KNOW YOUR WORTH: Making the case for a 25X EBITDA multiple on exit.

Matt Dahl

Founder/Managing Director

发布日期: 2020年1月17日

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...and how that can become a 383X total ROI to current investors.

Forward:

Q: How does one appropriately value a company - several years into the future?

A: Easy. You science the living 'bleep' out of it!

WARNING: This article is NOT a quick executive overview with a few pictures. This is an in-depth, step-by-step approach to fully justifying a 25X multiple on exit, presumably via an acquisition, of a company (in this case Energi Pros, LLC) - four years into the future.

Case:

Forecasting a potential exit (M&A) price is challenging, especially 4 years into the future.

Any number of factors may come into play: Market trends and/or saturation; Economic trends; Sector-specific valuation trends; growth rate formulas applied; etc…

It turns out that the old ‘wet thumb in the air’ projection of 4X EBITDA is actually fully supported by the historical numbers - across all industries and sectors.

However, such generalizations do not accurately represent the vast differences by industry and market sector and thus, if you are in a high-growth sector, as is Energi Pros, this tends to result in an exit projection that is grossly unfavorable to the company.

Note also, that the up and down trends tend to represent a reflection of the previous year’s EBITDA margin trends. As profits go up, valuations tend to follow, if delayed by roughly half a cycle. Overall, it’s pretty flat at the good old anecdotal 4X.

For Energi Pros, LLC, I propose forecasting an exit value based upon the valuation of high-growth, sector-specific comparables across a historical range of economic cycles… modified by the actual growth rate, TMT (Twelve Months Trailing) of the company relative to expectations for its market sector(s), then divided by four to reflect the fact that early-stage companies tend to grow faster and then flatten out in the years to come.

Thus, my recommended formula is: Valuation = (Historical Sector-Specific Multiplier, adjusted for trends) * EBITDA * (1 + ((TMT EBITDA Growth Rate) / (Sector-Specific Expected Revenue Growth Rate))/4)

Insert ‘Real’ Numbers here (using Energi Pros stated projections as a base):

Let’s say that the company’s expected Year 3 EBITDA (TMT) is $184.9MM, which it is.

This, of course, does not actually represent Twelve Months Trailing at 48 months, as we do not yet have projections for year 4, but it will do for our purposes. We can adjust later as those projections become clearer over time.

Let’s say that, over the past several years, the Historical Sector-Specific EBITDA Multiplier for our market sector(s) (in this case an average of: Renewable Energy Equipment & Services; Environmental Services & Equipment; Engineering Services; and Wholesale-Machinery, Equipment & Supplies) is 14X, which it is.

...or viewed another way...

...and that overall market valuations are, according to some sources, currently trending down at 5% per year since mid-2017, degrading our multiple to about 11.42X in 4 years, assuming (unlikely, but let's go with it) no change in the downward trend in the next 4 years.

Next, let’s say that the company’s expected 3rd-year Y/Y (Year over Year) EBITDA growth rate (TMT) was 67.67% or 0.6767, which it is.

Lastly, let’s assume that the sector’s expected growth rate is 8% or .08, which is the best (neither the most nor the least optimistic) estimate that I was able to cobble together from a number of sources.

Dividing the company’s actual growth rate by the sector expectations gives the rate at which the company is expected to exceed industry expectations… or its value relative to the competition. In this case, the company’s growth rate is 8.44X the industry average (which we will weight down to 2.11X). In other words: Extremely valuable.

Written in plain English, what that last paragraph says is: “You should pay twice as much for Energi Pros because it is growing eight times faster than the market average for companies of its type, within this segment.” - Seems fair and equitable, but could still be a tough sell.

That would give us a final formula that looks something like:

Why the 30% discount?

Simple. No sense in projecting a ‘perfect’ sale. Buyers want incentives and sellers want to sell. We may just as well allow for some ‘real world’ bargaining in our projections. 30% is an arbitrary, but reasonable, discount.

REALLY? A final 25X EBITDA multiple? Are we dreaming?

Fortunately no. For two reasons:

At 14X for the average multiple in our sector grouping, we are already 60% of the way there, and…
Expected growth IS over 8X that of the average company in this sector. Paying twice as much for 8 times the performance could be called “a bargain.” Especially assuming that the company continues to grow rapidly for another 4 to 6 years.

