Key Takeaways
- EV/EBITDA is a popular capital-structure-neutral metric, but its simplicity is a significant weakness in capital-intensive sectors where depreciation reflects real cash outlays for asset maintenance (capex).
- In industries like telecommunications, a low EV/EBITDA multiple might not signal value but rather chronic underinvestment or significant future capital expenditure requirements that the metric ignores.
- A comparative analysis of European telecom operators reveals valuation disparities that are only understandable when factors such as regulatory burdens, fibre rollout costs, and pension liabilities are considered alongside the multiple.
- In an environment of rising interest rates, the ‘capital structure neutrality’ of EV/EBITDA becomes a liability, as it masks the very real risks associated with debt servicing and refinancing for highly leveraged firms.
The enterprise value to EBITDA multiple is a remarkably durable tool in the analyst’s kit, prized for its ability to compare companies while elegantly sidestepping the inconvenient realities of debt and tax. As financial analyst Celine pointed out, it is particularly favoured for assessing capital-heavy sectors like telecommunications. Yet, its elegant simplicity is precisely where the danger lies. The metric’s neat abstraction from on-the-ground realities can lead to profoundly flawed conclusions, treating the very real cost of maintaining a business’s operational capacity as a mere accounting fiction.
The Allure of Simplicity
The persistence of EV/EBITDA is understandable. By adding back interest, tax, depreciation, and amortisation to net income, it offers a view of profitability that is independent of a company’s financing decisions, tax jurisdiction, and fixed asset accounting. This makes it theoretically ideal for comparing a highly leveraged legacy operator with a debt-free challenger, or businesses across different national tax regimes. It aims to answer a simple question: for every pound of enterprise value, how much core operational profit is the business generating before the financiers and the government take their share?
In this respect, it serves as a useful first-pass filter. It helps to quickly sort a universe of companies and identify apparent outliers. However, treating it as anything more than a crude starting point is a common and costly error, particularly in sectors where the ‘D’ and ‘A’ in EBITDA are not abstract concepts but proxies for immense, recurring cash expenditure.
Capital Intensity: The Metric’s Great Blind Spot
The critical flaw in the EBITDA measure is its treatment of depreciation and amortisation as non-cash charges to be ignored. While technically true from an accounting perspective, this overlooks a fundamental business reality: for an industrial or infrastructure company, depreciation is the financial echo of capital expenditure (capex). Assets wear out, technology becomes obsolete, and networks require constant upgrades. The cash spent on maintaining and replacing these assets is very real indeed.
A company can artificially boost its EBITDA by deferring necessary capex, allowing its infrastructure to degrade. On paper, its EV/EBITDA multiple might look attractive, suggesting it is undervalued. In reality, it is simply accumulating a ‘capex debt’ that a future management team, or an acquirer, will have to pay. A far more insightful metric would be EV/(EBITDA – Maintenance Capex), as this provides a much closer approximation of pre-financing, pre-tax free cash flow available to capital providers. Ignoring capex is akin to admiring a building’s rental income without checking its structural integrity.
A Comparative View of European Telecoms
The European telecommunications sector provides a perfect laboratory for observing these dynamics. A surface-level comparison of EV/EBITDA multiples suggests some clear valuation discrepancies. However, these numbers are only the beginning of the story.
| Company | Market | Forward EV/EBITDA (Approximate) | Key Contextual Factors |
|---|---|---|---|
| BT Group plc | UK | 4.9x | Massive fibre rollout via Openreach; significant pension deficit. |
| Vodafone Group plc | Pan-Europe | 5.3x | Complex portfolio; activist pressure to simplify and divest assets. |
| Orange S.A. | France/Pan-Europe | 5.4x | Strong position in France and Africa; state ownership influence. |
| Deutsche Telekom AG | Germany/US | 6.7x | Higher multiple driven by valuable US asset (T-Mobile US). |
Note: Ratios are illustrative, based on consensus estimates as of late 2023, and subject to market fluctuation.
At a glance, BT Group appears to be the most modestly valued. Yet, this lower multiple reflects the market’s cognisance of the enormous capital required to fulfil its fibre-to-the-premises (FTTP) ambitions, alongside a legacy pension burden that acts as a claim on cash flows. Conversely, Deutsche Telekom’s higher multiple is largely a function of its majority stake in the high-growth, high-performing T-Mobile US, which trades at a significantly higher valuation than its European parent. Without this context, the EV/EBITDA ratio tells a misleading story, comparing not just different companies but entirely different growth and investment profiles.
A Better Heuristic for a Complex World
Relying on a capital-structure-neutral metric becomes particularly fraught when the cost of that capital is no longer negligible. As central banks have moved away from an era of zero-cost money, the specific details of a company’s debt—its maturity profile, its currency exposure, its fixed-versus-floating-rate mix—have returned to the forefront of risk analysis. EV/EBITDA, by its very design, ignores this.
For investors navigating these sectors, the focus must shift. While EV/EBITDA can remain a tool for initial screening, it should be immediately supplemented with a rigorous analysis of free cash flow conversion—that is, how much EBITDA actually becomes cash after all necessary capital expenditures are accounted for. Furthermore, leverage should be scrutinised not just by its quantum (Net Debt/EBITDA) but by its character and cost.
As a closing hypothesis, the pronounced valuation gap between US and European telecom assets is unlikely to close on its own. Instead, it may serve as a catalyst for a new wave of M&A, driven not by public market sentiment but by private capital. Infrastructure funds and private equity firms, armed with long-term horizons and a sharp focus on cash flow after capex, are uniquely positioned to acquire these European assets. They can execute the necessary investment cycles away from the quarterly pressures of public markets, suggesting the ‘true’ value of these businesses will be realised not through multiple expansion, but through operational and financial re-engineering in private hands.
References
@realroseceline. (2024, August 16). [EV/EBITDA is often used to compare companies across different capital structures]. Retrieved from https://x.com/realroseceline/status/1936208742728806428
Corporate Finance Institute. (n.d.). EV/EBITDA Multiple. Retrieved from https://corporatefinanceinstitute.com/resources/valuation/ev-ebitda/
Hayes, A. (2023). What Is a Good EV/EBITDA? Investopedia. Retrieved from https://www.investopedia.com/ask/answers/072715/what-considered-healthy-evebitda.asp
Macabacus. (n.d.). How to Assess Company Value with the EV/EBITDA Ratio. Retrieved from https://macabacus.com/blog/assess-company-value-ev-ebitda-ratio
WallStreetPrep. (n.d.). EV/EBITDA Multiple (Enterprise Value). Retrieved from https://www.wallstreetprep.com/knowledge/ev-ebitda-enterprise-value/
