That quote demonstrates that the BusinessWeek writers don't understand the proper use of EBITDA or how it came into use in valuing companies, even if they are correct that it came to be misused.
I've said this here before, but it bears repeating. EBITDA is nothing more than a measure of the operating cash flow that a business is capable of generating, that enables you to value an enterprise (not its stock, directly) without regard to its current capital structure. It came into widespread use in valuing companies for acquisition (either by another company or in an LBO/MBO), because current capital structure is irrelevant when you are about to recapitalize the business. To value it, you need to know how much cash it can generate for ALL security holders, not just equity holders.
And as I've also said here before, to use EBITDA in valuing an enterprise, you need to also know what else can effect cash flows. This includes working capital as well as CAPEX requirements.
Now, EBITDA can also be used to measure relative valuations among otherwise similar companies that have differing capital structures. If you try to compare based on P/E or on price over cash flows available to equity holders only, you are ignoring potentially significant differences in leverage, making your comparison useless. In this context, BTW, working capital and CAPEX requirements may not be relevant because you are comparing companies that are otherwise similar, so those requirements should also be similar. Remember, you are not trying to judge the absolute value in this use, but rather the relative value only.
But never has EBITDA been properly used as a "temporary measure" to look beyond early CAPEX requirements of a "young industry." For such an industry, historical measures of earnings, EBITDA or free cash flow are all relatively unimportant simply because it is not a mature business or industry. In other words, you have to look ahead and guess at future levels of whatever financial measure you want to use because you expect all of them to be negative for a while. As the business progresses and matures, one should look at all three measures, as well as the capital structure, liquidity, etc. A positive EBITDA number for an emerging company can tell you a lot about the progress it is making and about its prospects for ever reaching profitability.
So, dismiss EBITDA if you want to. That's a very popular view these days, especially among people who studied English to learn how to write about things they don't understand. But if you dismiss it, you are throwing away potentially valuable information. |
