When valuing a company with significant operating leases, how should you adjust the EV/EBITDA multiple to make it comparable to a peer that owns its assets? Walk through the steps.
An advanced Valuation question — expect it in final rounds and case-heavy interviews (IB, PE, Big-4 Transaction Services).
THE SHORT ANSWER
First, capitalize operating leases by discounting future lease payments at the company's pre-tax cost of debt to get an asset value. Add this to EV and adjust EBITDA by adding back the implicit interest and depreciation from the lease. Alternatively, use a multiple like EV/EBITDAR (rent-adjusted EBITDA). For a clean comparison, I would compute an adjusted EV = Market Cap + Debt + Lease Liability - Cash, and adjusted EBITDA = EBITDA + Lease Expense. Then the adjusted EV/EBITDA multiple is comparable to the peer's EV/EBITDA if the peer owns assets. This normalizes for financing choice.
WHAT INTERVIEWERS LISTEN FOR
- ✓Capitalize operating leases to debt-like liability
- ✓Adjust EBITDA by adding back lease expense
- ✓Use adjusted EV and EBITDA for comparability
COMMON MISTAKES
- ✗Ignoring leases and using reported EV/EBITDA
- ✗Only adjusting EV without EBITDA
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