Private Equity valuation - which earnings multiple?

Hi all,

A private equity company is looking to value a potential target business. The initial premise was to buy out the whole target including all its debt so I initially used Enterprise Value/EBITDA multiple to work out the overall value of the target and also the value of the equity (EV - debt + cash = value of equity).

However, since then the acquirer has expressed an interest to keep the target’s existing senior bank debt in the company after the acquisition. The PE firm will own all equity and junior debt but the senior bank debt should remain as is. We were always going to buy the junior debt at face/book value so no change there however, I am not sure if EV/EBITDA is still the right way to value the equity in the business if the senior debt remains. I was thinking of using the price/earnings multiple now. Any thoughts?


Do your own homework.

be nice Itera

I’m not a PE guy, but my understanding is that enterprise value (and the things you compute from it) should not depend on who owns the debt, assuming that the debt is just standard debt and doesn’t confer any special privileges to its owners. If the debt was going to be retired or refiananced, then there may be changes to EV that go through the effect on WACC. Therefore, if you were using an EBITDA multiple before, I don’t see a big reason to stop using it under the new structure just because a different entity owns the debt.

I always thought that an EBIT based multiple makes more sense than an EBITDA one, since there’s no reason to assume that capex that is depreciated and/or amortized should not be counted as some kind of expense against revenues and deducted from ongoing earnings before using a multiple. Using EBIDTDA vs EBIT suggests that capex expenses are somehow less of a real expense than ordinary expenses. While it is true that capital does not get “used up” in the same way that raw materials do, capital eventually needs to be replaced or becomes obsolete, and if it doesn’t, then it is not depreciated anyway.

^ There’s a lot of “stuff” in EBIT that makes it difficult to compare companies with similar operations but have different capital structures. A PE firm wants to get to the core operational margin withoutvarying layers of cost of capital. Some PE firms don’t even issue debt so cash yield is important.

Why are you even on here?

Thanks bchad.

Are you even in finance bro? I will end you!

Stay with EV/EBITDA regardless of the financing structure; that is the common multiple in private equity.

I am not sure what you mean by “buying the debt”. You would typically either assume the debt when buying the company or refinance it as part of the transaction. However your wording seems to imply that the PE firm would actually be providing junior debt (ie shareholder loan), which is not unheard of, but I am not sure that was the intent. In that case you would still not be technically “buying junior debt” but simply refinancing it with your own sources.

Buying debt is different from refinancing in that when you “buy” debt, you assume the cash flows resulting from it in exchange for a price, which may be different than the outstanding amount. When you refinance, you generally repay the full amount (plus any fees) and issue new debt on new terms. In practice the second approach is more common to plain vanilla PE transactions.

Management has significant discretion about depreciation (for instance, they can choose to have accelerated depreciation to reduce tax liability in the near future) and CAPEX (is their current level of CAPEX spending reflecting ongoing maintenance of the fixed asset base, or growth investment that increases operating capacity? is there deferred CAPEX?). That level of discretion reduces comparability among companies even in the same industry. A PE firm assumes control of the company and one of the immediate things they may do is consider changing some of these policies - this can make EBIT multiples a lot less relevant for this type of valuation.

Thanks, that makes more sense to me.