Prepayments: The Cash Mirage Distorting EV/EBITDA
In industries with heavy prepayments—like airlines, SaaS, newspapers, and gyms—that low EV/EBITDA might not be the bargain it seems.
A few years ago, a buy‑side acquaintance burst into a Midtown coffee shop brandishing the print‑out of a small‑cap newspaper publisher’s financials. “Three times EV/EBITDA,” he declared, the words tumbling out almost faster than the foam from the cappuccino the barista had just handed him. “It’s practically free.”
The numbers on the page did look seductive. The company seemed to be swimming in cash, and because enterprise value equals market capitalization plus net debt (or minus net cash in this example), the pile of money pushed the EV figure down to a level that made the earnings multiple appear microscopic. Yet half a subway ride later the bargain had evaporated. Buried on the liability side of the balance sheet was an equally large line item labeled “deferred revenue.” Every dollar of that so‑called cash represented a subscriber who had paid for months—sometimes years—of papers the company still owed. The cash was an advance, the accounting equivalent of an interest‑free loan from readers. Net it against the liability, and the “cheap” stock priced up right alongside its peers.
So dear bargain hunters, beware. EV/EBITDA, a workhorse multiple for screeners and quick‑and‑dirty comps, depends on net debt’s accuracy. But prepayments—cash collected before goods or services are delivered—blur that figure. They sit invitingly in the bank account, yet in substance they are an obligation to perform or refund. Counting them as excess liquidity is no different from forgetting to record a loan.
Airlines are perhaps the most vivid illustration. Travelers often book tickets months in advance; the resulting float can equal several quarters of the carrier’s operating profit. When Covid‑19 grounded fleets in 2020, carriers discovered the dark side of that windfall as cash rushed out in refunds and vouchers. Cruise operators, tour companies and live‑event promoters face the same seasonal bulge. Software‑as‑a‑service providers pocket annual license fees up front, turning negative working capital into a hallmark of the model. Gyms lock in members with discounted yearly plans, and prepaid phone operators collect airtime before a single call is made.
None of this means prepayment‑rich businesses are poor investments. Steady subscription cash can cushion downturns, and managers who reinvest float wisely can create genuine value. What it does mean is that investors must distinguish available cash from encumbered cash. The task is hardly Herculean: pull up the latest 10‑K, search for “contract liabilities” or “deferred revenue,” and subtract that figure from the balance‑sheet cash before you compute net debt. Do the same for both current and long‑term portions. Recalculate enterprise value and, if you must lean on a multiple, use one that rests on solid ground.
In the case of my newspaper‑stock‑hunting friend, the lesson stung but stuck. He still screens for low EV/EBITDA names, but the first column he checks now is deferred revenue. The next time someone tries to sell you on a “cash‑rich” bargain, reach for the liability footnotes before reaching for your wallet. In finance, as in journalism, context is everything—and sometimes the headline figure hides the real story in the fine print.
