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.

Value to EBITDA

Back when I was discussing the Kraft/Cadbury acquisition in my entries in this blog, I spoke -- as the interested parties there were speaking -- of the P/E ratio, historically an important metric for stock pickers, investors, acquirers, executives who are in part compensated in equity, and gurus.

I believe the gist of that discussion was that over time, the "E" in P/E has acquierd a specific meaning, reflected in the more elaborate acronym EBITDA (earnings before interest, taxation, depreciation and amortization.)

Now it is time to return to the subject to mention that the P part of the P/E ration is in the process of a more radical redefinition. It is not stock price but "enterprise value" that figures in the emerging metric. Here's a discussion from the website of the Stern School of Business at New York University. The "enterprise value" is defined as the combined market value of all securities issued by the enterprise. Why? Because this allows for apples-to-apples comparisons. Different firms will have different balances of debt to equity, i.e. bonds to stock, and these differences would skew price-to-earnings.

Does this help in, say, the discussion of an impending acquisition? Presumably acquirers would look for a low enterprise multiple, because they are going to be buying up that stock and becoming responsible for the payments on those bonds -- they want a sizeable earnings stream in return. If a P/E or P/EBITDA multiple is used instead, the responsibility for the target company's bonds falls out of the picture, or never gets into it.

You can see here how "Seeking Alpha" applied the idea, four years ago.