Effectively Using EBITDA Multiples for Pharma Company Valuation

Determining the valuation of pharmaceutical and biotechnology companies is a crucial exercise to inform high-impact decisions including organic investments and prioritization, licensing deals, and mergers and acquisitions. EBITDA multiples are commonly used to value companies; technically, they are a subtype of multiples-based comparable company valuation method. This article provides a comprehensive overview of utilizing EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) multiples to value companies within the pharmaceutical sector.

What is EBITDA?

EBITDA represents a company’s core profitability from operations while excluding non-cash expenses. It is calculated by taking the company’s operating revenue or turnover and subtracting the operating expenses, excluding interest payments, tax obligations, depreciation of assets, and amortization of intangible assets.

Why EBITDA is Important for Pharma and Biotech Companies?

EBITDA provides an indication of the raw earning power and profit generation ability of a pharmaceutical company’s underlying business operations. By excluding non-cash charges, EBITDA hopes to capture the company’s core cash-generating ability. It is a particularly important metric and multiple for valuation purposes because it aims to provide a normalized view of profitability from the core business that can be compared across different companies.

EBITDA Multiples for Valuation

EBITDA multiples are financial ratios used to value a pharmaceutical company based on its EBITDA. The most common EBITDA multiples applied are EV/EBITDA (enterprise value divided by EBITDA) and P/EBITDA (share price divided by EBITDA). EV/EBITDA is the most commonly used multiple for valuation. It relates the entire firm value to its core earnings as represented by EBITDA.

Advantages Over Other Multiples

EBITDA multiples have certain advantages over other more common ratios like the price-to-earnings (P/E) ratio for valuing pharma companies. EBITDA provides a measure of core operating profitability that is not distorted by the considerable differences in accounting treatments for important items like depreciation policies across different pharmaceutical companies. Thus, EBITDA offers a more consistent metric focused on cash earnings for valuation multiple analysis.

Determining Appropriate EBITDA Multiples for Biopharma Companies

Choosing appropriate EBITDA multiples for valuing a pharmaceutical company requires careful benchmarking against comparable publicly traded companies in the industry. There are several factors that influence suitable EBITDA valuation multiples:

• Revenue growth rate – Faster growing firms warrant higher multiples
• Profit margins – More profitable firms achieve higher multiples
• Pipeline value – Promising pipelines command higher multiples
• Commercial potential – Assets close to launch warrant higher multiples

Therefore, benchmarks should be analyzed to select appropriate EBITDA multiples reflecting similarities and differences compared to peers based on these value drivers. Adjustments may be required if a company has substantially higher or lower growth assumptions versus the comparables. Studying historical EBITDA multiples over time for major pharmaceutical firms provides crucial insight. The resulting EBITDA multiples should be sanity checked against multiples from relevant recent M&A deals or licensing transactions for reassurance.

2023 EBITDA Multiples for Pharma, Biotech & Healthcare Sector

The 2023 EBITDA multiples for pharmaceutical, biotech, and wider healthcare sectors are described in the table below.

The data is based on the research of Professor Damodaran of the Stern School of Business at New York University. The EBTIDA multiples serve as a guide for conducting and triangulating valuation. However, each company must be valued individually using other valuation multiples and, fundamentals such as the DCF-based rNPV or other appropriate methods.

Applying EBITDA Multiples for Valuation

Once appropriate EBITDA valuation multiples are determined, the valuation is calculated by multiplying the company’s EBITDA by the selected multiple. The EBITDA can be current or forward estimates, depending on objectives. For example, consider a mid-sized pharmaceutical company with a trailing 12 months EBITDA of $50 million. Benchmark analysis determines an appropriate EV/EBITDA multiple of 10x for the company and peer set. The EV valuation is derived as:

EV = EBITDA x Multiple = $50 million x 10 = $5oo million

EBITDA Multiplier Valuation – the limitations

While valuable, EBITDA multiples have some inherent limitations and challenges:

Difficulty in Identifying Comparable Companies

A key challenge is the difficulty in identifying perfect peer-comparable companies for deriving multiples since in principle, no two pharma companies are exactly alike. Finding similar enough listed companies is challenging.

Accounting Practices Affect EBITDA Multiples

International accounting discrepancies can distort EBITDA multiples if caution is not exercised. Standards like IFRS and GAAP differ with respect to revenue, cost, inventory recognition, etc. Careful adjustment is required when comparing companies under different accounting standards.

EBITDA as a Proxy to Free Cash Flow

EBITDA overestimates core cash flow from operations as it is affected by the following issues:

• It is a pre-tax item.
• It does not include working capital requirements.
• It does not include fixed capital investment (aka CAPEX).

Free cash flow to the firm (FCFF) usage is superior to EBITDA for valuation purposes. FCFF is calculated as FCFF = EBIT(1 – Tax rate) + Dep – FCInv – WCInv.

One-Time Events Impact EBITDA Multiples

One-time financial events can skew EBITDA from its normalized level tied to core operations, distorting multiples. The use of normalized EBITDA is recommended to avoid this.

Limited Applicability to Pre-revenue Biotech & Pharma

Since pre-revenue biotech firms have minimal or no EBITDA, EBITDA multiples have limited relevance for valuing clinical-stage biotech companies with no commercial products.

In summary, EBITDA multiples valuation is a widely used methodology for the valuation of pharmaceutical and biotechnology companies grounded in market-based multiples. Diligence is required in selecting appropriate multiples and normalized EBITDA to avoid misleading valuations. When applied judiciously, EBITDA multiplier valuation provides a simple and meaningful valuation to complement other more robust valuation methods.

BiopharmaVantage is a specialist healthcare and life sciences consulting firm that specializes in providing valuation services specifically for pharma and biotech companies and investors. If you would like to explore how we can assist you, then please get in touch with us.