For craft-beverage companies that are now in the process of seeking acquisition or recapitalization—indeed for almost every company—the COVID-19 pandemic has suppressed sales revenues and resulting EBITDA. Yet there is wide acknowledgement that COVID-19 will not last forever. After some period of time—probably a matter of months—the effects of COVID-19 will diminish and, eventually, vanish. Admittedly, the economy won’t immediately bounce back. When we look back, the recovery will likely be compared to a “dimmer switch” that slowly turns up to full power over time.
On the far side of the COVID-19 pandemic, there is reason for optimism—substantial “tail winds” will power the economy. First, interest rates are low, and the past decade of monetary policy suggests that they will remain so. Second, the Federal Reserve Bank has shown signs that it will remain in an activist posture. Third, adding to serious pent-up demand for craft beverages, federal and state stimulus packages will pump substantial funds and tax incentives to fuel growth.
New Ownership Post-Pandemic
If a craft-beverage company seeks acquisition or recapitalization during, or soon after, the pandemic, the financial reports presented to potential acquirers will surely show suppressed performance caused by COVID-19. Craft-beverage company valuations are often based on the trailing twelve months (TTM) or last calendar/fiscal year EBITDA performance. However, an acquirer is not purchasing a company’s historical performance. That performance is normally a predictor of future revenue and earnings, and it demonstrates the company’s overall operational capacity. But an acquirer is buying future earnings. Accordingly, a company’s value should be tied to those future earnings and not to its performance under temporary stressors, albeit extreme ones such as COVID-19.
Given how long it takes for investment bankers to prepare a company for acquisition or recapitalization (typically about 60 days), the amount of time it takes to “shop a deal” (about 30–45 days), select the winning offer, and complete the due diligence process (about 90 days), most acquisitions or recapitalizations won’t close for a period of about six months, assuming they start today. Even if a company were to start the process of seeking an acquirer in the thick of the COVID-19 pandemic, it’s likely that an acquirer would assume company ownership, and enjoy the future revenue and earnings, when COVID-19 is no longer a factor or its impact is substantially diminished.
Assuming the economy recovers as COVID-19 retreats—a safe assumption indeed—how can a period of suppressed revenues and suppressed EBITDA be presented to a potential acquirer in a way that does not reduce a company’s long-term value?
A Multiple of EBITDA, but Which EBITDA?
First, a quick backgrounder. The vast majority of companies are valued and acquired using multiples of EBITDA. For example, let’s take a company and call it “Craft BevCo.” Assume that Craft BevCo had a 2018 EBITDA of $8 million, a 2019 EBITDA of $10 million, and a projected 2020 EBITDA of $12 million before COVID-19 hit.
Craft BevCo has had a consistent rise in EBITDA, year over year, from 2018, 2019, and 2020, with 2020 being a blend of actual and projected performance. That should instill confidence that 2020 projections are realistic and attainable. If Craft BevCo were acquired for a 7x multiple of 2020 EBITDA before the pandemic occurred, Craft BevCo would be worth $84 million (7 ´ 12 = 84).
Now, let’s examine how COVID-19 may negatively affect the $12 million projected 2020 EBITDA. Assume that COVID-19 is operative as a negative performance factor for four months. For example, let’s project the EBITDA to drop to $0 (zero) during these four months.
Craft BevCo was on a path to achieve a $12 million 2020 EBITDA, or $1 million a month. Due to COVID-19, Craft BevCo would come off that pace by $4 million. The projected EBITDA would drop from $12 million to $8 million. If Craft BevCo were acquired at 7x $8 million, the resulting total enterprise value (TEV) would be $56 million as opposed to the $84 million resulting from 7x $12 million. Ouch! That’s a $28 million reduction in TEV and, obviously, a situation to be avoided at all costs.
Permanent Debilitation or a Pandemic Anomaly?
Given Craft BevCo’s healthy balance sheet and track record, a potential acquirer must recognize that the $4 million in suppressed EBITDA is an anomaly caused by COVID-19. It is not a sign of a permanent debilitation of Craft BevCo’s ability to achieve the annualized $12 million EBITDA once the virus retreats. (If the potential acquirer refuses to recognize this, they are trying to use the pandemic to snatch up a company at a bargain.)
How can Craft BevCo possibly present that $4 million lost EBITDA in a positive light? The investment banker representing Craft BevCo should take the $4 million in suppressed EBITDA and make it an EBITDA adjustment. Call it the “COVID-19 Adjustment to EBITDA.”
Refer to the charts at right as I explain this. Chart 1 shows Craft BevCo’s performance before the pandemic hit. In 2018 and 2019, Craft BevCo performed well, with solid year-over-year growth.
Chart 2 shows a blend of Craft BevCo’s actual and projected 2020 EBITDA performance before the pandemic hit. The company was confidently on a path to achieve $12 million in EBITDA.
Chart 3 shows the dramatic effect the pandemic could have on Craft BevCo. In this example, COVID-19 has entirely chopped out four months of EBITDA performance. However, in the post-pandemic time period, projected to be fully in force starting in August, Craft BevCo would be back on track. But with four months of “missing” EBITDA performance, Craft BevCo’s projected EBITDA would be $8 million, not $12 million.
Given Craft BevCo’s strong historical performance, it is reasonable to assume—and it should be strongly argued by the seller’s investment banker—that COVID-19’s effects are only temporary. Craft BevCo will again attain its projected growth pattern. Accordingly, the missing $4 million EBITDA (Chart 4) is a valid credit to Craft BevCo’s EBITDA.
Craft BevCo’s TEV should not be $56 million (see Chart 5). The $56 million is its “pandemic value,” generated by temporarily suppressed earnings. Craft BevCo’s true TEV is $84 million, the value that would have been achieved had COVID-19 not occurred. The difference between the pandemic value and the non-pandemic value is a negative $28 million in TEV, so it is well worth the effort to argue for a COVID-19 EBITDA adjustment.
Stick to Your Guns
Should a potential acquirer insist on a suppressed TEV due to COVID- 19, the seller and their investment banker representatives should “stick to their guns” and insist on full value for a COVID-19 EBITDA Adjustment. There is, as always, some middle ground to be found here, should the buyer and seller not entirely agree on the adjustment’s acceptability. Perhaps that middle ground could be to acknowledge the extraordinary circumstances of the pandemic and the use of a risk-allocation mechanism, such as the widely used earn-out. But the COVID-19 EBITDA Adjustment is a credit to earnings that is just as valid as any credit to EBITDA (e.g., non-recurring, non-capitalized expenses) that would be accepted in typical deal-point negotiations.
For a seller to insist on a COVID-19 EBITDA Adjustment should not come as a surprise to any serious acquirer. Acquirers recognize the temporariness of the pandemic as much as the seller. A COVID-19 EBITDA Adjustment is simply an acknowledgement that a company such as Craft BevCo is as valuable today as it would have been before the pandemic occurred and that Craft BevCo will regain its footing, and its full value, in a matter of months.