to be compared. Multiple values are often higher in industries with greater future development potential, and larger, more established organizations have higher multiples than smaller companies. When it comes to allocating multiples, the amount of EBITDA will also play a factor. This variation allows for the analysis of possible risk vs reward; in general, large organizations or those with more profitability provide less risk. The EBITDA multiple used to assess value will reflect this.
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Advantages & Disadvantages Of Using EBITDA Multiples For Valuation
EBITDA multiples are generally implemented for valuation since they are simple to calculate from financial records. To compute operating income before depreciation and amortization and enterprise value, multiply the amount of the company’s stock market value, outstanding debt, and cash on the balance sheet by EBITDA to get the multiple. It’s a lot faster and easier than doing a cost or income analysis to figure out how much something is worth.
The disadvantage is that EBITDA does not provide a direct value for a firm; it is only an approximation that allows value assessment by comparing measures for similar companies. As a result, it has the same constraints as using the market technique to determine value. The main disadvantage of using EBITDA multiples is that they are only a rough estimate because the subject firm is likely to differ in one or more important ways.
Another significant disadvantage is that EBITDA is not defined by accounting laws. Because it isn’t legally defined, corporate managers and others are prone to misrepresenting it. While it is a convenient and rapid approach to estimate a number, it is not without danger of inaccuracy.
To answer the question, “What is a good EBITDA multiple?” all of the above factors must be taken into consideration. A good EBITDA multiple is one that isn’t skewed by misrepresentation or misinformation and closely aligns with the characteristics of the subject business. Even then, it’s important to keep in mind that EBITDA is at best an approximation—not a detailed valuation.
When are EBITDA multiples by industry useful, and when are they not?
When there is a level of comparability, EBITDA multiples might be beneficial. EBITDA may offer a decent approximation of enterprise value when dealing with income-producing property when comparable assets are generally consistent, and it is useful for analyzing stocks or making portfolio selections.
Using EBITDA to assess value for tangible and intangible assets gets increasingly complex. It could be achievable in some instances. A power purchase agreement, for example, may be present in the power market for a new project. In these rare cases, a comparison may be possible—the purchase agreement provides an estimate of revenues, and if you can figure out the market value of comparable power plants and the difference between the subject company’s expenses and those of other companies in the same market, you can use EBITDA. To make comparisons, you’d still need to make modifications, although EBITDA may be useful in this case.
In other cases, the issue is still one of comparability. Two cable businesses, for example, provide identical services and goods, but their market demographics and customer markets are vastly different, making a comparison difficult to impossible. In August 2020, Lumen Technologies Inc. announced the sale of its telecommunications assets in 20 U.S. states, as an example. This came after Lumen announced in July 2020 that it would sell part of its South American holdings. The US assets had an EBITDA of 5.5, whereas the South American assets had an EBITDA of 9.
It’s tempting to apply these multiples to other assets; nevertheless, the multiples indicate a business enterprise value and demonstrate that diverse sorts of assets exist even inside the same organization. Lumen’s assets in the United States were mostly old copper wire networks, whereas those in South America were mostly fiber optic. Differences in technology and markets, as well as the fact that most of these transactions represent investment value rather than market value, add to the complexity. The EBITDA multiples from these transactions might be useful in valuing the business enterprise values of similarly located enterprises for similarly situated purchasers, although modifications would be required.
As previously stated, EBITDA multiples change depending on the industry and the size of the company. The EBITDA multiple will be influenced by the size of the subject firm, its profitability, its growth prospects, and the industry in which it works. The table below shows the variances in average multiples by industry; multiples for individual firms within those industries will vary depending on their size.
| Industry | EBITDA Average Multiple |
|---|---|
| Healthcare information and technology | 38.58 |
| Airlines | 6.42 |
| Drugs, biotechnology | 56.20 |
| Hotels and casinos | 17.27 |
| Retail, general | 14.70 |
| Retail, food | 8.89 |
| Utilities, excluding water | 12.74 |
| Homebuilding | 10.52 |
| Medical equipment and supplies | 32.70 |
| Oil and gas, exploration and production | 4.60 |
| Telecom, equipment (phones & handheld devices) | 14.50 |
| Professional information services (big data) | 33.16 |
| Software, system & application | 41.53 |
| Wireless telecommunications services | 7.40 |
(Values in table courtesy of Professor Aswath Damodaran, NYU.)
(Values in table courtesy of Professor Aswath Damodaran, NYU.)
As shown, the EBITDA multiples for different industries/business sectors vary widely. There can also be wide disparities within industries or sectors. There are several reasons for these disparities:
- First, a business with high expected growth will typically have a higher EBITDA multiple: EBITDA is a measure of financial performance, and a company with prospects for good future financial performance due to valuable contracts or intellectual property is likely to be profitable in the future. This applies to businesses in high-growth sectors such as technology. Examples from the table above include healthcare information and technology, biotechnology, professional information services, and software
- Secondly, a business with a higher profitability margin will rate a higher EBITDA multiple: Because current profitability (EBITDA margin) is higher, more cash is likely available for distribution to shareholders as well as to create reserves to overcome adverse events, justifying a higher multiple.
- Third, a business with stable profitability that does not vary greatly from year to year will have a higher EBITDA multiple: because stability of profits is an indication that the business is less sensitive to the economic cycle. Stable profitability in the past is in most cases an indication of stable profits in the future, meaning that the risk for buyers or investors is lower; this is reflected in a higher EBITDA multiple. An example from the table above is utilities.
EBITDA multiples will be lower in industries with more risk and smaller profit margins. Airlines, which run on low and cyclical profit margins and are extremely vulnerable to fluctuations in fuel prices and the economic cycle, and oil and gas exploration and production, which are both high risk and economically cyclical, are two examples from the table.
The case of wireless telecommunications services is fascinating. Because of its maturity, this industry now has a low EBITDA multiple. The majority of people today own cell phones and use wireless telecommunications services. In the mid-1990s, when mobile phones were being accepted by huge numbers of customers and wireless networks were being expanded, the EBITDA multiple for this business would have been far higher. There is considerably less room for expansion in the sector now that the market is saturated. Phones and portable gadgets, on the other hand, have a significantly higher EBITDA multiple due to the ongoing design, manufacturing, and introduction of new variants of these items to the market.
Current market conditions also impact EBITDA multiples. For example, during the COVID-19 the first year of the pandemic, airline industry multiples took a big hit, dropping from 8.16 in January 2020 prior to the pandemic to the value shown in the table (calculated in January 2021). The average airline EBITDA multiple calculated in May 2020 would have undoubtedly been even lower, since air travel has significantly rebounded in the interim. Market uncertainty and stress depress EBITDA multiples across industries, particularly growth-sensitive industries. As the pandemic progressed, its social and economic impacts were reflected in lower EBITDA multiples for hotels and casinos and oil and gas exploration and production. Industries like utilities and food retail were impacted less, because they were essential even when many nonessential business sectors were shut down.
While EBITDA multiples by industry can offer insight into the growth, profitability, and stability of profits of various business sectors, and are useful for calculating a quick and easy valuation for an individual subject business, they are an estimation rather than a thorough valuation. For calculating a more comprehensive valuation for a particular business or asset, engage the services of a company experienced in providing valuation services, such as Taqeem.
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