Here at CVI we look at a lot of financial statements. One thing we have learned is that not all CFOs are created equal. They’re a bit like snowflakes. Some prefer to disclose a lot, some not so much so. Some like simple reporting, other’s don’t. Some don’t even don’t even do much of their own reporting!
One area we’re increasingly skeptical of is calculating “EBITDA”. It’s supposed to be Earnings Before Interest Tax Depreciation and Amortization. It’s a metric used by companies, banks, and analyst reports. It’s very important, as a company’s “EBITDA” is usually used by its lenders to determine pricing of its loans and whether it is in default or not (yikes). And it sounds official and definitive as all good acronyms should. But it’s not. It’s shockingly inconsistent even within the same industry. We have stood on our soap box (at least in the shower) saying it’s also not very useful in actually understanding how a business performs. However, where it is useful is understanding how management thinks about their business and what they want to tell you.
Thankfully it’s not just us complaining. S&P put together a thoughtful article on EBITDA we thought was well worth sharing called “When The Cycle Turns: The Continued Attack Of The EBITDA Add-Back”. Key points include:
“Companies and deal arrangers have become increasingly creative in presenting what qualifies as an add-back, resulting in an increase in both the number and types of adjustments. In some of these cases, S&P Global Ratings views the act--expanding the definition of management-adjusted EBITDA to inflate "marketing EBITDA" (EBITDA plus add-backs)--as an artificial deflation of leverage”
Complacent lenders and low interest rates make for an interesting time.
Check out the article here - https://www.spglobal.com/ratings/en/research/articles/190919-when-the-cycle-turns-the-continued-attack-of-the-ebitda-add-back-11156255
Fun for those at home - Here’s an exercise. Sit down and read five annual reports from five companies back to back in the exact same industry. Let us know how consistent they talk about their business and industry.
And what happens when things turn as all good cycle do?
“The good battle-tested professionals who were in their 40s and 50s during the 2008 downturn are now in their 50s and 60s and thinking about retirement or joining a more lucrative turnaround firm. This combined with banks focused intensely on their expense ratios as mandated by Wall Street and the slimming down of non-revenue producing divisions, has a created a dearth of experienced special assets professionals.”
http://www.abladvisor.com/articles/17092/space-cowboys-and-special-assets