EV/EBITDA and Acquisition valuation – Case Analysis for Dell Computer
Why is EV/EBITDA suitable for acquisition valuation?
That is because EV considers not only the equity value that the buyer should pay to the original owners but also the debt value they take over and need to repay.
The EV/EBITDA multiple also refers to the number of years it takes to recover the invested capital from the acquisition valuation perspective. For example, suppose that Firm A’s EV with the EBITDA of $2 million is $10 million. If a buyer who acquired A earns the EBITDA of $2 million for five years, he or she could recover all the capital of $10 million that includes the equity and debt value.
Equity valuation of a private company using EV/EBITDA
You can use EV/EBITDA to value the equity of the target company to acquire.
Target company’s EV = Listed comparable companies’ EV/EBITDA X Target company’s EBITDA
Like using PER to estimate the share price of a private company, you can calculate the target entity’s EV by multiplying its EBITDA by the listed similar firms’ EV/EBITDA. The procedure is like the following figure.
Acquisition valuation process with EV/EBITDA
- First, search and select listed companies to compare with your target company, and then calculate their average EV/EBITDA.
- Calculate or estimate the target company’s EBITDA.
- Estimate the target company’s EV by multiplying its EBITDA by the EV/EBITDA multiple of the comparable firms.
- Then, calculate the equity value you should pay to the original shareholders.
Let’s take the Dell Computer M&A, which occurred in 2013, as an example following these four steps. In this acquisition valuation, we use an EV/EBITDA multiple of ‘the year 2020’ to assess the old deal value level.
Case Analysis: Acquisition valuation for Dell Computer
Michael Dell founded Dell Computer in 1984 and had grown the company into one of the Fortune Fortune 500 companies in 1992 when he was 27. After years, for performance reasons, he was withdrawn from management in 2004. However, he came back as CEO in 2007 by the recommendation of the board of directors.
Michael owned only 13.4% share of Dell Computer when he returned to management. Over time, Michael Dell planned to buy out all the 86.6% stakes held by other investors in order to focus more on management according to his business strategy. Financially, in 2013, he took over all the shares by mobilising significant funds from investors such as Silver Lake Private Equity Fund and Microsoft.
The deal value in this M&A was about $22 billion.
Acquisition valuation stage 1: Calculation of their average EV/EBITDA after screening comparable companies.
Dell Computer was a computer manufacturer and sales company listed on Nasdaq. Thus, to search comparable companies, computer hardware was selected as an industry. The top six companies in the market share as of 2019 are Lenovo, HP, Dell, Apple, Acer, and Asus in order. Dell was excluded, and Apple was also left out of the six companies because of its high smartphone business proportion. And then, the average EV/EBITDA multiple was calculated with the remaining four companies. Although Asus and Acer are listed on the Taiwanese stock market, they were incorporated to secure the comparators’ number.
The average EV/EBITDA calculation of the peer group (Source: Yahoo Finance)
The average EV/EBITDA is 6.19 x, referenced by Yahoo Finance. Yahoo Finance uses Capital IQ data to provide it, but there was no mention of its calculation basis.
Acquisition valuation Step 2: Calculation or estimation of a target company’s EBITDA
Next, we need to calculate Dell Computer’s EBITDA. There are three main ways to figure it out: using past performance, using future performance, or combining the two methods.
- Use of past performance: Use of the average or weighted average EBITDA for the previous year, the last four quarters or twelve months, or the past n years.
- Use of future performance: Use of the average or weighted average estimated EBITDA for the next year, or the next four quarters or twelve months, or the coming n years.
- The mix of both: For example, mix the past two years’ EBITDA and the forecasted EBITDA for the next year, or combine the previous year’s one and the forecasted one for the following year.
It would be logical to determine what EBITDA you select based on your own analysis in consideration of the future EBITDA direction.
In the case of growth companies, the future EBITDA would be higher than in the present. In the case of mature companies that consistently generate profits without significant fluctuations, you could use the past EBITDA to estimate the near future. Also, it would make sense to reflect the EBITDA into decline if companies have entered bad seasons.
Dell Computer’s summarised income statement for EBITDA calculation
Dell Computer is a mature company, having an average EBITDA of $4,326m over the past ten years, an average of $4,869m over the past three years, and $4,156m in the previous year. We will estimate the company’s EV range using the average of the two EBITDA, the past three years’ average one and the past year’s one, just before the deal transaction.
Acquisition valuation stage 3: Calculation of the target company’s EV
Dell Computer’s acquisition valuation – Calculation of Enterprise Value and Equity Value
The 2013 EBITDA was used in the left column, and the average EBITDA for the three years in the right column. We can calculate Dell Computer’s enterprise value by multiplying the target company’s EBITDA by the peer group’s EV/EBITDA multiple. That resulted in about $26-30 billion.
The important point to note here is that the EV obtained here is an operating value.
Target company’s operating value = Target company’s EBITDA x Comparable companies’ EV/EBITDA
Since EBITDA is a profit from operating activities, the result using EBITDA reflects only the operating value. You can find the non-operating assets that are not related to EBITDA in the balance sheet’s assets section. Those are like short- or long-term investments and tangible assets for investment purposes. By adding them to the operating value, we can finally get the total enterprise value.
Total EV = Operating value + Non-operating asset value
Operating value = target company’s EBITDA x comparable comapnies’ EV/EBITDA
Dell Computer had about $2.6 b of non-operating assets as of 2013. Thus, the total EV amounts to $28-33 b. In conclusion, the actual deal value ($22 b) in 2013 is about $6-11 b lower than the current EV that we calculated above. So we can judge that Michael Dell’s MBO of Dell Computers was a success.
Acquisition valuation Step 4: Calculation of the target company’s equity value
In using EV/EBITDA in acquisition valuation, unlike PER, we need one more step calculation. That is calculating the equity value that a buyer must pay to a seller: the market value of equity capital. The formula about that is as follows.
Enterprise value = Market value of equity capital + Net debts
Market value of equity capital = Enterprise value – Net debts
Net debts = Total debts – cash assets
Dell Computer held $9.1 b of total debts and $12.8 b of cash in 2013. So, at that point, Dell Computer’s net debts were -$3.7 b.
Negative net debts mean that companies have more cash on hand than their total financial debts.
The market value of Dell Computer’s equity capital is about $32-36 b by deducting net debts from its EV. Therefore, the value of the 86.6% stake that Michael Dell acquired is around $28 ~ 32 b.
$32.0 ~ 36.5 b x 86.6% = $27.7 ~ 31.5 b
In the real deal, Michael Dell and his investment corps paid about $21.5 b. Compared with the EV/EBITDA calculation above, we can conclude that Michael Dell had spent at the undervalued price.