In the telecommunications sector, earnings before interest, taxes, depreciation and amortization(EBITDA)is a popular equity valuation metric for analyzing companies mainly because of what the metric excludes—depreciation.
Because telecoms businesses invest heavily in network equipment, the EBITDA metric allows for a more accurate comparison across telecoms firms.
Key Takeaways
- Telecoms companies invest heavily in network equipment—a capital expenditure which gets depreciated.
- EBITDA excludes depreciation, which allows for a more accurate comparison across telecoms firms.
- However, some analysts argue that capital expenditures should be carefully scrutinized precisely because they are so important to telecom companies.
Understanding the Telecommunications Sector
The telecommunications sector is characterized as high-growth andcapital-intensive, with high fixed costs and relatively high levels of debt financing. Many companies have a large base of fixed assets, leading to correspondingly high levels of depreciation expenses. To maintain a high level of service, telecom companies must continually invest in network equipment such as switches, telecom towers, and fiber-optic cables.
An additional factor to consider is that telecom firms sometimes receive tax incentives from the government. These tax incentives can result in volatile swings in free cash flow, which meanscash flow metrics may not be the best-suited evaluation points for telecom firms. By excluding capital expenditures, depreciation and financing costs, EBITDA provides a cleaner evaluation of a company's earnings and profit margins.
Advantages of the EBITDA Metric
Because EBITDA excludes the impact of accounting and financing decisions related to capital expenditures, it allows for more accurate comparisons between similar firms, especially if one firm is in the midst of extensive capital projects while the other is not.
EBITDA is considered a more reliable indicator of a company's operational efficiency and financial soundness, because it enables investors to focus on a company's baseline profitability without capital expenses factored into the assessment.
Also, from a purely practical standpoint, using EBITDA is helpful because it is used in other valuation measures commonly applied to telecom companies, including EV/EBITDA and debt/EBITDA.
EBITDA Drawbacks
One of the major strengths of EBITDA—its exclusion of capital expenditures—can also be viewed as a weakness. Some analysts arguebecause capital expenditures are very important to telecom companies, they should be included and, in fact, carefully scrutinized.
EBITDA provides an assessment of profitability, but not of operating cash flow, a metric that provides very good tracking of a company's working capital management.
FAQs
Telecoms companies invest heavily in network equipment—a capital expenditure which gets depreciated. EBITDA excludes depreciation, which allows for a more accurate comparison across telecoms firms.
Why do you think EBITDA is commonly used as a valuation metric? ›
EBITDA is used as a valuation metric as it removes external accounting factors and non-operating expenses from view, focuses on the operating performance of the business and takes into consideration an approximate value of company cash flow.
Why is EBITDA a good measurement? ›
Comparing Like Companies
In addition, EBITDA is a good measure of core profit trends because it eliminates some of the extraneous factors and allows a more "apples-to-apples" comparison. Ultimately, EBITDA should not replace the measure of cash flow, which includes the significant factor of changes in working capital.
Why are companies valued on EBITDA? ›
EBITDA stands for earnings before interest, taxes, depreciation, and amortization, and its margins reflect a firm's short-term operational efficiency. EBITDA is useful when comparing companies with different capital investment, debt, and tax profiles. Quarterly earnings press releases often cite EBITDA.
What is the EBITDA multiple for telecom? ›
EV/EBITDA in the technology & telecommunications sector worldwide 2023, by industry. Worldwide, the average value of enterprise value to earnings before interest, tax, depreciation and amortization (EV/EBITDA) in the technology & telecommunications sector as of 2023 was a multiple of approximately 12.2x.
Why is EBITDA a better metric than net income? ›
Since EBITDA shows income before non-cash expenses (expenses like depreciation and amortization that are recorded on an income statement without any cash changing hands), it's a better indicator than net income of a business's ability to bring in cash.
Why is EBITDA more important than revenue? ›
Differences. EBITDA is a more comprehensive financial term than revenue as it considers a company's operating expenses. Revenue, on the other hand, only indicates a company's total income. EBITDA is derived by adding back interest, taxes, depreciation, and amortization to net income.
What is the biggest impact on EBITDA? ›
The most prominent factors that influence the EBITDA margin are inflation or deflation in the economy, changes in laws and regulation, competitive pressures from rivals, movements in market prices of goods and services, and changes in consumer preferences.
What is measured by EBITDA in telecommunications? ›
In the telecommunications sector, earnings before interest, taxes, depreciation and amortization (EBITDA) is a popular equity valuation metric for analyzing companies mainly because of what the metric excludes—depreciation.
What is KPI for telecom industry? ›
Key Telecom Metrics
Key performance indicators (KPIs) are the most important business metrics for a particular industry. When understanding market expectations for integrated telecommunications, whether at a company or industry level, here are some of the telecom KPIs to consider: View Current Data. Ending Subscribers.
Price to Earning Ratio
Arguably one of the best stock valuation metrics, the price to earning ratio communicates how cheap or expensive a stock is. The lower the price to earning ratio is, the more undervalued a company is.
How do you use EBITDA for business valuation? ›
To compute the Enterprise Valuation of a business, you take the EBITDA amount and multiply it by an enterprise multiple to get the total enterprise value. The enterprise multiple is dictated by the business' industry, the cost of capital, and the overall health of business.
Why is EBITDA valuation bad? ›
Insensitivity to Debt Levels:** EBITDA does not consider interest payments, which can lead to an overestimated valuation for heavily leveraged companies.
Is EBITDA a valuation metric? ›
However, one valuation metric in particular — EBITDA — can be a great starting point in measuring a company's potential value in a sale. Before sitting down with prospective buyers or investors, small business owners should understand how this valuation metric will be used to calculate the worth of their company.
What is EBITDA as a metric? ›
EBITDA is considered an alternate metric of profitability for companies. It helps investors understand how profitable a company is once you remove all the expenses they make.
What is the purpose of using EBITDA as a financial metric different from EBIT )? ›
Why Is EBITDA Preferred to EBIT? EBITDA is often preferred over EBIT by companies that have invested heavily in tangible or intangible assets, and therefore have high annual depreciation or amortization costs. Those costs reduce EBIT as well as net income.