A bargain? Sure. Here’s why.

In the case of Energi Pros, even if growth falls off by 5% each post-acquisition year (dropping from 65% to 60, 55, etc…), that means that a sale price of $4.6BN is fully recouped, in cash, in as just over 5 years, and the company itself is still an asset (by then potentially worth up to $30BN).

Compare that with a similar company, purchased for the same amount but operating at our mildly optimistic industry-standard growth rate of 8%. That's thirteen and a half years to recoup the same investment and worth maybe $8.7BN.

So, yeah, a HUGE bargain.

Additionally, there is at least some historical market data to support such an expectation. Companies that are considered ‘high performers’ within their segment typically sell at the high end, or even above, the ‘usual’ multiples for their segment. This even applies in industries as relatively static as packaged food and meat, let alone higher-profile industries such as ours.

Next, let’s look at ‘total exit multiple’ relative to capital invested.

Let’s assume that the investment being considered was made via the current Energi Pros, LLC Private Placement Memorandum, at a total post-money valuation of $12MM.

So, $12MM into $4.6BN equals a potential 383X total ROI, excluding any profit distributions received along the way.

Yes, I said a 383X exit. ...and yes, that is both amazing... and possible.

In other words: $1MM invested today, might turn into $383MM within 4 years. Not a bad ROI if it comes true.

So, where did we land and how did we get here?

“It’s all about growth” claim McKinsey’s Alok Bothra and Zane Williams in their September 2019 report entitled Multiples analysis: Industry labels don’t matter, performance does.

When companies are looking to acquire, they are on the hunt for either incredible bargains, relative to earnings, or incredible performers, relative to industry norms.

In the case of Energi Pros, like many start-ups and re-boots, the expected growth is incredible. However, a significant portion of that expected growth is down to the fact that revenues are starting from zero. In other words: What is the percentage increase in profits from year zero at $0.00 to year 1 at, say, $65.7MM? Well, it’s 100%. That first year from no profits to ANY profits is ALWAYS going to be 100% growth. The next two or three years tend to show very high growth rates as well, but, even at 60% to 70% growth, are already ‘down’ by 30% or even 40% over the first year.

By way of example, my wife's executive coaching business grew at almost 470% Y/Y last year over the year previous. This is an amazing feat that she will likely repeat for another year or three but certainly can't maintain forever.

This is why we do not value a start-up or re-boot’s revenue growth at ‘face value’ but, in the case of my proposed equation, weight it down by 75%.

That said, it IS still high performance, even if much of that is owed to the fact that the company is new. As such, it still commands a premium, and it should.

Next: Market segment (which DOES, in fact, still appear to matter).

Obviously, the majority of M&A transactions are measured by their cost of acquisition relative to the EBITDA of the acquisition. A 4X multiple is ‘a steal’, whereas a 15X multiple may indicate that someone paid a premium. What is less obvious is that different industries, such as REITs or SaaS (20X+), tend to support significantly larger multiples than others, such as Air Transport (6.5X) or Coal Mining (3.3X).

Fortunately for Energi Pros, the company sits at the juncture of roughly 4 well-defined market segments, all of which tend to carry a fairly high multiple at acquisition.

The topmost, in terms of expected multiples, is Engineering Services which, at 22.22X, actually makes up the bulk of EP’s activities. However, in the interest of simplicity, I have just decided to run a flat, unweighted, average between the four.

What that means is that it is reasonable, even if the company only showed industry-standard growth rates (or even the mildly optimistic ones that I selected), that the company could be expected to ‘fetch’ a sale price of up to 14 times its last 12 months EBITDA.

...and what does this all mean?

What all of this magic ‘jiggering’ of the numbers amounts to is this:

One CAN support a 25X valuation, relative to EBITDA, and therefor a 383X ROI, on exit, IF one is lucky enough to be sitting in the middle of the 'perfect storm.'

In other words: Sitting at the intersection of high market sector valuations, AND high year over year revenue growth, AND high profits relative to revenues.

As luck would have it, Energi Pros is sitting right smack dab in the middle of all of the above. 14X sector multiples, 67% growth, and 40% EBITDA.

I have said it before and will say it again: I am privileged to be part of the team.

I have been both an advisor and investor since mid-2019 and a member of the Board of Directors since November of 2019, with a dual focus on capital formation and exit strategy.