Why the Market is Thinking About Bitcoin Differently – Visual Capitalist

Posted: April 9, 2021 at 2:22 am

The Ballooning Valuations In Private Equity Deals

Private equity is getting increasingly expensive. As a result, the pricing of an average deal today, by the EV/EBITDA metric, is expected to be at a premium relative to the last decade.

The EV/EBIDTA ratio breaks down into two parts:

Overall, EV/EBITDA shows the relationship between a companys total value and its earnings, and is often seen as the price-to-earnings ratios sophisticated sibling, used to view companies the way acquirers would.

However, the EV component is not necessarily intuitive, so lets expand a little on it:

To acquire a company completely, one must pay out all stakeholders in order to reach the final cost of the acquisition. This includes the stock (equity holders) and the debt holders, subsequently, adding back the market value debt to market cap does just this.

Subtracting cash can also be seen as arriving at net debt. That is, the remaining debt after using the cash and equivalents on a companys balance sheet to pay it down. In other words, if cash exceeds debt, enterprise value shrinks, and the cost of acquiring the company becomes cheaper. Whereas if debt exceeds cash, the acquirer would have to pay off more debt holders, thus making the acquisition more expensive.

First, the public markets are often used as a starting point to derive valuations for deals. Generally, companies with similar business models and operations should be assigned similar valuation multiples. For instance, Lowes and Home Depot, or alternatively, Pepsi and Coca-Cola. Therefore, a company under consideration in private equity often has peers trading publicly.

Furthermore, the average multiple assigned to businesses in the stock market fluctuates through peaks and troughs. Today, theyre trading at a premium to historic averages, a result of a rallying prices and elevated investor risk appetite. Naturally, these public valuations spills over into the private equity space.

Second, asset markets move based on relativity and opportunity cost. A low interest rate environment pairing with the trillions in money printing is placing debt securities at unattractive levels. Hence, low rates of return on debt is resulting in money moving elsewhere.

For private equity though, debt is considered fuel. And in this industry firms use high levels of leverage to acquire companies. For this reason, low rates and cheap debt are a private equity managers dream.

But whats true for one private equity firm can be true for all. Because access to cheap debt means more money chasing deals, and this heightened level of competition is reflecting in the higher multiples and expensive deals today.

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Why the Market is Thinking About Bitcoin Differently - Visual Capitalist

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