- April 2, 2019
- Posted by: Jennifer Lawson
- Category: Capital, Economics, Eric Bosveld
by Eric Bosveld
I get asked all the time “what multiple do you think my business would sell for?” For businesses operating in the Produce Industry, my answer is always “that depends!” Most profitable businesses with less than $10 million in operating profit will trade between 4 to 8 times EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). That is a huge variation and there are literally dozens of variables that will impact whether your business trades at the high end or low end of that range.
First, it is helpful to understand what EBITDA is, and why is it used so extensively as a valuation metric. EBITDA is a proxy for cash flow (before capital expenditures and changes in working capital) and is helpful in comparing one business to another. It normalizes comparisons of companies’ operating earnings with different levels of debt (interest payments), different tax structures and where different investment decisions have been made (capital expenditures).
Next, potential sellers must understand the period for which the EBITDA multiple applies. A forward EBITDA multiple is typically based on the current fiscal year before its completion. If a company is growing, the same multiple means a higher enterprise value when compared to an EBITDA based on a previous period. Buyers, however, typically think of EBITDA multiples that are based on the last fiscal year, the average of the last 2-3 years, or more commonly, the trailing twelve months (TTM) period. It is important that both potential buyer and potential seller are using the same period when talking about EBITDA multiples and their respective valuation expectations.
So, hypothetically, why does a grower packer with $5 million in TTM EBITDA trade for 5x and a value-added processor with the same EBITDA trade for 7x, when they both have the same historical and potential growth? What makes the processor worth 40% more?
The first important variable may be the EBITDA margin (TTM EBITDA as a percentage of TTM sales). The grower-packer may be generating an EBITDA margin of 5% whereas the processor is generating 10%. In other words, it takes the grower-packer $100 million in sales to generate $5 million in EBITDA, whereas it takes the processor half that amount. EBITDA margin is a function of both operating efficiency and the company’s ability to differentiate itself in the marketplace. The processor’s value-added market position may generate higher margins compared to the grower-packer that is forced to accept commodity level prices from powerful customers with lots of choices on where they buy. Ultimately, there are more potential acquirers for a 10% EBITDA margin processor than there are for the 5% EBITDA margin grower-packer. More potential buyers mean more buyer competition, which subsequently can lead to more bids and higher potential multiples.
The grower-packer may also have a lot more capital tied up in buildings, equipment, and land. It, therefore, may have much higher capital expenditures to maintain and/or grow its existing operations. The grower-packer may also need more working capital to finance its operations for the same level of profit. Neither future capital expenditures or changes in working capital are reflected in EBITDA, so it must be reflected in the EBITDA multiple.
Relative to the value of land and water rights, the revenue generated from the farming side of the grower packers’ business may also lower the Return on Investment (ROI) for a new buyer. The ROI on land is often a combination of the cash it generates and its appreciation over time. Not all investors are interested in investing in long-term land value appreciation. Grower packers should consider separating land from the operating business (sale-lease-back) to unlock value if a sale is contemplated in the future. With the operating entity leasing the land at market rates from the landholding company, the EBITDA will drop proportionally but it should attract a higher multiple in a sale. Furthermore, it gives the seller more options to sell the land to one buyer and the operating business to another which may provide a better overall outcome. Sale-lease-backs may have tax implications that need to be considered and potential sellers need to get expert advice, specific to their situation on whether the benefits outweigh the costs.
So next time you ask me about my opinion on what multiple would apply to your business, please forgive me when I start by “that depends!”