EBITDA or ‘earnings before the bad stuff’

Keenly eyed visitors to London may have noticed a new addition to the London office space from a relatively new entrant, WeWork. WeWork is reportedly now London’s biggest office occupier and has made headlines  for its trendy new offices and  valuation of US$20 billion.

Reading through the financial press I came across media columns on WeWork’s recent bond offering and a unique new measure reportedly used by WeWork’s management team. This term was ‘Community Adjusted EBITDA’ which, I am informed, is EBITDA adjusted by adding back general and administration costs. And yes, these costs reportedly include day-to-day operating costs and sales and marketing costs.   

The Financial Times (April 26, 2018) reports that WeWork had an Adjusted EBITDA loss for the year ended 31 December 2017 of (US$193,327k) but a Community Adjusted EBITDA profit of US$233,147k; suggesting there has been quite a few not insignificant add backs.

Corporate buyers and M&A teams in the insurance sector will have come across equally creative EBITDA definitions, and as EBITDA is not a defined GAAP term, management teams have great leeway in defining EBITDA in a way that suits them. 

Whilst I have yet to come across an EBITDA definition as aggressive as WeWork’s, I have seen some interesting definitions including EBITDAR (before rent), EBITDA Contribution (applied when spinning off a division), and Cash EBITDA (adding back deferred revenue and where relevant R&D). 

Lessons for insurance M&A buyers

A typical M&A transaction structure will expect to cater for some normalisation of EBITDA. The difficulty here is that the normalisation of EBITDA is very subjective and depends on judgement and experience, and each normalisation procedure is unique to each individual transaction.

In the current ongoing soft market corporate acquirers need to take care to ensure they can reconcile their expectation of what EBITDA means to them as buyers, as against the sellers EBITDA definition as there could be a divide. 

It is often the case that in the speed to sign heads of terms, the definition of EBITDA remains unclear and the implications of this ambiguity is only picked up by good corporate advisers. With EBITDA typically used as the key metric used in calculating the purchase price on which businesses are bought and sold, the financial and strategic implications of an error in poorly defining EBITDA could be fatal to an acquirer’s strategy.

In insurance M&A transactions we work on, we work with clients to establish and analyse the true level of EBITDA, what EBITDA normalisation adjustments they should consider (upside and downside), and the validity of the seller’s definition of EBITDA. We also provide an illustrative view of what the normalised EBITDA could look like in the hands of a client making the acquisition. 

In our experience, normalisation adjustments could simply be an adjustment for management’s remuneration, the establishment of a claims provision, overlaying relevant incremental aspect of the buyer’s overhead cost structure or, in some cases, very much more involved. Each adjustment is then magnified by the valuation multiple in use and provides a clearer view on the fullness of the purchase price.

Moore Stephens’ Corporate Finance team has advised on multiple transactions in the insurance sector and should you wish to discuss our services please do get in touch with Oladipo Oye-Somefun.

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