Do unfunded pensions or leases belong in enterprise value?

Tie it to EBITDA. Add an unfunded pension like debt, often after tax. Under US GAAP operating lease rent is already in EBITDA, so leave that liability out, under IFRS add it, and treat every comp the same way.

The numbers, step by step

The pension and the retailer from the answer, in $ millions, with the lease liability set at 10 times rent to keep it simple.

Pension deficit after tax$100 × (1 − 25%)

$75

US GAAP multiple$1,000 ÷ $100

10.0x

IFRS EBITDA$100 + $30 of rent

$130

IFRS multiple, leases left out$1,000 ÷ $130

7.7x

IFRS multiple, leases added($1,000 + $300) ÷ $130

10.0x

What the interviewer listens for

• Do you tie the decision to how EBITDA is defined?
• Do you treat an unfunded pension as debt-like, possibly after tax?
• Do you split US GAAP and IFRS lease treatment?
• Do you treat every comp the same way?

Common mistakes

• Adding US GAAP operating lease liabilities while using EBITDA that already pays the rent.That counts the leases twice.
• Treating leases differently across the comps, which makes IFRS reporters look cheaper than they are.
• Putting in the full pension deficit with no thought to tax, when contributions are deductible.
• Stating these as fixed rules.They're judgment calls tied to how EBITDA is built.

Likely follow-ups

• Why tax-effect the pension but not the debt?Cash put into the pension is deductible when it's paid, so the after-tax cost is lower. Repaying debt principal isn't deductible, so debt goes in at full value.
• Your comps mix IFRS and US GAAP companies. What do you do?I put them on one basis: subtract rent from the IFRS companies' EBITDA and leave the lease liabilities out, or use EBITDAR and add leases for everyone.
• What other debt-like items would you look for?Earnouts from past deals, legal or environmental liabilities and retiree healthcare obligations, each decided the same way for every comp.

More finance technicals

• What multiples would you use for a bank, a REIT, an oil producer and a software company?
• How does valuing a private company differ from valuing a public one?
• What is a control premium, and how big is it usually?
• How do you estimate a company's cost of debt?
• What is the mid-year convention in a DCF, and what does it do to the value?

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