SHAREHOLDER EQUITY — VALUING YOUR COMPANY

HAVE YOU heard of the term “Enterprise Value”? Without discussing all of the details and exceptions, enterprise value is a measure of how a buyer determines the value of a printing company in its entirety—and is computed as a multiple of EBITDA. This article discusses the valuation process of a printing company in a logical order as follows:

1. What is EBITDA?

2. Your company is worth enterprise value, and enterprise value is computed as a multiple of EBITDA.

3. How does one maximize enterprise value, which obviously increases the value of your company?

EBITDA is an acronym for earnings before interest, taxes, depreciation and amortization. For example, as illustrated in Chart 1, EBITDA is computed by simply adding back to reported earnings—interest, taxes, depreciation and amortization.

EBITDA does not replace true earnings and too much emphasis on EBITDA can be a mistake. However, it has the most applicability to capital-intensive industries, such as printing.

To give you a feel for EBITDA, Chart 2 presents an illustration of the EBITDA of the PIA/GATF Ratios for all participants and the profit leaders assuming companies with $10,000,000 in sales.

Generally speaking, the value of a printing company can vary from three to five times EBITDA, depending on current market conditions. In the example in Chart 2, the enterprise value for all firms could vary from $2,601,000 to $4,335,000 and the enterprise value for profit leaders could vary from $4,173,000 to $6,955,000. Assuming an interest rate of 7 percent, then all firms would have interest-bearing debt of approximately $2,250,000 and the profit leaders’ interest-bearing debt would be $1,670,000.

Why is EBITDA the factor to be capitalized in arriving at enterprise value? It is sufficient to say that the printing industry is a capital-intense industry and that EBITDA better serves this purpose. As a result, we can readily use EBITDA in determining enterprise value. Aside from this purpose, we have very little use for EBITDA.

Other useful data when analyzing the value of a printing company, although not a topic covered in this article, is after-tax cash flows. Buyers of printing companies should be concerned with after-tax cash flow, as well, since this is typically what can be reinvested in the business or paid out as dividends to the shareholders.

It is a fact that EBITDA is a commonly used factor to determine the acquisition price paid by buyers of printing companies. It is not uncommon to see the seller provide information on a restructured EBITDA. This takes into account certain income and expense activities that impact the bottom line, but are unusual in nature, infrequent in occurrence or are unnecessary to the business operations.

Both the buyer and seller negotiate over the relevancy of such adjustments (e.g., excess owner’s compensation, travel and entertainment expenses deemed personal in nature or below-market rentals).

Although EBITDA is represented as a numerical amount, different companies with similar EBITDAs are not necessarily equivalent in value. Therefore, consider EBITDA as a starting point to be used in a rule of thumb for your marketplace. Using EBITDA at a multiple of four gives the appearance of a lower purchase price. Using the example in Chart 2 for all firms, a purchase investment price of $3,468,000 is only four times EBITDA, but it is actually 21 times pre-tax earnings, which is a horrendous price.

In the above scenario, rather than alter the EBITDA number, an educated buyer would reduce the multiple because the quality of earnings is poor and the acquirer would inherit a significant project of reducing costs.

Further, the multiple may be affected by the position the fixed assets are in their life cycle, as determined by the detailed depreciation and amortization schedules. The shorter the estimated life of fixed assets, the less the quality of cash flows provided by depreciation and amortization.

So now you know the importance of EBITDA and that it is a component of enterprise value. Since enterprise value is the value of your company to an investor, what exactly does it mean to you?

Enterprise value is a measure of how a buyer determines a value for a printing company in its entirety. It is not just what the buyer is paying for the shareholder’s equity, but also includes all of the seller’s interest-bearing debt. Enterprise value is not the cash with which the seller ends up.

The buyer is acquiring the business and the associated balance sheet subject to certain adjustments. The seller usually keeps the cash, cash equivalents and marketable securities. The buyer expects to assume a balance sheet without interest-bearing debt.

