Many of you may have seen the coffee mug circulating on social media; EBITDAC, earnings before interest depreciation, amortization, and COVID-19! Brilliant, but also to a certain extent true. Many potential sellers simply will not accept transactions based on their 2020 numbers, which were adversely affected due to the level of disruption. Yet deals will still need to be done and perhaps more pressingly in economic slowdowns, where synergy and economies of scale driven by acquisitions become even more important. Therefore, we can see the EBITDAC ‘tag’ and ring-fencing the COVID-19 numbers may be appropriate. This is fair but there is, in fact, a broader question, why EBITDA in the first place?
Given there have been three pandemics in the last 102 years, with SARS a near-miss, it could be said another was inevitable. COVID-19 is, of course, a ‘game-changer’ as governments seek to protect lives and our healthcare systems, despite the economic costs. As virtualisation and technology support the challenges of social distancing, this has also made companies pause to consider what is truly essential for productivity. We will also see other impacts, for example perhaps data tracking of our locations. Consequently, there is no doubt that every business model is experiencing a game change in some way with the key to survival as we wrote in last weeks ‘Lead ahead building your strategy around productivity’.
The broader question, therefore, is should valuations be so driven by the financial models such as EBITDA, or is the whole multiple of EBITDA valuation method flawed and actually, valuations should be measured by productivity and sustainability.
To a certain extent, we already see this trend in SaaS valuation models, with profits being less relevant than growth margins, the market size, and recurring and retainable revenues. Why therefore is this not the sort of modelling being carried out in other sectors and valuations? If COVID-19 is a game-changer is it not the time to also change valuation methods and look beyond the numbers. Should key valuation measures be centered around the business capabilities including technology, automation, productivity per head, team track record, growth rate, retention rate of customers and brand recognition?
To be contentious the EBITDA model is simply driven by a lack of imagination and risk management. No one in the finance world wants to say they made a value up or just ‘felt’ that it was the right deal looking at all the metrics. They feel they need a formula to follow and a justification to protect shareholders. When Pixar was acquired by Disney in 2006 for 7.4 billion against net income of just 30 million, many said Disney paid too much – but really the question was ‘how expensive would it have been for Disney if Pixar fell into someone else’s hands?’ In retrospect, the deal has proved enormously valuable with Disney’s overall stock rising. If you invested $10,000 in Disney 10 years ago, that investment would in February 2020 be worth $40,600.
In business valuations, it is a common yet mistaken statement that ‘you can’t pay for potential’. A buyer will argue that it has not yet been achieved, so it cannot be valued, whilst a seller will argue that the growth prospects will enhance yield. However, today with Covid 19 causing a poor performing period, this must be modelled aside. We may use historic profits to analyse yield, however, it is always the potential profits which are being purchased and paid for. In fact, the best deal structures take account of future trading and welcome a valuation in part based upon potential and capabilities. As leaders, we should be looking for deals that offer far more than their own isolated potential. In addition to the financial objective, what other strategic opportunities does the acquisition present?
Unfortunately, many leaders leave valuation methodologies to their finance analysts. A more beneficial approach would be for the financial analysts and business strategists to collaborate on their approach to identify a true reflection on valuation. M&A advisors tend to spend more time arguing about levels of working capital with buyers and sellers than helping them build truly world-class highly capable companies with competitive advantage, which is a shame. Avondale believe the game-changer for advisors is to raise their own game – to ring-fence financial performance due to COVID-19 and to focus on the growth and synergistic opportunities of tomorrow. Where all parties look past the recent EBITDAC financials, focus on the real value attributes of the business, and be creative with deal structure. There is little doubt this will result in a more successful acquisition and a more productive game.
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