This article originally appeared on LandscapeManagement.net on March 8, 2023. Greg Herring regularly writes for Landscape Management, providing financial analysis and insights tailored to landscape business owners.
Here are the facts. BrightView is valued at a multiple of 6.7 times adjusted earnings before interest, taxes, depreciation and amortization (EBITDA). Large, privately-held landscape companies sell for 10 times EBITDA or more. The difference is significant, but what does it mean?
A public company is almost always more valuable than an equivalent private company because investors in a public company can sell at any time. Private company investors cannot. (In valuation terminology, that reality is called the “liquidity premium.”) In the landscape industry, the valuation of larger companies is at higher multiples than smaller companies.
Last week, I reviewed BrightView’s financial results for Dec. 31, 2022, and asked whether negative real growth in the landscape maintenance division constituted a warning to the industry.
In this article, I will explore the possible implications of this unusual valuation situation on the landscape industry.
In the landscape industry, a company is valued based on a multiple of EBITDA. Negotiation between the buyer and the seller determines the multiple.
That calculation generates the “enterprise value” of the company — the value of a debt-free company with all the assets needed for operations, excluding cash. For a public company, the enterprise value is equal to the price of a share of stock multiplied by the number of shares outstanding plus the amount of debt minus the amount of cash. The enterprise value divided by EBITDA provides the current market multiple. In BrightView’s case, that multiple is 6.7.
To be clear, the seller of the “enterprise” would sell all the assets —including the accounts receivable, vehicles, equipment, websites and trademarks — for the price calculated by multiplying EBITDA by the agreed-upon multiple. The buyer would pay that price and also assume all routine accounts payable and accrued expenses, but not any other debt (e.g. promissory notes and lines of credit).
Factors Influencing EBITDA Multiples
The supply of companies available to purchase and the demand for companies is a big factor influencing the multiple — perhaps the biggest factor. The greater the number of buyers in relation to sellers, the greater the multiple. We have seen that reality in the landscape industry. Over the last five years, the number of buyers has grown significantly due to private equity investments. Therefore, multiples increased significantly over that period.
Interest rates also affect multiples. Lower interest rates enable buyers to spend less on debt financing, which increases cash flow and what buyers can pay. Although we have not seen it yet, higher interest rates generally reduce multiples. In addition to actual interest rates, mere expectations of interest rate increases or decreases also impact multiples.
The company’s growth rate influences multiples — the higher the growth rate, the higher the multiple assuming companies have the processes and management teams to grow quickly and profitably.
The degree of consistency in revenue growth and profit margins usually increases multiples as well. Accelerating growth and consistent increases in profit margins would increase multiples even more.
Companies that are not dependent on an individual, the owner, for example, will tend to sell for a higher multiple than companies with that dependency. Why? Because risk is lower.
Revenue mix can influence multiples. In the landscape industry, maintenance revenue is more valuable than construction revenue because maintenance revenue is recurring and more resistant to recessions.
To summarize, fundamentally, the law of supply and demand usually impacts valuation. The other factors cited above represent an effort to assess the risk of experiencing a decline in cash flow. The lower the risk (or the greater the certainty), the higher the multiple. Owners who build a business with less risk will likely receive a greater reward – a higher multiple of EBITDA.
Exploring BrightView’s Valuation
One year ago, on Dec. 31, 2021, BrightView was valued at a 9.5 multiple of adjusted EBITDA. Why has BrightView’s valuation multiple declined to 6.7 on Dec. 31, 2022?
The real answer is that no one knows the reasons for the decline in BrightView’s valuation multiple nor why its valuation multiple is lower than the multiple for large, private companies. However, we can consider some possible reasons.
BrightView had a debt of $1.4 billion on Dec. 31, 2022, and equity valued at $555 million. Stock investors may be concerned about the high amount of debt in relation to equity, given the possibility of a recession.
Investors may wonder how a recession will impact BrightView, specifically whether BrightView will have the sufficient cash flow to pay interest on its debt.
On Dec. 31, 2022, the ratio of debt to adjusted EBITDA was 4.9. One year ago, the ratio was 4.5. In my opinion, that ratio is high and presents a significant financial risk to the company and its investors.
Said differently, BrightView had free cash flow after paying for capital expenditures and interest of $104 million, just 3.7 percent of revenue, for the 12 months that ended Dec. 31, 2022. Using BrightView’s estimate of annual interest expense of $100 million for 2023 reduces the free cash flow to $71 million or 2.5 percent of revenue. That free cash flow does not provide much margin for a decline in revenue and cash flow due to a recession.
The company has fixed the interest rate on 70 percent of its debt, which eliminates interest rate risk on that debt. The interest rate on the remaining debt floats with the market; therefore, interest expense could increase or decrease.
To its credit, the company has refinanced its debt and extended the maturity of its $1.2 billion term loan to April 2029. BrightView’s revolving line of credit matures in April 2027. These extended maturities mean that BrightView does not have to use its free cash flow to repay material amounts of principal in the near future.
BrightView’s valuation is low because of the value of its stock. Stock investors may be concerned about the following:
- The high amount of debt in relation to EBITDA, given the possibility of a recession;
- The potential for higher interest expense on the floating rate debt; and
- The lack of organic growth in the key landscape maintenance division, as discussed here.
Implications for Landscape Business Owners
Most private equity investors are not long-term investors. Therefore, they plan how to sell even as they buy companies. Generally, they will want to buy companies at a low multiple and sell them at a high multiple. For many years that plan looked like it would work because BrightView was selling for a much higher multiple than private companies. How much longer will private equity-backed companies pay a higher multiple than BrightView?
If you are considering selling your company, it will be very important to think about the possible answers to that question.
I have made numerous judgments in calculating the numbers and ratios above. For example, I have excluded operating lease liabilities on the company’s balance sheet in my calculation of debt, valuation and related ratios. I have used adjusted EBITDA instead of EBITDA. For free cash flow, I started with adjusted operating income rather than “cash flows from operating activities” on the Statement of Cash Flows to exclude changes in working capital. Other people may make different judgments. These different judgments may impact the calculations, but not the essence of this commentary.
Because of the decrease in free cash flow and the decline in the stock price, I believe BrightView likely makes decisions focused on short-term results, not long-term success. If correct, that short-term focus creates problems and opportunities for other landscape companies and should impact their business strategy and tactics, including their pricing strategy. As financial leaders, we discuss these issues and opportunities with our clients routinely, BrightView is too big to ignore in many markets.