CAPEX and how it relates to adjusted EBITDA to Value the business?

August 05, 2024

by a searcher from University of Massachusetts at Lowell in Worcester County, MA, USA

I've been looking at asset heavy (CNC Machines) manufacturing businesses to acquire. For one of the businesses in particular, I see that the seller is buying a lot of equipment that essentially wipes out the profit in the business for the last 3 years (i.e. 20% of revenue spent on CAPEX for last 3 years which is about equal to adjusted EBITDA) I'm told this was to add capacity in the business and upgrade aging equipment but my feeling is that it was primarily for tax purposes since the revenue did not increase significantly as a result of the investment in the past 3 years. I know that most of their remaining machines are less than 10 years old and that useful life of CNC machines that are well maintained can be as long as 20+ years.

My estimates is that I can continue to get buy and limit CAPEX investment to around <5-6% of revenue.

My question is this:

How should I think about CAPEX as it relates to enterprise value of the business? If I have to plan 5-6% investment in CAPEX on a go forward basis, should I value the business on 15% approximate adjusted EBITDA (20% adj. EBITDA - 5% CAPEX)?

As always my concern is that lowering the EBITDA this way during my analysis may land me on a number that's no longer competitive to the seller. But if the last 3 years shows heavy equipment investment, I think I probably need to model some level of CAPEX and still have enough to cover debt service at a reasonable DSCR.

Thoughts?

As always thanks for the help from the great community here.

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

You are thinking about it correctly, it will come out in your free cashflow analysis and this is the reason that high capex companies will trade at lower multiples than a theoretical identical company that has no capex.

Since it sounds like you have "lumpier" capex needs you may want to project specific years for major replacements in your FCF analysis rather than an annual % of existing capital since it may impact your model, especially the first couple years of DSCR. It sounds like here you can push some replacements into the future but other companies you may need a higher initial rate of capex investment than you will need in perpetuity.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I concur with what has already been said. Most lenders are going to do an analysis and figure out what future CAPEX needs look like. If you can justify some one-time CAPEX in the past for growth, then you can likely convince a lender to use a lower number. But if CAPEX is always high and will likely need to be so going forward, you would need to adjust EBITDA to take it in account. I have seen many clients look at businesses, especially equipment heavy businesses, that appear to be very profitable and have strong EBITDA, but once the equipment cost is factored in the businesses really are not generating more than a meager living for the owner(s).

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