The entire private equity industry measures value creation with a broken tool. E&Y signs off on it. Harvard and Wharton teach it. Should it even be legal?
Agreed that this level of attribution is sub-par at best. However attribution done correctly can help allocators determine how GPs are creating returns. The analysis needs to go several layers deeper like revenue growth broken down by acquired revenue and organic as well as change in EBITDA margin. Some allocators compare changes vs. public comps or private comos but this is data intensive. Many GPs provide the data for full attribution. If they don't we just move on to the next one.
This is why I teach the real thing at Business School with my own investment cases :)!
Our industry does like to keep the value creation story a secret, in a way to make us sound like the only magicians who improve EBITDA. Reality is simpler and it is not rocket science. What I can affirm is that over my career, all returns I made were by not overpaying and focussing on managing well. The exit multiple will always be a bonus and lottery, it can go either way; but hopefully never below the entry multiple. And that’s the formula…
The strongest version of your critique may be even simpler: leverage should not appear in an enterprise value decomposition, at all.
Leverage does not create or destroy enterprise value—it determines how that value is financed and distributed among debt and equity holders. The negative leverage value (-14% in your very helpful example) is a symptom of that category error, not evidence that debt destroyed value.
So there are at least two distinct questions: 1) what made the business more or less valuable, and 2) what drove equity returns? Leverage belongs in the second decomposition, not the first.
The inclusion of leverage in a value bridge calculation systematically flatters operational value creation while obscuring leverage's actual contribution to equity returns.
This is not a critique of value bridges, but of sloppy work and lack of care. Value bridges are still immensely useful in industry where nobody is dumb enough to ascribe negative value to leverage.
In Table 2, are you saying that the growth in EBITDA was due to inorganic growth? Did the company pay $55 mm ($47 mm of equity plus $8 mm of debt) for $5 mm of EBITDA? If that is the case, then wouldn't any investor simply look at the equity return on a per share basis? Are you saying the PE firm behind such a deal would be so naive as to think that it invested $87 mm ($40 mm initially and then $47 mm for inorganic growth) and then benefitted from one turn of EBITDA multiple expansion and that created $57 mm of "value" ont he orignal $40 mm investement? No way even bad PE firms are that stupid. If you say they are, I would love to see a real world example.
The fool here is not the PE firm. They know what they are doing. The fool is the reader of the report by France Invest, E&Y, the Wharton students, the Harvard one, all the people reading Invest Europe reports, those of the BVCA, because the industry produces these statistics. The people producing this stupid thing probably, hopefully, know what they are doing.
Agreed that this level of attribution is sub-par at best. However attribution done correctly can help allocators determine how GPs are creating returns. The analysis needs to go several layers deeper like revenue growth broken down by acquired revenue and organic as well as change in EBITDA margin. Some allocators compare changes vs. public comps or private comos but this is data intensive. Many GPs provide the data for full attribution. If they don't we just move on to the next one.
This is why I teach the real thing at Business School with my own investment cases :)!
Our industry does like to keep the value creation story a secret, in a way to make us sound like the only magicians who improve EBITDA. Reality is simpler and it is not rocket science. What I can affirm is that over my career, all returns I made were by not overpaying and focussing on managing well. The exit multiple will always be a bonus and lottery, it can go either way; but hopefully never below the entry multiple. And that’s the formula…
Very helpful.. thank you
The strongest version of your critique may be even simpler: leverage should not appear in an enterprise value decomposition, at all.
Leverage does not create or destroy enterprise value—it determines how that value is financed and distributed among debt and equity holders. The negative leverage value (-14% in your very helpful example) is a symptom of that category error, not evidence that debt destroyed value.
So there are at least two distinct questions: 1) what made the business more or less valuable, and 2) what drove equity returns? Leverage belongs in the second decomposition, not the first.
The inclusion of leverage in a value bridge calculation systematically flatters operational value creation while obscuring leverage's actual contribution to equity returns.
This is not a critique of value bridges, but of sloppy work and lack of care. Value bridges are still immensely useful in industry where nobody is dumb enough to ascribe negative value to leverage.
In Table 2, are you saying that the growth in EBITDA was due to inorganic growth? Did the company pay $55 mm ($47 mm of equity plus $8 mm of debt) for $5 mm of EBITDA? If that is the case, then wouldn't any investor simply look at the equity return on a per share basis? Are you saying the PE firm behind such a deal would be so naive as to think that it invested $87 mm ($40 mm initially and then $47 mm for inorganic growth) and then benefitted from one turn of EBITDA multiple expansion and that created $57 mm of "value" ont he orignal $40 mm investement? No way even bad PE firms are that stupid. If you say they are, I would love to see a real world example.
The fool here is not the PE firm. They know what they are doing. The fool is the reader of the report by France Invest, E&Y, the Wharton students, the Harvard one, all the people reading Invest Europe reports, those of the BVCA, because the industry produces these statistics. The people producing this stupid thing probably, hopefully, know what they are doing.