EBITDA and Stock-Based Compensation

The acronym "Ebitda" is in the news again.

For the record, this stands for "earnings before interest, taxation, depreciation and amortization," and is sometimes thought a useful statistic as an approximation of cash flow.

Over time, the significance once attributed to the P/E ratio has come to be relocated -- the value/EBITDA ratio is now the important one.

Value, for such purposes, is a modification of the simpler statistic of market cap, or price.

So: why do I bring it up today? Because it is in the news, of late. Two listed companies, Penson Worldwide (NASDAQ: PNSN) and Comtech Telecommunications (NASDAQ: CMTL) have been called out on fiddling with their EBITDA calculation.

Penson has added stock-based compensation into the EBITDA figure, while Comtech has addedf the amortizationof stock-based compensation. Well ... the A does stand for amortization, but not as it happens that amortization.

Of course, if the EBITDA figure itself can be jiggered with in this way, then any ratios of which EBITDA forms a part become less useful for any investors who might be relying on them. If an investor is diligently working out the value-to-EBIDTA ratio, he'll end up with a smaller ratio that he "should" for these firms. Smaller, that is, than he would if the rules were adhered to consistently. That smaller ratio might well lead him to include, "these stocks are at bargain prices."

Sam Antar has done good work bringing these shenanigans to public notice, and I congratulate him on that.

Another way of looking at this story, though is as a new episode in a continuing controversy over how to account for stock-based compensation. On that, I hope to have something to say next week.

Kraft-Cadbury Concord

Kraft and Cadbury have settled on terms, with Kraft increasing its offer from about $17 billion to $19.5 billion, in a deal that is part cash purchase, part stock-swap.

Hershey had apparently been planing a white-knight offer of $17.9 -- Kraft has obviously now leapfrogged past that. This purchase price is a multiple of 13 times Cadbury's underlying 2009 EBITDA.

I don't believe I've ever defined that acronym in this blog. Just for the record, then, EBITDA means "Earnings Before Interest, Taxes, Depreciation, and Amortization."

The acronym became popular when analysts noticed that the P/E ratio could otherwise be very misleading. According to an older theory, if a corporation's stock price reflected a low ratio of market cap to earnings, the stock itself was undervalued, and a good investment. Obviously, that is a theory that runs into some difficulty given the premise that capital markets are efficient (or even not horribly inefficient) at incorporating such data. But never mind that for now.

No ... the fatal problem for the P/E ratio, as it turned out, was that the earnings number incorporated a lot of fluff in terms of distinct ways of computing amortization, etc. EBITDA, then, is the "E" part of the P/E ratio with the subjective or fluffy stuff taken out, which is supposed to be a more relevant number for purposes of comparison.

As it happens, the "price" side of the old P/E ratio has been modified too over the years for the purposes of analysis. Instead of price-to-EBITDA, one often hears about Value to EBITDA, with value defined as price (i.e. market cap) + the market value of debt. That particular refinement is a subject for another day.

We'll give the final word to Cadbury Chairman Roger Carr: "We believe the offer represents good value for Cadbury shareholders and are pleased with the commitment that Kraft Foods has made to our heritage, values and people throughout the world. We will now work with the Kraft Foods' management to ensure the continued success and growth of the business for the benefit of our customers, consumers and employees."