William J. DeRosa, Jr., CFA

Free Cash Free Calculation for Serial Acquirers: VCA Antech

September 24, 2010 | About:

Discussion concerning the use and calculations is a popular topic within the investment community. While a company’s earnings gets a majority of the attention, cash flow has gained a certain amount of recognition – for good reason. Analyzing a company’s free cash flow can provide a solid insight into true profitability.

The process of calculating free cash flow is relatively straightforward. Most define it as the following (assuming the direct method);

Net Income

+ Non cash charges (depreciation/amortization)

+/- Changes in working capital

- Capital expenditures (some prefer to use maintenance cap exp)

= Free Cash Flow.

Although it is a simplified formula, this definition works well in most cases. We should always attempt to dig deeper into these numbers where appropriate. In my experience of analyzing company’s cash flows, there is a type of company where I feel this formula falls short. It’s with the serial acquirer. I’m not talking about those large deals that grab the headlines such as Intel, HP, or IBM. I’m talking about companies that consistently make small acquisitions annually as part of their business plan. They usually occur when a good size company dominates a niche market that is highly fragmented. With this in mind, let’s begin with our first example;

VCA Antech (NASDAQ:WOOF)

 2009 2008 2007 2006 2005 Period End Date 12/31/2009 12/31/2008 12/31/2007 12/31/2006 12/31/2005 Period Length 12 Months 12 Months 12 Months 12 Months 12 Months Stmt Source 10-K 10-K 10-K 10-K 10-K Stmt Source Date 02/26/2010 02/26/2010 02/26/2010 03/01/2007 03/14/2006 Stmt Update Type Updated Reclassified Reclassified Updated Updated Net Income/Starting Line 135.59 137.11 124.86 105.53 67.82 Depreciation/Depletion 39.57 31.91 27.05 22.24 19.34 Amortization 0.0 0.0 0.0 0.0 0.0 Deferred Taxes 24.6 22.58 10.94 7.69 10.5 Non-Cash Items 18.23 11.28 3.25 1.36 24.84 Changes in Working Capital -34.52 -5.58 7.66 -9.93 -7.4 Cash from Operating Activities 183.47 197.31 173.76 126.89 115.1 Capital Expenditures -50.8 -55.05 -48.71 -35.32 -29.21 Other Investing Cash Flow Items, Total -79.97 -157.67 -222.59 -52.42 -86.22 Cash from Investing Activities -130.77 -212.71 -271.31 -87.73 -115.43

There is nothing inherently wrong with making these ‘tuck-in’ acquisitions as long as they profitably contribute to the long term growth plan. However, they must be accounted for in the free cash flow calculation – at least in my opinion. These acquisitions represent an ongoing capital expenditure – similar to a retailer spending cap exp to expand its footprint. The company’s acquisition history is clearly laid out in the 10K filing. However, if you want to take the quick and dirty approach simply subtract out “other investing cash flow items” from the standard free cash number. While it isn’t perfect it will give you a much better (and more conservative) indicator of real cash being spent on the business.

William J. DeRosa, Jr., CFA
William J. DeRosa, Jr. is the General Partner of Anthem Asset Management, LLC is an independent investment management company. He has also served as Director of Equity Research and Senior Portfolio Manager at various buy-side asset management firms. Mr. DeRosa is a Chartered Financial Analyst and is a member of The CFA Institute.

 Currently 3.83/512345 Rating: 3.8/5 (6 votes)