When and how to use EV?

[yadayada]

Let's say that a 15x multiple is reasonable for a business that is likely to grow with a moat and reasonable return on capital.

 

One business (that fullfills the above requirements) makes 100 million and has zero debt, the other company is identical in everything but has 1 billion in debt at reasonable interest rates. How much lower will the second company rate? If we say the first one deserves a 15x multiple, would the second one get a 10x multiple? If you go by FCF/EV first one deserves a 15x multiple? But the second one should by that same logic get a 5 earnings multiple vs a 15 earnings multiple? (to get the same FCF/EV ratio).

 

Let's assume that this business will v likely be around at least a bigger size then now in 20-30 years from now and like I said, they have a nice moat and arent a threat to each other.

 

 

Another example would be cigar butts Obviously if the business might not be around 10 years from now, debt plays a much bigger role?

 

What is a good way to think about this?

 

Real life examples might for example be Outerwall which has v nice FCF now (300 million), 600 million in debt, but might not be around in 10 years (or they might, you don't know). But it is certainly not a close to 100% probability they will in this size.

 

But for example GNCMA will v likely be around 30 years from now (and earn more) and has 100m in FCF and 1 billion in debt. So how much do you discount their debt in the FCF multiple here?

[Hielko]

You should always use EV when you compare businesses that have a different capital structure.

 

FCF/EV is not a suitable ratio because (usually) interest expenses are not excluded from the FCF number. You also need a predebt number for this (such as EBIT(DA) or FCFF).

 

If it's a business that will be around 30 years from now even with a 1 billion in debt the company with no debt would have a suboptimal capital structure and it would need to trade at a discount to reflect that fact. What the optimal debt load is depends on how much (business) risk the company has. A company with an above average amount of risk could trade at a market multiple if it has zero debt. A company with a low amount of risk could trade at a market multiple while employing a lot of financial leverage. It's all about risk.

[yadayada]

hmm ok so your basicly pricing risk then when looking at debt. No risk would mean your mostly discounting the debt.

 

And FCF implies interest payments right? FCF is ebitda - capex - taxes - interest?

[Palantir]

I think you can use fcff. It is only suboptimal if you account for taxes. For your example the concern is how to project cash flows not so much accounting for debt.