Welcome to Lorelli, Inc. - 2002

Don't Confuse P/E Multiples With EBITDA Multiples
"What was the multiple on that deal?" is a question asked all the time in the M&A world. A recurring theme that we have written about in past newsletters is there are many different kinds of "multiples" and that it is easy to confuse one with another. Comparing multiples can very often involve apples and oranges, even when applied to the same transaction or company. As illustrated below, the P/E multiple on the recently announced DuPont acquisition of ChemFirst is over 30, while the EBITDA multiple on the deal is only around 7. In the financial press (like the Wall Street Journal in the illustration) P/E multiples are almost always used. In chemical industry press however (like Chemical Marketing Reporter in the illustration) you will usually see references to EBITDA multiples instead. In the article that follows we will discuss the differences between these two very different measures and how to convert a P/E multiple of a public company into an EBITDA multiple.

P/E Multiples are commonly used with Public Companies
When an investor buys a share of stock on the stock market, he or she is buying a share of an entire company, including that company's cash, liquid assets and debt. Consequently, the most relevant earnings measure for the investor is the bottom line, or net income figure. This figure takes into account not only the income of the operations of the business, but also income and expenses associated with the company's cash assets and debt, respectively. Because buying stock on the stock market involves an entire company, the most relevant multiple to use for the typical investor is the P/E multiple, i.e. the stock price per share divided by (bottom line) net income per share.

In chemical industry M&A however, the more common earnings multiple is the EBITDA multiple, i.e. total valuation of a deal or company divided by EBITDA (earnings before interest, depreciation and amortization). Why is this?. First of all, most acquisitions do not include the acquisition of a company's cash assets or the assumption of a company's debt. In fact, many deals do not even involve a whole company, but only a part of one, be it a division, a plant or a product line. Secondly, even in cases where a whole company is acquired lock, stock and barrel, such as when DuPont acquires ChemFirst, and the debt on the acquired company's balance sheet is assumed in the deal, this debt is normally paid off or refinanced by the acquiring company. Thus the bottom line earnings of the acquired business are not as relevant as EBITDA, which is a measure of the earning of the business, before the factoring in the financial structure of the company or business being acquired.

Converting a P/E Multiple to an EBITDA multiple.
When a public chemical company like ChemFirst is acquired or evaluated, it is much more informative to see what the EBITDA multiple is as opposed to the P/E multiple. How do you convert a public company's P/E multiple to the more relevant EBITDA multiple?

Calculation a Public Company’s EBITDA Multiple


Step 1	Calculate Market Cap	Take the company’s stock price per share and multiply it by the number of shares outstanding.

Step 2	Subtract Cash and Cash Equivalents	If you pay $100 million and get a business with $5 million in cash, you are effectively paying $95 million.

Step 3	Add Debt and Preferred Stock	Conversely, if you pay $100 million and get a business with $5 million in debt, you effectively are paying $105 million (preferred stock is usually treated as debt for these purposes). This will give you the total value of the business, or what is often called Enterprise Value.

Step 4	Calculate EBITDA	In some cases, a company will have a separate line item for operating income, which excludes interest and taxes. To this you add back depreciation and amortization to get to EBITDA. Value Line, on the other hand, uses an “operating margin” percentage of revenues that already is on an EBITDA basis.

Step 5	Divide Enterprise Value by EBITDA	Gives you the EBITDA multiple

Example
Let's take a look at Arch Chemical, using figures published by Value Line as of
September 20, 2002:

Arch Chemicals EBITDA Multiple Calculation


Step 1	Calculate Market Cap	Stock price of $20.45 per share times 22.4 million shares outstanding equals a market cap of $458 million;

Step 2	Subtract Cash and Cash Equivalents	Minus $9.3 million in cash;

Step 3	Add Debt and Preferred Stock	Plus $225 million in debt equals an Enterprise Value of $674 million.

Step 4	Calculate EBITDA	For the year 2001, Arch had revenues of $921 million and an EBITDA margin according to Value Line of 8.9%. Thus EBITDA was $82 million (estimated figures for 2002 would give you a forecasted EBITDA of $89 million, according to Value Line).

Step 5	Divide Enterprise Value by EBITDA	$674 million divided by $82 million gives you an EBITDA multiple of 8.2x (the multiple based on 2002 estimates would be 7.6x)

Arch had a P/E multiple that day of 36.5 according to Value Line, but its EBITDA multiple that day based on 2001 earnings was just 8.2.