The Acquisition That Flatters the P&L
Ridgeway Industrial (€420m revenue, EBIT margin 7%, net debt €95m) proposes acquiring a smaller rival for €140m cash plus €30m in assumed debt. The target reports EBITDA of €18m and EBIT of €6m; the gap is largely capitalised development costs and a maintenance capex deferral the target has run for three years. Ridgeway's CFO presents the deal as accretive to EPS, financed by new debt at 5.5%. Ridgeway's tax rate is 25%. The board is told the deal is "6.5x EBITDA, a good multiple." One non-executive director asks what the multiple is on earnings and what happens when the deferred capex is caught up.
1. Reconstruct the deal economics on a basis that reflects the target's true earnings.
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The 6.5x EBITDA headline is misleading because EBITDA excludes exactly the items that are unsustainable here. Enterprise value is €170m (€140m equity plus €30m debt). On EBIT of €6m the multiple is about 28x - a very different number.
The deferred maintenance capex must be estimated and deducted. If the target has underinvested for three years, the catch-up is a real cash obligation that the buyer inherits. Suppose catch-up capex is €5m per year for three years: true EBIT falls toward €1m in those years, and the multiple becomes indefensible on current earnings.
Financing cost: €140m at 5.5% is €7.7m of annual interest, versus target EBIT of €6m. On a pre-tax basis the acquisition is loss-making before any catch-up capex. The CFO's accretion claim depends on the tax shield (interest deductibility at 25% reduces the net cost to about €5.8m) and on synergies not yet quantified. Even with the shield, EBIT of €6m does not cover €5.8m of net interest plus the catch-up capex. Accretion, if it exists, comes from somewhere other than the target's operations.
2. Advise the board on what conditions would make the deal defensible, and what the non-executive director should insist on.
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The deal is defensible only if two things are established: a credible catch-up capex figure, and quantified synergies that exceed the financing cost plus catch-up.
The board should require: (1) a capex normalisation schedule - a three-to-five-year estimate of what it costs to bring the asset to steady state, signed off by operations rather than by the seller's finance team; (2) a synergy case with named owners and timing, since without it the target does not cover its own interest; (3) a price adjustment mechanism, because the €140m was set on flattered EBITDA - the board should renegotiate on normalised EBIT or walk.
The non-executive should insist that the accretion analysis be presented on normalised EBIT after catch-up capex, not on reported EBITDA, and that the debt covenant headroom be shown post-acquisition. Ridgeway's own EBIT margin is 7%; adding a target with a 3.5% EBIT margin and deferred capex raises leverage and lowers group returns. The board's question is not whether 6.5x is a good multiple but whether the earnings being bought are real.