Company valuation: beyond EBITDA: key metrics for mergers and acquisitions

When it comes to mergers and acquisitions, valuing a company is the first step. And while EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) is a widely used metric, it is not the only one that determines the real value of a business. In this article, we will explore some of the key metrics beyond EBITDA that experts consider when making investment decisions.

Why EBITDA is not everything?

EBITDA, while a useful tool for quick comparisons between companies, has certain limitations that prevent it from being considered as the sole indicator of the financial health and value of a business. By eliminating items such as interest, taxes, depreciation and amortisation, EBITDA provides a simplified view of operating profitability, but obscures fundamental aspects that are crucial for accurate valuation.

First, EBITDA does not reflect a company’s ability to generate free cash flow. The latter is a much closer indicator of the amount of cash a business generates that can be used to pay dividends, reduce debt or reinvest in growth. By omitting capital expenditure (CAPEX), EBITDA can overestimate the cash generation capacity of a company that requires significant investments to maintain or expand its operations.

Furthermore, EBITDA does not take into account a company’s capital structure. Companies with high levels of debt have to allocate a significant portion of their revenues to interest payments. Although these payments are not reflected in EBITDA, they have an impact on profitability for shareholders and on the company’s ability to cope with future crises.

Another important aspect that EBITDA does not capture is the efficiency of asset use. Two companies with the same EBITDA may have very different asset management. One company may generate high EBITDA through high asset turnover, while another may achieve it with lower efficiency.

Finally, EBITDA does not take into account the value of intangible assets, such as brands, patents or human capital. These assets can represent a significant part of a company’s value, especially in technology sectors.

Key metrics for a comprehensive assessment

When we enter the world of mergers and acquisitions, the valuation of a company becomes a crucial process. While EBITDA is a widely used metric, it is not the only one that provides a complete picture of the value of a business. To perform a comprehensive valuation, we must go further and consider a number of metrics that allow us to assess various aspects of the company.

Free cash flow, for example, reveals the amount of cash a company generates that can be reinvested in the business, distributed to shareholders or used to reduce debt. This metric is critical, as it provides a more realistic picture of a company’s ability to generate long-term value.

Valuation multiples, such as EV/EBITDA or price to earnings, allow us to compare the company with its competitors and establish a reasonable valuation range. These multiples help us understand whether we are paying a fair price for the company or whether we are overvaluing it.

Book value, on the other hand, shows the difference between a company’s assets and liabilities. Although it may not reflect market value, it is an important measure of the financial strength of a business.

Intangible assets, such as patents, brands or know-how, represent a significant part of the value of many companies, especially in sectors such as technology or pharmaceuticals. These assets, although not tangible, generate value and should be considered in valuation.

Future growth potential is another key factor. Companies with high projected growth rates tend to be more highly valued, as investors expect higher returns in the future.

In short, a comprehensive valuation of a company requires the analysis of a combination of financial and non-financial metrics. Each of these metrics provides a different perspective and helps us to build a more complete picture of the company’s value.

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Other factors to consider

Beyond traditional financial metrics, there are other qualitative and quantitative factors that can significantly impact a company’s valuation. These often subjective elements must be carefully evaluated to obtain an accurate and realistic valuation.

The economic environment and the sector in which the company operates are determining factors. A favourable economic cycle, sustained growth in the sector and strong demand can increase the value of a company. Conversely, an adverse economic environment or a declining industry can reduce its value.

Competition also plays a crucial role. A highly competitive market can put pressure on profit margins and limit growth opportunities, while a market with few competitors can allow the company to earn higher profits and set higher prices.

Government regulation is another factor to consider. Changes in laws and regulations can have a significant impact on a company’s operating costs and its ability to generate revenue.

The quality of management is critical. An experienced management team with a clear vision can generate greater shareholder value. Conversely, inefficient management or high staff turnover can reduce the value of the company.

The potential for synergies is a key factor in mergers and acquisitions. When two companies join forces, they can generate economies of scale, optimise processes and access new markets. These synergies can significantly increase the value of the deal.

Brand reputation and customer loyalty are intangible assets that can influence valuation. A strong and recognised brand can generate greater shareholder value and facilitate entry into new markets.

Conclusion

The valuation of a company is a complex process that requires consideration of a wide range of factors, both quantitative and qualitative. A thorough analysis of these factors will lead to a more accurate and realistic valuation, which in turn will facilitate informed decision-making in the context of a merger or acquisition transaction.

If you are considering a merger or acquisition, a thorough valuation of the target company is essential. EBITDA is a useful tool, but it should not be the only valuation criterion. A comprehensive valuation should consider a wide range of factors, both financial and non-financial.

At ILP Abogados we offer you comprehensive legal advice on mergers and acquisitions.

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