Learning About EBITDA Using The Sydney Harbour Bridge

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Photo by Photoholgic on Unsplash

The Sydney Harbour Bridge is an icon adorning one of the most famous harbours in the world. And it can teach you about the importance of understanding EBITDA.

It begins with the value proposition.

It’s the same as the popular value proposition for most toll roads. The Sydney Harbour Bridge saves thousands of commuters and travellers time on their trips, and there is no workaround unless you want to add an additional one-hour to your trip and save the roughly four dollar toll.

In addition, it would take too much capital, and the return on that capital would be far too low to warrant building a new bridge. So competition is ruled out (let’s assume you own the Sydney Harbour Tunnel too).

It has all the makings of a great business, though the government owns it and would regulate the price should it ever be made private.

With toll roads, earnings and operating costs are fairly predictable.

Let’s assume the price is $4 and 50 million vehicles pay the toll each year. That’s $200 million in revenue. Now assume operating costs are $100 million, or two dollars per vehicle. You then pay 30% tax on top (you own it outright, so no debt and no interest payments).

(Note: all these numbers are illustrative only).

As such, you think you’re earning $70 million every year ($200 million less $100m costs less $30m tax).

You’re not.

Built in 1923 and still generating revenue, all the depreciation on the asset has long been paid. Therefore our calculation of earnings was correct, we didn’t subtract depreciation but there isn’t any, as the accounting depreciation is zero.

When the bridge was built the cost was probably depreciated over 50 years, and anything longer would have seemed in the distant future. As a result there’d be no more depreciation charges.

There is apparently no further subtraction from the $70 million earnings.

Where all depreciation has been paid, EBIT equals EBITDA. But this isn’t the underlying economic reality.

True earnings are inflated, as maintenance capital expenditure needs to be taken into account.

The bridge needs to be painted, surveyed, engineering studies are required, parts need to be replaced and the road will need paving. These are capital costs, not expenses, and have not been subtracted from the earnings.

But they are very real costs.

If they were to total $5 million for the Sydney Harbour Bridge, real economic earnings are then $65 million.

Being over 90 years old the Sydney Harbour Bridge is the perfect example of where capital expenditure exceeds depreciation and amortisation.

It is also the perfect introduction to the concept of look-through earnings. The need to take maintenance capital (the funds required to stay in business) into account when it differs from accounting depreciation.

Said another way, depreciation and amortisation is a real cost as it proxies capital expenditure. But capital expenditure is often higher due to the time depreciation is calculated on or the increasing the cost of replacements (with inflation).

The Sydney Harbour Bridge (with our illustrative numbers here) probably underestimates the calculation for most real life businesses. With some businesses, earnings may look good, but there’s often more to it.

Always remember that maintenance capital expenditure needs to be taken into account.

Again, depreciation and amortisation is a real cost. Hopefully the Sydney Harbour Bridge is a neat way of showing this. So beware people quoting EBITDA.

And finally, tip to those currently building the next generation of businesses:

Build a bridge that doesn’t need to be painted.