Mr. Nobuzane, Representative Director and President of CGS, who has a career as a foreign institutional investor mainly in Fidelity, prepared this report for the purpose of verbalizing to investors the reality of our roll-up M&A strategy and the resulting transformational growth in equity value (through increased corporate value by increased cash flow).
As a result, while the index of “investment recovery” relative to “invested capital” (=Incremental ROI), which is important for the company which conducts M&A, was at the highest level compared to other companies in the same industry, the EV/EBITDA multiple, which took growth rate into account, was discounted by approximately 70% to 80% compared to other companies in the same industry.
While the selection and the forecast for growth rate by other companies in the same industry are based on CGS, the above analysis is a mechanical calculation based on actual market value, and we believe that we have quantitatively presented the upside to investors. We present the specific summary below.
As a company whose core business is M&A, we have consistently emphasized “M&A at appropriate valuations” since we got listed. Specifically, we have emphasized the importance of “investment recovery” (EBITDA of the target company) relative to “invested capital” (EV of the target company) through M&A.
However, we focused only on EBITDA growth of the target company after the M&A in IR to date. While it is true that an increase in cash flow of the target company promotes the investment recovery is good, this is only a means, not an end. We were not able to measure the effect of “investment recovery” relative to “invested capital,” which was the main objective.
Therefore, in this report, in order to measure the effect of “investment recovery” against “invested capital,” we measured the increase in operating cash flow (≒ EBITDA) ÷ the increase in invested capital (=”Incremental ROI”) by using the increase (due to M&A) in GENDA’s consolidated balance sheet (≒EV), not the one of the target company itself, as “invested capital” and the increase in operating cash flow (due to M&A) (≒EBITDA) as “investment recovery” and compared it with other companies in the same industry.
The other companies in the same industry are defined as “companies from a boarder range of industries that similarly employ roll-up M&A strategies within mature markets (p21 of CGS Report)”. There are a number of companies that are engaged in this industry on a large scale in the U.S. Among those companies, the report mentions Waste Management, which conducts roll-up M&A in industrial waste services (Incremental ROI is about 20%), Service Corp International (about 8-9%), which conducts roll-up M&A in funeral services, Rollins (about 25%), which conducts roll-up M&A in pest control industry, and Danaher (about 10%), a leading company that achieves growth through M&A.
In contrast, the result of the analysis shows that our index is approximately 25%, which is the highest level in comparison to other companies in the same industry (“This expected performance compares favorably with global companies in other sectors following a roll-up M&A growth strategy (p. 20)“). Therefore, it is quantitatively shown that it is justified even if valuations are relatively high compared to other companies in the same industry.
However, it is noted that when calculating the EV/EBITDA multiple relative to growth rate, our company is 0.3x while Waste Management is 1.5x, Service Corp International is 1.1x and Rollins is 2.5x (“…at an approx. 70-80% discount. This suggests a strong sense of undervaluation per growth, from an objective standpoint (p.1)”)
EV/EBITDA multiple compared to growth rate is calculated as “EV/EBITDA multiple divided by EBITDA growth rate.” A similar approach is commonly used for PEG (Price/Earnings-to-Growth), which is calculated by dividing P/E multiple by EPS growth rate, but this analysis is performed for EBITDA. The idea behind this approach is that a higher multiple is justified for a company with a higher growth rate. Following is a concrete example.
If Company A and Company B have the same EBITDA (e.g., 10 billion yen), and Company A grows at 10% (11 billion yen, 12.1 billion yen, 13.3 billion yen…) annually while Company B grows at 20% (12 billion yen, 14.4 billion yen, 17.3 billion yen…) annually, even over 3 years alone, EBITDA growth of Company A is 1.3x and that of Company B is 1.7x, which is a large difference, justifying Company A < Company B in corporate value. As a result, even if Company A = Company B in the current EBITDA, it is justified that Company A < Company B in EV/EBITDA multiple calculated by dividing because it is Company A < Company B in corporate value.
In addition to growth rates, higher multiples are also justified if there are higher figures measuring cash flow generation capacity (such as Incremental ROI, ROIC and operating CF conversion rate etc. in the CGS report).
This is because, although EBITDA is a concept similar to cash flow, in reality, it is steady free cash flow from which (taxes and) investments necessary to maintain the business (maintenance CAPEX) are taken into account that affects the theoretical corporate value. In other words, even if EBITDA is the same amount, a company with a higher conversion rate from EBITDA to cash flow will have a higher theoretical corporate value.
From this perspective, the CGS report states, “From FY21 to FY23, GENDA’s invested capital has increased by approx. ¥15.5bn, with cumlative operating CF over the same period totaling around ¥2.9bn (¥3.8bn if including FY24 estimates by CGS). This results in their incremental ROI of 20-25%, which CGS considers an impressive figure based on our long-time investment experience (p. 20).”
The CGS report makes an evaluation based on the capacity to generate cash flow right down the line, centered on EV/EBITDA multiple. We believe that EV/EBITDA, which is a valuation based on cash flow, is more appropriate to evaluate companies which core business is M&A (compared to general PER).
This is because a roll-up M&A style company repeats M&A by relying on its own cash flow or the one of the target company and financing, however, if it cannot raise funds, it cannot conduct M&A and as a result, the growth in corporate and equity value suspends.
In other words, cash flow itself is a source of growth and an indicator of potential for future growth. We will keep showing investors EBITDA, the most common indicator to show cash flow simply, as a KPI which we emphasize.
Regarding PER, since we believe it is show the reality better to use PER based on “current income before amortization of goodwill” (which is a pseudo current income under IFRS) from the viewpoint of cash flow-based valuation and comparison with overseas companies, we present the PER on our website for your reference.