How to think about valuation for companies with large amounts of inventory/assets

April 24, 2018

by a searcher from Bentley University in Boston, MA, USA

What is everyone doing for valuation when a company has 1-2x ebita in inventory or assets? The typical valuation model of 3-5x ebita or 2-3x SDE doesn't seem to capture this fully. For example the same business could be running with fully owned inventory, or on a business credit line. The payment towards the line would dent ebita but it would be a fraction of the inventory value.

I'm seeing sellers wanting to get a multiple of ebita/SDE plus something for inventory, as they see inventory as their stored cash. While that is true, the inventory is needed to generate the cash flow. Are other's seeing this and how are you thinking about it in terms of valuation? What conversations are you having with sellers about this, or do you simply move onto the next deal because the seller is irrational?

Reply by an investor
from University of California, Berkeley in Moorestown, NJ 08057, USA

I recently posted on this and have walked from a few such businesses lately for this very reason. Others have posted a lot of good advice on inventory. On fixed assets, if a company needs more in machinery and tools than it's worth in SDE or EBITDA, then it's probably more attractive to a strategic acquirer who can shed the assets and assume the business into its existing operations, and as a financial buyer you'll be hard-pressed to compete against that. Unless none of their competitors want to buy them and then you have to ask yourself why that is. Fixed assets can also be financed but only at a percentage of their market value.

Reply by a searcher
from Harvard University in Los Angeles, CA, USA

If you believe in the metaphor that a business is a machine that prints money, then whatever you put in (your assets), are providing a return (cashflow). So if you want to buy a business with a lot of assets, and pay more than an similar cash flow generating asset-light business, I would think of it in terms of increasing your ROI- is it predictability of cashflows? Cheaper debt? + in many cases, small business owners are not great at supply chain management, and may have built up significant inventory that you cannot sell. You may not want to include all of the inventory in the purchase and be stuck with dead weight.

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