Be Wary of EBITDAC

Nick Hulme, Managing Director for Benchmark International’s Manchester site, wrote an article pre-Covid around company valuations based on ‘multiples of earnings’.

Recently, articles around ‘EBITDAC’ have emerged – a measure of Covid adjusted earnings, and while he agrees that there is some great literature about EBITDAC, Nick warns that we need to be wary when negotiating so it doesn't take over.

In this blog, Nick summarises the most important takeaways from Covid, and what we can look forward to post-Covid.

A key message in my article on company valuations was that we all-too-often fail to sell on the real essence of the opportunity and that we can miss a trick if we allow our negotiations to become a number-crunching exercise, especially if the focus is on the past. Of course, buyers will want to understand the past and will be pretty focused on Covid right now, but we should remember that the ‘multiples of earnings’ valuation methodology is just an approximation of ‘net present value (NPV) of future cash flows’. The emphasis here is on the future and to get the best deals for our clients; our valuations need to look forwards, not backwards. Now more than ever.

Negotiations start with the marketing materials, otherwise known as the Information Memorandum. At Benchmark International, we are now adding a statement regarding the impact Covid has had on the business, bringing out any positives (‘resilience’ being a key word) and explaining the likelihood and timing of a return to normality. On top of this, we are ensuring that projections over the next 2-3 years are robust enough to focus discussions on the opportunity post-Covid.

Both trade and PE buyers will understand the need to focus on the opportunity to its fullest and not to insist that valuations are based on some form of EBITDAC assessment. Trade buyers will usually have a great insight into the sectors in which their targets operate, and PE buyers will do what they are good at, focusing on people and growth.

Stay Positive

Post-Covid, there will be plenty to be positive about:

• If a client has made super profits year-on-year historically and is soon to be a month or two into recovery, a buyer’s focus will be on true underlying earnings and growth. Up-to-date management information is essential, though.
• If a client has shown its resilience to recession, perhaps ahead of others, this might demand a premium. Appetite from buyers will be strong and multiples should increase.
• Better strategic buyers still have cash to use for acquisitions, and shouldn't be burdened by the need to raise debt (which is still difficult, especially from the newer debt funds) to complete deals, meaning they will soon be ‘chomping at the bit’ again. We may see a run of opportunistic consolidations, but we may also see the opposite as corporates look to offload non-core businesses – all great for M&A activity levels generally.
• The PE sector is still sitting on dry powder and is itching to get involved in sectors that have shown resilience. Healthcare of all guises will be in focus as the UK moves to reduce reliance on other countries, as well as anything related to financial services, technology or software, to name a few.

There will be some issues we need to keep a close eye on, of course, but UK business is ready:

• Brexit has been off the radar for a few months, but we can see Boris Johnson more than ever wanting to get this done and dusted. Good or bad, who knows? This recent period of uncertainty will surely have brought the best out of our business leaders and placed them well for whatever comes next.
• There are concerns that Capital Gains Tax (CGT) could increase from the current 10% or 20%, but there is reason to be hopeful as pre-Covid receipts from CGT were at an all-time high – would the government really want to tamper with this?
• There is also talk of a possible second Covid wave, perhaps into early 2021. Business owners will be ready for this. We all have our own part to play here, of course!

There is little doubt that M&A activity is on the up. In a recent spot poll of Manchester professionals, 50% said they are feeling an increase in activity levels on both sides, buyers and sellers. The other 50% will get left behind!

 

Author
Nick Hulme
Managing Director
Benchmark International