EBITDA’s use as a measure of “clean” operating performance is questionable
- For capital intensive industries, where capex is a fundamental part of standard operating performance, excluding depreciation and amortization does not provide a “cleaner” picture of operating performance. Sprint’s financial results, for instance, swing from $7.4 billion of EBITDA in 2016 to essentially zero EBIT once D&A is taken into account.
- Similarly, if necessary capex is financed via debt and other financing arrangements, the same can be said about excluding interest expense. Charter Communications, for instance, which financed much of its capex via necessary debt issuance, with one bad year in 2008 where the business didn’t operate efficiently, had to file for bankruptcy despite maintaining positive EBITDA.
- Finally, excluding tax expense for certain industries where geographical location and/or capital structure are not easily changed (e.g., the defense industry), again distorts, rather than clarifies, the assessment of operating performance.
EBITDA is often a bad proxy for cash flows
- Comparing EBITDA and operating cash flows for Apple and Exxon, one can see a huge gap between the EBITDA of these companies ($56 billion vs. $95 billion) but not the cash flow from operations ($52 billion vs. $55 billion), which were almost equal in June 2012.
- Taking the case of La-Z-Boy, the eponymous recliner company, in 2017, the company was able to convert over 90% of its EBITDA into operating cash flows, but in 2015 and 2016 the opposite was true.
EBITDA is sometimes a dubious valuation metric
- Seth Klarman believes that EBITDA might have been used as a valuation tool because no other valuation method could have justified the high takeover prices prevalent at the time (1980s). According to him, EBITDA overstates cash flow as it does not take into account all the non-cash gains and expenses along with working capital changes.
- A research paper on valuation analysis at the University of Oxford looks at how Twitter valued itself using adjusted EBITDA, the definition of which excluded depreciation and amortization, interest, and taxes but also stock-based compensation. In fact, Twitter incurred more than $600 million in stock-based compensation expenses in 2014, which was more than 40% of its 2014 revenues.