| EBITDA Musings : The bubble may be over, but that doesn't mean that rationality has returned to the market. Today, a host of stocks that tend to be valued on EBITDA (earnings before interest, taxes, and depreciation and amortization) are getting crushed, with the theory apparently being that what happened to Worldcom could happen to them. But it's important to understand that Worldcom's accounting fraud didn't really have anything to do with the fact that they were valued on an EBITDA basis; the deception and the resulting devastation would have been the same even if the company had been valued based on GAAP earnings per share. Based on preliminary reports from the company, it appears that Worldcom reduced operating expenses by categorizing routine maintenance costs on its network as capital spending. This misreporting would reduce every known measure of earnings: GAAP EPS, pro forma EPS, and EBITDA. It could be said that other companies which manage similar networks, whether they're telecom, radio, or cable TV, could have similarly misreported maintenance costs as capital expenses. While this can't be ruled out, it should be noted that it's unlikely that such blatant accounting fraud was repeated at other firms which generally weren't under the same liquidity pressures facing Worldcom. Even in the Worldcom case, it's hard to fathom how the executives responsible for the deception actually believed that it would ultimately help the company or them personally. But in the cases of companies that were still profitable and facing no adverse liquidity issues, to engage in similar accounting fraud would have been beyond stupid (we'll leave open the question of what lies beyond). If investors are looking for companies with a higher probability of Worldcom-type accounting fraud, they would be better served by looking at companies in any sector that were under liquidity pressures, rather than other companies valued on an EBITDA basis. EBITDA valuation was not related to the cause or effect of Worldcom's fraud. - Greg Jones, Briefing.com |
