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Chapter 5 of 5 · 10 min

Maintenance versus growth capex

Some capex keeps the business standing; some is a bet on more EBITDA. Why the split matters, and when cutting it destroys value.

By the end of this chapter you can
  • Split capex into maintenance and growth, and calculate free cash flow before and after each
  • Value growth capex at the exit multiple and work out its payback
  • Find the growth capex a target increase in EBITDA needs
  • Show whether cutting growth capex before exit helps or hurts
1

The intuition

A taxi owner spends money every year on tyres and servicing, which just keeps the cab on the road. This year they also buy a second cab to take more fares. Both are spending on equipment, but only one is optional, and only one should earn more money.

Maintenance capex keeps today's EBITDA where it is; it is really an operating cost the accounts capitalize. Growth capex is an investment meant to add EBITDA. A sponsor can pause the second to boost cash, but not the first.

The key idea

Growth capex = total capex − maintenance. Extra EBITDA = growth capex × return. At exit it is worth extra EBITDA × multiple. Cutting it saves the capex once and gives up that value.

2

Why it works

  • The conventions here: maintenance capex is a share of EBITDA; growth capex is everything above it and earns a stated cash return in EBITDA every year from next year. Free cash flow is EBITDA − capex, ignoring tax and working capital. Exit value is a multiple of EBITDA.
  • Free cash flow after maintenance only is what the business earns standing still; lenders often size debt off it.
  • Growth capex pays at exit when return × exit multiple is above 1: each dollar spent adds more than a dollar of exit value.
  • Payback in cash is 1 ÷ return, however big the multiple. The exit multiple is what turns a slow payback into value.
  • Cutting growth capex before a sale flatters free cash flow this year and lowers the EBITDA a buyer pays for. Sophisticated buyers look for it.
  • Telling them apart: ask what capex would be at flat revenue, compare capex with depreciation over a cycle, and check the age of the assets.
EBITDA $100M; capex $30M; maintenance 12% of EBITDA; growth capex returns 25%; exit at 9x
Maintenance: 12% × 10012; growth capex 18
FCF after maintenance: 100 − 1288
FCF after all capex: 100 − 3070
Extra EBITDA: 25% × 184.5, worth 40.5 at 9x
Cutting growth capex: +18 of cash, −40.5 of value−22.5 net
Return at which growth capex stops paying: 1 ÷ 911.1%

For $5M of extra EBITDA: 5 ÷ 25% = 20 of growth capex, 32 in total.

3

The formulas

Maintenance capex = maintenance share × EBITDA

What standing still costs.

Growth capex = total capex − maintenance capex

The optional part.

FCF after maintenance = EBITDA − maintenance; FCF after all capex = EBITDA − total capex

Before and after the choice.

Extra EBITDA = growth capex × return; exit value = extra EBITDA × multiple

What the spending buys.

Payback = 1 ÷ return

Years for the cash to come back.

Growth capex for a target = target extra EBITDA ÷ return

Run it backwards.

4

Worked example

Extra EBITDA from the return, value it at the exit multiple, then compare with the money spent.

Drawing the numbers…
5

See it move

Same company. Change total capex, how much of it is maintenance, the return on growth projects and the exit multiple.

Drawing the numbers…
Try this
  • Raise maintenance as a share of EBITDA. Growth capex shrinks and so does FCF standing still; FCF after all capex does not move.
  • Raise total capex. Growth capex grows and FCF after all capex falls; FCF standing still does not move.
  • Raise the return. The EBITDA added and the exit value grow, and payback shortens.
  • Raise the exit multiple. Exit value grows, but payback does not move: cash comes back at the same speed.
6

Run it backwards

Same company, reversed: the plan needs a set increase in EBITDA from growth projects. How much growth capex does that need?

Drawing the numbers…

Each dollar of growth capex adds its return in EBITDA, so divide the target by the return. Maintenance still has to be paid on top.

If that is more than the business spends today, the extra comes out of free cash flow that would otherwise repay debt. That trade-off should be explicit in the plan.

7

Traps

Treating all capex as optional.
Maintenance keeps today's EBITDA. Cut it and the business decays.
Judging growth capex on cash payback alone.
In a buyout the exit multiple on the extra EBITDA is usually what makes it worthwhile.
Cutting growth capex to flatter the last year before a sale.
It saves the spend once and gives up EBITDA × multiple. Buyers notice.
Taking management's maintenance figure on trust.
Compare capex with depreciation over a cycle and check the age of the assets.
Forgetting maintenance in the total for a growth target.
Total capex = maintenance + the growth capex the target needs.
8

Say it in the interview

The interviewer asks

“Why does the split between maintenance and growth capex matter in a buyout?”

Say yours out loud first, then compare.
9

Check yourself

4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.

Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.

0 of 4
Drawing your questions…
Remember
  • Growth capex = total − maintenance.
  • Extra EBITDA = growth × return; worth × the exit multiple.
  • Pays at exit when return × multiple is above 1.
  • Payback = 1 ÷ return, whatever the multiple.