how would you value this distribution company?

October 07, 2019

by a searcher from The University of Chicago - Booth School of Business in Chicago, IL, USA

distributor of name-brand building products to contractors and construction companies (commercial construction not residential). HD Supply Holdings, Inc. (NasdaqGS:HDS) and other public comps trade 9x to 10x EBITDA. obviously, this business doesn't justify that, but the company is high quality and very steady cash flow. SDE $1.5M. EBITDA $1.2M.

Is 5.0x EBITDA too much for the business?

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Reply by a searcher
from The University of Chicago in Chicago, IL, USA

Thanks for the comments. If I recall correctly, the search fund literature and the HBR book indicate a reasonable range is 3.0x to 4.0x EBITDA for businesses of this size (seems to be regardless of industry). This is what gives me pause when I look at my numbers. The equity return (at a 5.0x purchase price) after taking into account SBA guaranteed debt is higher than using a###-###-#### debt equity capital structure (more typical without SBA financing). Does it make more sense to look at equity IRRs without the benefit of SBA backed debt (even if one intends to employ SBA backed debt)? More like a###-###-#### debt equity capital structure? Seems like the ability to pay with the SBA loan is higher than the intrinsic value might be calculated. Asked another way, if IRR / DCF is the only way to look at this because, from a practical perspective, there isn't a way to compare multiples, what is the right WACC to use? 50% debt at 7% (blended) interest with 30% equity return? Seems to me if one uses a WACC that is 80% to 90% debt at 8.25% (the current SBA rate) and only 10% equity, the discount rate is too low and will result in a valuation that is too high. [I note here that the personal guarantee effectively makes some portion of the SBA backed debt equivalent to equity, even though it is supported by the guarantee instead of a cash contribution.] Look forward to your thoughts.

Reply by a searcher
from Manhattan College in Port St. Lucie, FL, USA

The common theme is that the numbers have to make sense for you. Worked on a $5M deal via SBA and it was an ordeal. Once we drilled down on the financials, the value of the deal collapsed. The $1.2M EBITDA would worry me because it is just barely above the threshold for most lenders when they look for long term viability of the company. You want something with at least $2M or just below that before you dig into the numbers so that when they come up short, you’re at least above the threshold. $1.2m may turn out to be $600K-$800k when you lift the covers.

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