Case Study on Capital Expenditures (MCX)

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MCX and Iridium Case Study

Our first discussion of Maintenance Capital Expenditures (“MCX”) occurred here:

One method of learning is to EXHAUSTIVELY analyze and read about a subject so we can master the topic and understand the principles and subtleties in applying those principles.

We are focused on Return on Invested Capital which has been defined one way as Operating Earnings (Earnings before Interest Expense and Taxes, EBIT) or better yet, (Earnings before Interest Expense, Taxes and Depreciation & Amortization, “EBITDA” – MCX) divided by tangible capital or (Net Working Capital + Net Property, Plant and Equipment). We have covered EBITDA thoroughly in a 36 page discussion here:

Now we review MCX as part of the (EBITDA – MCX) calculation.

The link below has a PDF that further analyzes how to calculate one aspect of Return on Invested Capital–(EBITDA – MCX) divided by Tangible Capital.

Also, this case study will be placed in the VALUE VAULT

The Bridge of Death

If you do not master the above case study then as investors you will not be able to cross the Bridge of Death:

8 responses to “Case Study on Capital Expenditures (MCX)

  1. Actually, IRDM is an important case study to understand the importance of analyzing true capex requirements for a business in order to value the business properly. EVERYTHING in investing is RELATED. The competitive dynamics of the industry will determine true capex.

    Remember Buffett’s analogy of his textile business–everyone stands on their tippy-toes to see, but the added effort makes them no better off than before.

  2. I’m a bit confused by some of the write-ups for IRDM (bull cases). Are the authors of the reports suggesting that the launch of the new satellite spectrum is growth vs. maintenance capex? Shouldn’t the launch of the IRDM Next spectrum be viewed as maintenance capex?

    If I buy a truck that lasts 10 years, I need to replace that truck after 10 years to maintain my company’s competitive position, revenues, profits, etc. If I own a satellite spectrum that lasts 15 years, then needs to be replaced by spending $2.7 billion, that is a maintenance capital expenditure. Therefore, business analysts should be deducting a charge each year when trying to estimate after-tax free cash flow.

    Check out slide 15 of Tilson’s presentation. He shows how capex increases (as it would when the spectrum needs to be replaced), but then decreases substantially (and thus, I’m assuming, FCF increases). This seems to be a bit misleading given the fact that the spectrum needs to be replaced every X years… so that capex should be smoothed over time. Also, the fact that the management team is trying to fund a substantial portion of the spending through debt on this maintenance capital expenditure is not very comforting.

    Given the fact that almost all companies in the industry have gone bankrupt, I question whether any competitive advantages actually exist in this business/industry. If there are no competitive advantages, financing a substantial amount of maintenance capex through debt would be a bad idea, imo.

    • Dear Logan James:

      You have the crux of the issue. Launching the satellites would be (in my opnion) MCX because without the launching of Sats cash flows will decline to $0 within 5 to 20 years.

      I believe Tilson is misguided in his analysis. I am bearish on IRDM.

  3. Thanks for the material. Sounds like the moral of the story is to know your industry, but estimating MCX can still be difficult so …have a margin of safety.

    Greenwald’s technique of working with Sales/PP&E sounds great in theory, but I’ve had trouble putting it into practice for companies that aren’t extremely stable like KO. You end up having situations where the company spent on CapEx, but revenue declined for whatever reason. So math-wise, MCX turns out to be a negative number!

    Just to add to our arsenal, this WSJ article questioning Avon’s accounting ( leads me to believe that there might be a quick way to gauge MCX, at least for large caps. Add up the last decade’s FCF and divide by a similar decade sum of Net Income. If you get a ratio close to 1, then the company is apparently not under-reporting depreciation, so EBIT grabbed directly from the financial statements may be very close to EBITDA-MCX.

    If you get a figure significantly smaller than 1, like 0.76 for Avon, then maybe that’s a sign to either take a pass on the company or at least scale down their reported EBIT by 0.76 for your quick & dirty EV/EBIT calculation.

  4. The Piotroski score is indeed an element of my basic screening, despite the fact that the universe I’m picking from for my work is neither small/mid-cap nor lowest of the low P/B. As stated before, context is key. For my large caps I don’t worry as much about increasing debt levels in an era of almost 0% interest rates. I do care a lot about deteriorating ROA and gross margins though.

  5. Yes, Deteriorating ROA is a concern as well as PEAK margins (what can’t continue will stop–as one economist once said.)

    Capex is really tied into the businessm the specific assets employed and its competitive environment. All the capex in the world wouldn’t have helped Berkshire in the textile business.

    Sometimes, a business will invest heavily in capex to improve efficiency (Sealed Air as one example) and the market punishes the decline in earnings then rallies once those efficiencies kick in two years later. Go figure.

  6. If a company is in a growing industry where it has economies of scale. If in order to maintain its competetitve advantages (in EOS) and thus its margins the company is required to grow should part of its growth be considered maintenance capital?
    What about inflation? Inflation could be raising maintenance capex but it could also be rasing the company’s revenues. If that is true, Greenwald’s method of calculating Maint. Capex becomes a little cumbersome. Any suggestions of how to treat this?

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