As an M&A company, why do you use EBITDA as a KPI instead of operating income, given the increase in goodwill amortization expenses?

In conclusion, using an earnings measure from which goodwill amortization has been deducted to determine enterprise value would result in a double deduction of enterprise value for the reasons discussed below.

First, we believe that for a normal company that only does organic growth, it is appropriate to measure it in terms of operating income. This is because depreciation is something that will “actually” continue to cash out in the future due to capital expenditures. We do not believe that it is inherently necessary to add it back to operating income.

On the other hand, there is no additional cash outflow for amortization (of course, capital investment will be made, and the same arguments apply for depreciation as described above). In this respect, it differs significantly from depreciation, that actually need additional cash outflow whereas none for amortization.

Because of this difference, if goodwill amortization is also deducted in the analysis of performance, as discussed below, it is doubly deducted from the value of the enterprise. This is because the cash outflow has already been completed at the completion of the acquisition, it has already been factored into the balance sheet either through a decrease in cash or an increase in debt, and unlike capital expenditures, it will not occur in the future.

In the DCF method, which measures the intrinsic corporate value of a company, the equity value is calculated by adding up all the free cash flows that will be generated forever, and then deducting the “Net Debt” on the balance sheet at the end, which exactly deducts the completed cash out for the M&A. Therefore, judging the M&A company by its operating income afterwards is a double deduction of value.

M&A companies emphasize the addition back of goodwill amortization because only the amortization of goodwill differs from companies with organic growth, and GENDA, in that regard, is an appropriate inspection indicator as long as the goodwill amortization is added back to operating income. In other words, it is precisely speaking, “EBITA”.

In addition, companies that only grow organically basically have zero goodwill amortization, so in a sense, operating income = EBITA as a figure that adds back (zero) goodwill amortization to operating income.

However, EBITA is not an indicator that is displayed in a general-purpose database, so we recommend that you make your decision based on EBITDA, which is a common indicator.

The above is the concept of calculating value on an all-share basis based on the assumption that control is acquired. When looking at value per share without control, we believe that it is common to refer to P/E multiple and compare relative to other companies in the same industry.

For investors who look at valuations of M&A companies in terms of P/E multiple, we believe it is appropriate to think in terms of P/E multiple before goodwill amortization. This is because it is the same as P/E multiple under pseudo IFRS. This is because P/E multiple before goodwill amortization is almost the same regardless of which accounting standard is adopted.

In other words, if GENDA were to adopt IFRS in the future, the P/E multiple based on GENDA’s net income in each database would suddenly drop, giving the appearance of being undervalued, even though there would naturally be no essential change in GENDA, because this is not inherently correct. Therefore, we believe that the P/E multiple before amortization of goodwill, which remains unchanged regardless of which accounting standard is introduced, is appropriate.

On the other hand, P/E multiple before goodwill amortization is not available in general databases, so for your reference, I will explain a simplified way to look at GENDA’s P/E multiple before goodwill amortization. In GENDA’s case, it is “P/E multiple of net income × 0.8x = P/E multiple of net income before amortization of goodwill”.

This is because GENDA’s forecast for the current term is 5.4 billion yen for net income before amortization of goodwill and 4.3 billion yen for net income, a difference of approximately 1.25 times, and thus a PER of (1/1.25=) 0.8 when calculated at 1.25 times the P/E multiple normally seen in a database.

Tag: 2024/3/25