Therefore, if the seller receives the total enterprise value, the seller enhances that amount with the cash and marketable securities, and must liquidate all of the interest-bearing debt. It is like an algebraic equation and the deal can be structured in various ways; but the end result is that the seller only gets the cash, marketable securities and the portion of the enterprise value applicable to shareholders’ equity. The buyer gets the remainder of the balance sheet without any interest-bearing debt.

The definition of enterprise value takes into account not only the printing company’s shareholders’ value, but also the interest-bearing debt.

1. Interest-bearing debt is all short- and long-term notes and leases payable.

2. Shareholders’ value is enterprise value less interest-bearing debt.

3. In most transactions the enterprise value of printing companies is the capitalized EBITDA.

4. Perhaps it will all make sense by going through an example, in its simplest terms, and then attaching the technical titles. In this way we will strip it of its sophistication and one will not be intimidated by a merger and acquisition transaction.

a. Let’s assume that the value of your printing company is four times its EBITDA.

b. Remember that EBITDA is earnings before interest, taxes, depreciation and amortization.

c. Earnings are the reported financial income plus or minus expenses and income that are peculiar to the present ownership, but will not exist for the subsequent company.

d. Now we can compute the capitalized value of EBITDA.

We have now determined that the enterprise value of your company is $4,000,000. Do not misunderstand: the $4,000,000 is not all yours, because you have to go back to the definition of enterprise value. Enterprise value is the amount determined for the shareholders’ equity plus the company’s interest-bearing debt; therefore, the interest-bearing debt must be subtracted from the $4,000,000.

Now that you have a better understanding of the calculation of enterprise value and what it means, we will make a comparison of two different companies to illustrate a point for our final stage of this article. (See Chart 4)

Company A has less sales, more profit, more EBITDA, more total enterprise value, less debt and more than four times the value accruable to the owners than Company B. Company B, in spite of its $6,000,000 in sales, has only a $500,000 equity value to the owners.

The underlying message is clear: enterprise value management is critical. How can you increase this value to help boost the worth of your company to a buyer? What management strategies should you be employing to maximize the enterprise value to owners?

Remember, the formula is simple (see Chart 5).

You must develop strategies capable of delivering maximum shareholders’ value. This formula points out the following relationship; shareholders’ value will increase with more profits and less interest-bearing debt. However, the truth is that “it is easier said than done.” For example, you decide to purchase a six-color, 40˝ press. You incur a debt of $2,000,000 and you now know that diminishes shareholder value. This long-term investment will have a detrimental effect on shareholders’ value until the capitalized EBITDA of the incremental business attributable to this asset exceeds $2,000,000.

This example illustrates the complications of enterprise value management. You must balance what you want for short-term results with your long-term strategies.

The surest way to increase shareholders’ value is increasing profits. How?

1. Increase sales;

2. All-inclusive hourly cost rates for estimating and costing;

3. Cost selling price discipline;

a. Target selling price;

4. Improve value-added; and

5. Decrease costs.

This means that management has to find ways to spend less money. It’s a strategy of increasing shareholders’ value without an offset caused by increased debt. To follow a safe financial plan, interest-bearing debt should be in the range of 35 percent to 45 percent of the total assets.

Our objective is to increase enterprise value, but those first to take their share of the enterprise value are the interest-bearing debt holders. The remainder lies with the shareholders. Or said another way: the less debt, the more value for the shareholders.

About the Authors
H.R. Margolis Co. is a public accounting and consulting firm with specialties in turnarounds and profit planning, valuation of printing companies, mergers and acquisitions, auditing, and tax and financial management for the graphic arts industry. The company has prepared the PIA Ratios since 1960. Stuart Margolis, CPA, MS, or Brian Enverso, CPA, MS, CVA, can be reached at (610) 667-4310 or (212) 736-1060; or e-mail, smargolis@hrmargolis.com or benverso@hrmargolis.com.