High EBITDA margin company. Concern for too high Price/Rev?
March 02, 2020
by a searcher from IESE Business School in Barcelona, Spain
March 02, 2020
by a searcher from IESE Business School in Barcelona, Spain
from University of Pennsylvania in Indianapolis, IN, USA
As others have stated, go back several years on financials and if the high margins are a recent spike, check for the seller eliminating costs close to a sale that they previously ran through the business or one-time business. If the business is in manufacturing or some other high capex business, check to make sure they are not deferring maintenance or other capex to inflate EBITDA that a buyer would then have to make up post sale.
If you are really concerned and EBITDA plus the margins have peaked recently, a 3-to-5 year average could be used similar to cyclical industries.
The main question is do you, as the buyer, believe the margins are real and, more importantly, sustainable post-close? If not, then you should use a normalized EBITDA. If you think they are sustainable, use them and maybe include an escrow, seller note or earnout based on those margins being sustainable.
Sometimes they are real. I originated an acquisition of a large industrial scrap processor that had 15% plus EBITDA margins in an industry of 10% or below, which was due to their operational efficiency. The company made a great platform for an industry consolidation where there was a large amount of value created from valuation arbitrage and their operational approach immediately improved the profitability of each of their add-on acquisitions.
from New York University in Berlin, Germany
I feel, most important is your judgment on being able to generate a return and this depends on the company itself and the industry.
For instance: with a high EBITDA margin company your lever to generate a return might not be improving the margin but rather revenue growth. While vice versa for a high revenue but low margin company the lever might be in improving the margin. Whether either one is feasible depends on the company and the industry, I'd say.
My investment focus is slightly off from the traditional searchfund model but when I look at companies I try to fast figure out if I see a viable strategy during the initital DD/conversation and follow my playbook of value generation. If I don't see that path, I don't spend more time on it.