Enterprise Value-Based Multiples#

When investment bankers value companies for acquisitions, they rarely use P/E. Instead, they rely on Enterprise Value multiples—and for good reason. EV multiples reveal what you're actually paying for a business, regardless of how it's financed.

Why EV Multiples Matter#

The Capital Structure Problem#

Consider two identical businesses:

Company B looks cheaper on P/EBITDA. But is it?

Company A: EV = $800M + $0 - $50M = $750M
EV/EBITDA = 7.5x

Company B: EV = $450M + $400M - $50M = $800M
EV/EBITDA = 8.0x

Company B is actually MORE expensive! The low market cap masks high debt. EV multiples cut through capital structure differences.

EV/EBITDA: The Workhorse#

EV/EBITDA is the most common EV multiple, especially in M&A.

What EBITDA Represents#

EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization
       = Operating Income + Depreciation + Amortization
       = Revenue - Cash Operating Costs (roughly)

EBITDA approximates operating cash flow before reinvestment—what the business generates before:

• Financing decisions (interest)
• Tax strategies
• Capital intensity (D&A)

EV/EBITDA Ranges by Industry#

Example Calculation#

TechCorp:

• Market Cap: $5B
• Debt: $1B
• Cash: $500M
• EBITDA: $600M

EV = $5B + $1B - $0.5B = $5.5B
EV/EBITDA = $5.5B / $600M = 9.2x

If the sector average is 12x, TechCorp might be undervalued—or there's a reason for the discount.

EV/Revenue: For Unprofitable Companies#

When EBITDA is negative or volatile, use EV/Revenue.

When EV/Revenue is Useful#

EV/Revenue Ranges#

The Problem with EV/Revenue#

EV/Revenue ignores profitability entirely. A company with 80% gross margins and one with 20% gross margins could have the same EV/Revenue—but vastly different values.

Solution: Compare EV/Revenue alongside gross margin. Two companies at 5x EV/Revenue:

• Company A: 80% gross margin → effective 6.25x EV/Gross Profit
• Company B: 40% gross margin → effective 12.5x EV/Gross Profit

Company A is actually cheaper relative to its profit potential.

EV/EBIT: Accounting for Capital Intensity#

EV/EBIT includes depreciation—useful when comparing companies with different capital intensities.

EV/EBITDA vs. EV/EBIT#

Example: Asset-Heavy vs. Asset-Light#

Same EV/EBITDA, but the manufacturer needs much more reinvestment to maintain operations. EV/EBIT reveals this difference.

Calculating Enterprise Value: Details Matter#

Standard Formula#

Enterprise Value = Market Cap + Total Debt + Preferred Stock
                   + Minority Interest - Cash and Cash Equivalents

Common Adjustments#

Using EV Multiples: Practical Steps#

Step 1: Calculate EV Accurately#

Verify:

• Market cap (shares × price, including all classes)
• Total debt (short-term + long-term, including capital leases)
• Cash (confirm it's not restricted)
• Any unusual items (preferred stock, minority interest)

Step 2: Calculate Consistent EBITDA#

Watch for:

• Adjusted EBITDA vs. GAAP EBITDA—companies love to add back costs
• One-time items—strip out restructuring, legal settlements
• Stock compensation—real cost, but often excluded
• Lease effects—post-ASC 842 treatment varies

Step 3: Compare to Peers#

Target at 9.2x vs. peer average 10.5x looks cheap—but grows slightly slower. May warrant modest discount.

Step 4: Derive Target Price#

If the target "should" trade at peer average:

Implied EV = 10.5x × $600M = $6.3B
Current EV = $5.5B
Upside = 15%

Implied Market Cap = $6.3B - $1B (debt) + $0.5B (cash) = $5.8B
Current Market Cap = $5.0B
Implied share price = Current × (5.8/5.0) = Current × 1.16

Common Mistakes#

1. Mixing Adjusted and GAAP EBITDA#

Company A reports GAAP EBITDA; Company B uses "Adjusted." You're comparing apples to oranges. Always adjust to a consistent basis.

2. Ignoring Debt Completely#

Looking only at market cap undervalues leveraged companies and overvalues debt-free ones. Always check EV.

3. Using Stale Financials#

If Company A's EBITDA is trailing 12 months but Company B's is management guidance, the comparison is flawed.

4. Forgetting About Growth#

EV/EBITDA of 8x is cheap for a 20% grower but expensive for a 5% grower. Always adjust for growth differences.