Understanding CAPEX & Multiples?

Currently, in the M&A community, discussions regarding the purchase price of a target company are most often expressed as a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization). If EBITDA is the benchmark, what is the justification for such a wide range of transaction multiples from 3-4-5 to 8-9-10 in the same or different industries? It is particularly important that buyers and sellers understand the concept of actual free-cash flow. The most accepted measure of free-cash flow is EBITDA less Capital Expenditures (EBITDA-CAPEX).

When considering an acquisition, the analysis of CAPEX is essential. CAPEX may be separated into two categories:

  • Immediate expenditures required to bring the operating assets into good working order; and
  • Ongoing annual, recurring reinvestments for existing operations or for revenue and earnings growth.

The choice of multiple(s) depends on the nature of the business. Service companies normally require very little capital re-investment, and as such, EBIT (Earnings Before Interest & Taxes) is an appropriate cash flow metric. For capital intensive businesses, EBITDA-CAPEX is more appropriate, since it accounts for the necessary capital reinvestment to maintain and grow the business.