107 12 Valuation Multiples Growth Rates Margins Slides

8/19/2019 107 12 Valuation Multiples Growth Rates Margins Slides

1/14

• Question that came in the other day…

• “I’m confused about how to interpret valuationmultiples. If one company’s EV / EBITDA mulhigher than another’s, does that mean it is gro

more quickly? Or does that just mean its EBITmargins are higher?”

• “In other words, are multiples more strongly co

with growth rates or margins?”

Multiples, Growth Rates, and Ma


2/14

• This is a tough question to answer because it on which multiple, which growth rate, and wmargin you are referring to

• BUT the short answer is: Valuation multiples a

generally correlated with growth rates becausvaluation multiples are shorthand for a full Danalysis

• Higher FCF Growth Implies a Higher Multip



3/14

• Point #1: Why Multiples are Shorthand for a F

• Point #2: Does This Really Hold Up in Real Li

• Point #3: Why the “Real-Life Correlation” is

Sometimes Questionable

• Point #4: Recap and Summary



4/14

• Remember the formula for Terminal Value:

Final Year FCF * (1 + FCF Growth Rate)(Discount Rate – FCF Growth Rate)

• Higher Terminal Value: Higher FCF Growth R

Lower Discount Rate

• Lower Terminal Value: Lower FCF Growth RHigher Discount Rate

Why Multiples are Shorthand for a


5/14

• Multiples: From that Terminal Value you can cthe EBITDA Multiple directly correlated

• So: Clearly a higher or lower FCF growth rate explain a higher or lower EBITDA multiple, but

about the Discount Rate?

• Answer: No, not really! Because typically youthe Discount Rate for all companies in a set of

comps is about the same for that industry/size



6/14

• Example: Specialty Pharma Companies with Between $500 Million and $2 Billion:

• These companies should all have similar risk/rprofiles… same industry, similar financial criter

the Discount Rate should be similar as well



7/14

• So if the Discount Rate is the same or similar fof comparable companies:

• Higher Terminal Value and Multiple: Higher Growth Rate

• Lower Terminal Value and Multiple: Lower FGrowth Rate

• But what determines the FCF Growth Rate?



8/14

• Components of FCF: Revenue growth, operamargin, taxes, non-cash charges, Working Ca

CapEx requirements

• Major Drivers: Revenue Growth and Operatin

Margin (or EBITDA Margin)

• In other words, Operating Income Growth orEBITDA Growth should be strongly correlated

FCF Growth, and therefore with the Implied M



9/14

• OpInc / EBITDA Growth: Margins stay the sathis will move in-line with revenue growth

• Margins don’t stay the same: All bets are offincreasing margins will drive growth higher

• KEY POINT: It’s NOT about the margins, it’s ahow those margins are CHANGING (if they arehow those changes impact OpInc / EBITDA G



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• Example: 40% EBITDA margin company and EBITDA margin company

• If they’re both growing EBITDA and FCF at thrate, and they’re the same size in the same ind

the multiplesshould

be very similar

• Why? Because the Terminal Value formula dofactor in margins at all! Just the FCF growth ra



11/14

• Back to the Pharmaceutical Example:

United: 10% EBITDA Growth, 7x EV / EBIT

Cubist: 14% EBITDA Growth, 21x EV / EB

Alexion: 22% EBITDA Growth, 23x EV / EB

JAZZ: 36% EBITDA Growth, 11x EV / EBIT

Salix: 41% EBITDA Growth, 10x EV / EBIT MDCO: 137% EBITDA Growth, 9x EV / EB

• Not a particularly strong correlation at all… w

Does This Work in Real Life?


12/14

• Sometimes yes, sometimes no… here’s why:

1) Acquisitions! These throw off the growth n

2) EBITDA != FCF They’re often quite far apaother items such as CapEx will impact FCF

3) Valuation Based on Speculation Will the make it through clinical trials?

4) Mispriced Asset – Maybe the market got it

Does This Work in Real Life?


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• Valuation Mult iples: A multiple like EV / EBITshould be correlated with EBITDA growth in th

• Why: Discount Rate and FCF Growth affect acompany’s Terminal Value, and therefore its im

multiple, but the Discount Rate is similar for mcompanies in the set

• So: FCF Growth is the key driver, and that sho

trend with EBITDA Growth

Recap and Summary


14/14

• Real Life: This correlation often does not holdespecially for “speculative” industries like

pharma/biotech

• Acquisitions and other items that go into FCF also distort the numbers

• …or maybe the company you’re analyzing is juundervalued or overvalued

Recap and Summary

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107 12 Valuation Multiples Growth Rates Margins Slides