Dont Want to! Capital l Leases in Enterprise Value Your treatment - - PowerPoint PPT Presentation

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Apr 01, 2023 355 likes •444 views

Capital Leases in Enterprise Value: Why You Should Include Them Even If You Dont Want to! Capital l Leases in Enterprise Value Your treatment of capital leases in Enterprise Value is wrong! You should NOT add capital leases, or

SLIDE 1

Capital Leases in Enterprise Value: Why You Should Include Them – Even If You Don’t Want to!

SLIDE 2

Capital l Leases in Enterprise Value

“Your treatment of capital leases in Enterprise Value is wrong!” “You should NOT add capital leases, or any leases, when moving from Equity Value to Enterprise Value, because they’re all operational items, not Debt.”

SLIDE 3

Capital l Leases in Enterprise Value

SHORT ANSWER: You could make that argument, and there is

some disagreement over the nature of leases…

But: From a practical perspective, you pretty much have to add

capital leases so that you get consistent valuation multiples

Problem: If you do not add capital leases, then you have to

adjust the denominators of valuation multiples such as EV / EBITDA

Theoretically: This approach might work, but most companies do

not disclose enough information to make the required adjustments

SLIDE 4

Leases 1 101: Operating vs. Capital

Operating Leases: Company signs an agreement to pay a set

amount of rent each year; no ownership of the asset

Income Statement: Expense shows up as “Rent” within the

company’s Operating Expenses

Capital Leases: The company records the Leased Asset as PP&E on

the Balance Sheet, and the lease is counted as Debt on the L&E side of the Balance Sheet

Income Statement: No rental expense, but the company records

Depreciation on the Asset and Interest Expense on the Debt

SLIDE 5

THE PROBLEM: Valuation Multiples

RULE: If you include a Balance Sheet item in the numerator of a

multiple, you exclude the corresponding expense in the denominator (i.e., add it back)

And: Vice versa if you exclude an item in the numerator
Example: Debt is included in Enterprise Value, so in the EV / EBIT

and EV / EBITDA multiples, you exclude the corresponding Interest Expense in the denominator

So: Think about the problems this rule creates for the treatment
f capital leases…

SLIDE 6

THE PROBLEM: Valuation Multiples

Add Capital Leases: Then it’s easy to calculate EV / EBITDA –

because EBITDA already excludes all Depreciation and Interest!

By definition, then, the Depreciation and Interest from capital

leases are also excluded from EBITDA, and this rule is satisfied

BUT: What happens if you do not add capital leases when

moving from Equity value to Enterprise Value?

Then: You need to adjust a metric like EBITDA so that it includes

the Depreciation and Interest from capital leases (i.e., you have to subtract those items) – and then it’s no longer EBITDA!

SLIDE 7

THE PROBLEM: Valuation Multiples

Adjustments: EBITDA – Interest on Capital Leases –

Depreciation on Capital-Leased Assets

Problem #1: What do you even call this new metric? “EBITDA

Adjusted for Capital Leases?” What does that mean?

Problem #2: Does the company disclose enough information to

make this calculation? Probably not!

Many Companies: Won’t break out Interest and Depreciation from

different sources separately, or might lump all expenses associated with capital leases together (including principal repayments!)

SLIDE 8

Our Recommendation: Keep It Simple

So: We recommend keeping it very, very simple, and adding capital

leases when moving from Equity Value to Enterprise Value

Why: Not because of the “philosophical arguments,” or because we

think all leases are financial in nature, but because of practicality

Ideal: Use standard metrics, such as EBITDA, that everyone is

familiar with and that can be easily defined and calculated

Avoid: New, non-standard metrics or numbers that require

footnotes or additional explanation