Case: Michael Dell’s MBO of Dell Computer
Michael Dell founded Dell Computer in 1984. At his age of 27, in 1992, he grew the company into one of the Fortune 500 companies. In 2004, Michael withdrew from management for a time because of declining performance. However, the board of directors brought him back as CEO in 2007. At that time, he owned just 13.4% of the shares of Dell Computer. Michael felt challenging to exercise his own business strategy because of other investors. So he made a plan to buy their all shares. In 2013, Michael brought in investors such as Silver Lake Private Equity Fund and Microsoft. And finally, he succeeded in it. The EV of Dell Computer was about $22 billion at the deal.
Why EV/EBITDA is suitable for M&A valuation
EV/EBITDA is a relative valuation method suitable for M&A. Buyers must consider not only the equity value paid to shareholders but also the debt value that they succeed to. EV/EBITDA reflects both of them.
EV/EBITDA multiple also means the number of years it takes to recover all the capital invested for acquisition. For example, suppose that EV of Company A is 100 with EBITDA of 20. The buyer who acquires Company A can recover both the equity and the debt value of 100 if he or she earns the EBITDA of 20 for five years.
Valuing private companies with EV/EBITDA
You can use EV/EBITDA when valuing a private company.
Target company’s EV = Comparable companies’ EV/EBITDA X Target company’s EBITDA
Like PER, you can estimate the EV of a target company by multiplying the EV/EBITDA of the peer group to the EBITDA of the target company. Let’s judge the level of the deal value at that time by valuing Dell Computer with the EV/EBITDA method as of Sep. 2020.
Step 1: Find EV/EBITDA from comparable companies
Dell Computer was a computer manufacturer and sales company listed in Nasdaq, US. To select comparable companies, ‘computer hardware’ is chosen as a sector. By the market share as of 2019, the top six companies are Lenovo, HP, Dell, Apple, Acer, and Asus in order. For the EV/EBITDA calculation, Dell is excluded from them because it is a target company. Apple also goes out of them due to the high proportion of smartphone and iOS in business. Although Asus and Acer are listed on the Taiwan stock market, they are incorporated to secure the number of comparable companies.
It extracted the EV/EBITDA of four companies from Yahoo Finance, and the average is 6.19. Yahoo Finance’s data is from Capital IQ, but there is no reference to the calculation method, which is a downside.
Step 2: Calculate the target company’s EBITDA
Now we need to calculate Dell Computer’s EBITDA. There are three ways to figure it: Using past performance or estimated future performance, Or mixing both.
- Using past performance: Use the average or weighted average EBITDA for the previous year, or the last four quarters or 12 months, or the past n years.
- Estimation of future performance: Use the average or weighted average EBITDA estimated for the next year, or the next four quarters or 12 months, or the next n years
- Mixing both: For example, the average of the past two years and the next year, or the average of the previous year and the following year.
Appraisers should calculate EBITDA with qualitative judgment, but it would be logical to get it in consideration of the direction of future earnings. In the case of growth companies, EBITDA will grow higher over time. For mature companies that consistently generate profits without significant fluctuations, you could use the past performance. If companies had entered a period of decline, it would make sense to reflect the future reduction in profits. Dell Computer was a mature company in a slightly declining trend.
The company had the average EBITDA of $4,326m over the past ten years, $4,869m over the past three years, and $4,156m in the previous year of M&A. Here, it will use both of the past three years’ and the previous year’s EBITDA to get the range.
Step 3: Calculate the target company’s EBITDA
The left column of the figure above uses the 2013 EBITDA, and the right column uses the three years’ one, 2011 to 2013. Then, the EV of Dell Computer ranges $26~30billion.
What is important is that the EV calculated in this way is the operating value.
Since EBITDA is earnings from operating activities, the value obtained with it reflects only the operating value. You can find non-operating assets in the assets section of the balance sheet such as short- and long-term securities, tangible assets and assets under construction for investment purposes. Adding the value of non-operating assets to the operating value yields the total enterprise value.
Total EV = Operating EV + Non-operating asset value
Operating EV = EBITDA of a target company x EV/EBITDA of comparative group
Dell Computer owned about $2.6 billion of non-operating assets as of 2013. Therefore, the operating EV and the non-operating asset value is $28~33 billion. The actual EV was $22 billion in 2013, $6~11 billion less than the current calculated EV.
Therefore, we can judge that Michael Dell’s MBO of Dell Computer was successful from the present viewpoint.
Step 4: Calculation of the equity value of the target company
Unlike PER, EV/EBITDA requires one more step for the acquisition purpose. Buyers need to calculate the market value of equity that they must pay to the seller. We could use the below formula.
EV = Market value of equity + Net debts
Market value of equity = EV – Net debts
Net debt s= Market value of financial debts – Cash
For Dell Computer, the net debt is about -$3.7 billion (=$9.1 billion-$12.8 billion).
Negative net debts mean that a company has more cash than its financial debts.
The equity value of Dell Computer is about $32~36billon. Thus, the market value of the 86.6% stake is about $28~32billon, which is the amount that Michael should pay. (It does not consider the premium for the management right.)
$32.0 ~ 36.5 billon x 86.6% = $27.7 ~ 31.5 billon
In fact, Michael Dell and his investment group paid about $21.5 billion. Therefore, in light of the current EV/EBITDA calculation, we can judge that they bought the company at an undervalued price.
- (Excel financial model) Evaluating the Dell’s MBO deal value with EVEBITDA
- (Blog) EV/EBITDA, Distinction between EV and Equity Value