Journalists love change. It gives them something to write about. No matter whether the change is positive or negative, whether there is an unprecedented success to report or an unqualified disaster, the resulting instability creates unlimited potential for comment and analysis.
Analysts also love change. As long as it is at arm’s length. Analysts at investment banks are not entirely comfortable with the prospect of change resulting from current investigations into their business activities and conduct. Not that they have done anything wrong of course; they have simply been misunderstood.
Analysts at investment banks love change in the industries they track because it creates possibilities for making money. Not for the investment banks themselves—perish the thought—but for the bank’s clients. Positive change creates investment opportunities, indicating where you can place your money to earn substantial returns. Negative change creates a trigger for realizing those returns, indicating when you should take your money out to optimize your profit.
Clients of investment bankers’ analysts love change when it results in profits. Profits for them as investors, not necessarily profits for the industries in which they are investing. The two are not always correlated. Investors tend to focus on short- to medium-term profits, industries on the medium to long term. The medium term for many investors is measured in days, sometimes weeks. For industries, the medium term may be months; more often it is measured in years.
Investment analysts exist to serve their clients, not the industries they monitor. Their job is to predict what will happen in the industry and how the stock market will react. And markets do not behave rationally.
Telecommunications companies used to report profits or losses. No longer. Telecommunications companies these days report positive or, quite often, negative EBITDA.
Earnings before interest, tax, depreciation and amortization is an analytical tool that surged into fashion at the beginning of the dotcom era. It is an appropriate tool for analyzing a start-up company in a business that requires substantial initial investments. Such companies can never make profits during the early years. But once they achieve positive EBITDA, they are heading in the right direction. The road to eventual profitability may be long, but at least they are on the right road.
EBITDA is a supremely inappropriate analytical tool for an established business. It omits some of the most important costs of running the business. It ignores the effects and consequences that decisions have on the balance sheet. It hides the fact that the business may never pay tax because it will never make a profit.
Yet the use of EBITDA has now become standard practice within the telecom industry. Some established companies are reporting stunning increases in EBITDA. They have massive debts and once interest charges have been paid those companies are actually making huge losses. Other established companies with truly astronomical levels of debt are reporting declining EBITDA. The road those companies are on is heading straight toward oblivion. Established but over-borrowed companies reporting negative EBITDA have essentially reached the end of that road.
Tools such as EBITDA are active instruments for short-term investors during periods of change. But they mask reality for those within the industry itself, especially during periods of negative change. EBITDA should be shunned—facing up to reality has now become a priority as never before.
