Who Invented The Term EBITDA? Was It KKR? Milken? by S&C Messina
Contrary to popular belief, the term EBITDA as a measure of a company’s cash flow was not invented by the early buyout shops. Neither KKR nor any of the other pioneers of the 80’s-style mega LBOs introduced EBITDA into the financial lexicon. Junk bond pioneer Michael Milken wasn’t the inventor either.
EBITDA was introduced into the vocabulary by John Malone. He is currently the largest landowner in America. But he’s more well-known as the billionaire who earned his fortune by becoming the “King of Cable.” Malone started working in the mid-70’s at a cable TV provider called TCI which was purchased by AT&T Corporation in 1999. AT&T kept TCI’s broadband internet services, and TCI’s cable TV systems were sold to Cablevision and then to Comcast. Malone is likely to have something to do with your current internet connection and what you’re watching on TV today.
Regarding Malone’s introduction of “EBITDA” into the financial lexicon here is an excerpt from The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success discussing Malone’s role in the birth of EBITDA:
- In lieu of EPS, Malone emphasized cash flow to lenders and investors, and in the process, invented a new vocabulary, one that today’s managers and investors take for granted. Terms and concepts such as EBITDA (earnings before interest, taxes, depreciation, and amortization) were first introduced into the business lexicon by Malone. EBITDA in particular was a radically new concept, going further up the income statement than anyone had gone before to arrive at a pure definition of the cash-generating ability of a business before interest payments, taxes, and depreciation or amortization charges. Today EBITDA is used throughout the business world, particularly in the private equity and investment banking industries.(1) [emphasis added]
So why did Malone invent “EBITDA”? Long story short, Malone had a key insight about the cable industry. While Wall Street and most of his peers were obsessed with net income and EPS, he wanted to minimize net income. Higher net income meant higher taxes. Also, to grow as a cable company, you wanted scale to achieve more purchasing power and lower costs, and in turn this led to the ability to pay higher prices (often financed by leverage) for assets while earning the same or higher returns. The key was to fund internal growth and acquisitions with pretaxcash flow. More details from The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success:
- Malone, the engineer and optimizer, realized early on that the key to creating value in the cable television business was to maximize both financial leverage and leverage with suppliers, particularly programmers, and that the key to both kinds of leverage was size. This was a simple and deceptively powerful insight, and Malone pursued it with single-minded tenacity. As he told longtime TCI investor David Wargo in 1982, “The key to future profitability and success in the cable business will be the ability to control programming costs through the leverage of size.”
- In a cable television system, the largest category of cost (40 percent of total operating expenses) is the fees paid to programmers (HBO, MTV, ESPN, etc.). Larger cable operators are able to negotiate lower programming costs per subscriber, and the more subscribers a cable company has, the lower its programming cost (and the higher its cash flow) per subscriber. These discounts continue to grow with size, providing powerful scale advantages for the largest players.
- Thus, the largest player with the lowest programming costs would have a sustainable advantage in making new acquisitions versus smaller players— they would be able to pay more for a cable company and still earn the same or better returns, thereby creating a virtuous cycle of scale that went something like this: if you buy more systems, you lower your programming costs and increase your cash flow, which allows more financial leverage, which can then be used to buy more systems, which further improves your programming costs, and so on ad infinitum. The logic and power of this feedback loop now seems obvious, but no one else at the time pursued scale remotely as aggressively as Malone and TCI.
- Related to this central idea was Malone’s realization that maximizing earnings per share (EPS), the holy grail for most public companies at that time, was inconsistent with the pursuit of scale in the nascent cable television industry. To Malone, higher net income meant higher taxes, and he believed that the best strategy for a cable company was to use all available tools to minimize reported earnings and taxes, and fund internal growth and acquisitions with pretax cash flow.
- It’s hard to overstate the unconventionality of this approach. At the time, Wall Street evaluated companies on EPS. Period. For a long time, Malone was alone in this approach within the cable industry; other large cable companies initially ran their companies for EPS, only later switching over to a cash flow focus (Comcast finally switched in the mid-1980s) once they realized the difficulty of showing EPS while growing a cable business. As longtime cable analyst Dennis Leibowitz told me, “Ignoring EPS gave TCI an important early competitive advantage versus other public companies.”
- While this strategy now seems obvious and was eventually copied by Malone’s public peers, at the time, Wall Street did not know what to make of it. In lieu of EPS, Malone emphasized cash flow to lenders and investors, and in the process, invented a new vocabulary, one that today’s managers and investors take for granted. Terms and concepts such as EBITDA (earnings before interest, taxes, depreciation, and amortization) were first introduced into the business lexicon by Malone. EBITDA in particular was a radically new concept, going further up the income statement than anyone had gone before to arrive at a pure definition of the cash-generating ability of a business before interest payments, taxes, and depreciation or amortization charges. Today EBITDA is used throughout the business world, particularly in the private equity and investment banking industries.(1) [emphasis added]
(1) Thorndike, William N. (2012-10-02). The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success (p. 89-91). Harvard Business Review Press. Kindle Edition.
