John Malone the man who invented EBITA
WHo IS JOHN MALONE?
John C. Malone is an American billionaire businessman, landowner, and philanthropist born in 1941 in Connecticut. He is best known for his influential role in the cable television industry and his financial innovations.
Career Highlights
Served as CEO of Tele-Communications Inc. (TCI) from 1973 to 1996, transforming it into the largest cable television company in the United States14.
Pioneered the use of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) as a financial metric in the 1970s23.
Currently serves as Chairman of Liberty Media Corporation, Liberty Broadband Corporation, and Liberty Global plc7.
Business Approach
Malone is known for his aggressive growth strategy and financial acumen:
Focused on scaling nationwide to gain negotiating power with TV networks and studios3.
Emphasized cash flow over traditional profit metrics, coining terms like EBITDA to showcase a company's cash-generating potential25.
Pursued a strategy of minimizing reported earnings and taxes while funding growth through acquisitions and internal expansion2.
Other Ventures and Interests
Largest individual landowner in the United States, owning over 2.2 million acres7.
Holds significant stakes in various media and entertainment companies, including Lionsgate and the Atlanta Braves7.
Known for his libertarian political views and has made donations to various political campaigns7.
Malone's innovative approach to business metrics and growth strategies has had a lasting impact on the cable industry and corporate finance practices.
WHY DID HE INVENT EBITA?
John Malone invented EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) in the 1970s for several strategic reasons:
To showcase cash flow potential: Malone wanted to highlight the cash-generating ability of cable companies, which were capital-intensive and often showed low profits on paper due to high depreciation costs12.
To minimize taxes: Malone believed that the best strategy for a cable company was to minimize reported earnings and taxes while funding growth with pretax cash flow12.
To attract investors and lenders: By emphasizing cash flow rather than earnings per share (EPS), Malone could present a more favorable picture of his company's financial performance1.
To support aggressive growth: EBITDA allowed Malone to justify his strategy of rapid expansion through acquisitions and internal growth, which was difficult to reconcile with traditional EPS metrics2.
To gain a competitive advantage: Ignoring EPS in favor of cash flow metrics gave TCI an important early advantage over other public companies in the cable industry4.
This approach was highly unconventional at the time, as Wall Street primarily evaluated companies based on EPS. Malone's innovation in financial metrics helped him build TCI into the largest cable television company in the United States and significantly influenced corporate finance practices beyond the cable industry14.
WHAT IS EBITA?
EBITA stands for Earnings Before Interest, Taxes, and Amortization. It is a financial metric derived from EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) by subtracting Depreciation2.
EBITA is used to assess the profitability of a business while including the effects of the asset base. This makes it a more comprehensive metric than EBITDA for evaluating a company's financial performance2.
The key difference between EBITA and EBITDA is:
EBITA includes depreciation costs
EBITDA excludes both depreciation and amortization costs
While EBITA provides a more detailed picture of a company's profitability by accounting for depreciation, it has not gained as widespread adoption as EBITDA in financial analysis2.
WHO LOVES IT AND WHO HATES THE TERM?
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) has both proponents and critics in the financial world:
Supporters of EBITDA
Investors and analysts: Many use EBITDA to evaluate a company's earning potential before considering financing costs and taxes1.
Lenders: EBITDA is commonly used to assess a company's ability to cover its debt obligations1.
Company management: EBITDA allows them to showcase operational performance without the impact of non-operational factors1.
Private equity firms: They often use EBITDA in valuation, particularly for leveraged buyouts4.
Critics of EBITDA
Warren Buffett: He is one of the most outspoken critics of EBITDA. Buffett argues that it ignores real expenses like depreciation and can make unprofitable companies appear profitable2.
Financial purists: They criticize EBITDA for excluding important costs such as interest, taxes, depreciation, and amortization, which significantly impact a company's true profitability and cash flow4.
Skeptical investors: Some argue that EBITDA can be easily manipulated through adjustments, potentially inflating a company's financial performance4.
Industry experts: Critics point out that EBITDA is particularly problematic for capital-intensive industries, where depreciation represents a significant and real cost of doing business5.
The debate around EBITDA highlights the importance of using multiple financial metrics and understanding their limitations when evaluating a company's financial health.
Why does Warren Buffett and Charlie Monger dislike EBITDA
Warren Buffett and Charlie Munger strongly dislike EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for several key reasons:
Exclusion of real expenses: They argue that EBITDA ignores critical costs such as depreciation, which Buffett considers "an expense, exactly as sure as are labor costs and overhead"5. By excluding these real expenses, EBITDA can make unprofitable companies appear profitable.
Misleading representation: Buffett calls EBITDA a "very misleading statistic" that can be used in "pernicious ways"7. It fails to account for capital expenditures (Capex) and changes in working capital, which are crucial for assessing a company's true financial health1.
Potential for manipulation: The lack of standardization in EBITDA calculations allows for subjective judgments and "creative" accounting, potentially inflating a company's financial performance1.
Ignores capital intensity: Buffett criticizes EBITDA for failing to account for the capital intensity of a company, which is especially problematic for industries with high depreciation costs9.
Inaccurate cash flow representation: EBITDA can overstate cash flow by ignoring changes in working capital, leading to potential overvaluation of companies5.
Encourages short-term thinking: Munger and Buffett believe the focus on EBITDA can foster a culture of earnings manipulation and short-termism, ultimately harming investors and the market2.
Widespread misuse: They express concern over the widespread adoption of EBITDA, particularly in business schools and among financial professionals7.
Munger famously suggested replacing "EBITDA" with "bull**** earnings" whenever you hear it8, highlighting their deep skepticism towards this metric. Both investors advocate for a more comprehensive approach to evaluating a company's financial performance, one that considers all costs and sources of income to provide a true picture of its economic health.