How to think about necessary CapEx relative to EBITDA multiples?

September 26, 2023

by a searcher in Boston, MA, USA

Say a business has $1M EBITDA, but is dependent on a set of machinery or vehicles that require periodic replacement at an average cost of $300K per year. Businesses like this seem to consistently be listed by brokers at 4-5x EBITDA, with no "discount" given for the necessary recurring CapEx. Are these businesses just overpriced? Or is it standard to ignore that cost when valuing the business? Obviously the answer will vary somewhat by industry, but this seems to be the norm across a range of industries.

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

From a lender perspective, most lenders are going to adjust EBITDA for future CAPEX needs. They are going to determine those needs by looking at historical changes in gross fixed assets. If the company has been spending on average $300,000 for fixed assets for the past several years, then you are likely going to see a CAPEX adjustment of $300,000 made. Now you can counter this if the company was in growth mode and acquired more equipment then it normally would have, or if some of the assets were job specific or were for the owner (really high end owner vehicle, airplane, etc.). But outside of that, this is how I see most lenders adjust for CAPEX going forward.

As far as businesses being over-priced, I have seen a number of deals no longer work once the CAPEX adjustment occurs. Whether the multiple needs to be adjusted that much higher with the CAPEX removed, that is not my expertise, but often times it becomes hard to finance much of the purchase price if the broker is not factoring in those adjustments. Good luck.

Reply by an intermediary
from University of Missouri in Kansas City, MO, USA

Vinil has posted a very good explanation. Businesses that have a heavy reliance on fixed assets must consider the annual spend on CapEx as part of the business structure. He is correct that the majority of companies--if not all companies in that industry --will have basically the same CapEx requirements. That's when you also have to look at free cash flow versus your ability to service debt. It is also important to understand that you have a certified valuation on the total value of those fixed assets and that you understand what the seller's normal cadence has been to invest and replace aged equipment over the years. It's an easy trick to cut way back on investment in CapEx to strip extra cash out of the business prior to a sale and leave the buyer with antiquated equipment that will require a substantial investment in new equipment early in the deal. Then that can be weaved into the price of the deal.

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