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Well, let's get straight to the point. Today we will talk about a financial indicator that is found literally everywhere. You see it in the income statements. You hear it on the news. It's used in huge multi-billion dollar deals, but it's also a metric that one of the smartest investors in history, Charlie Munger, called a complete and utter lie.
So, let's look at the EBITDA paradox. That's it. Munger never minced his words, did he ? Its relationship to EBITDA, which, by the way, stands for earnings before interest, taxes, depreciation and amortization. This is perhaps his most famous and, frankly, most aggressive criticism. For him, it wasn't some useful abbreviation .
It was a dangerous way to distort reality. And that's the main question, is n't it? This is a mystery we will try to solve. If a titan like Munger thought it was a scam, why the hell do CEOs, private equity funds, and Wall Street bankers keep using it? To find out, we need to go back to the very beginning.
So, our story begins not in a fancy office on Wall Street, but back in the 1970s with a man named John Malone, a legend who was called the "cable cowboy." Malone had a grand vision, but an even bigger problem. The usual way of keeping accounts made his business model look like a complete disaster. You know, what Malone did was just amazing, because he completely changed the script on how to do business.
He borrowed huge amounts of money to buy up competitors and lay all this cable. On paper, with all the interest he was paying and the depreciation on his equipment, his company was showing huge losses. But that's where the genius lies. Malone knew that as long as there was enough cash from subscribers to pay the bills, he was actually building an empire.
So he used EBITDA to show lenders, "Hey, look past this weird accounting stuff." Look at the net cash this company generates. And did it work? Oh yes, it worked. Malone's strategy provided investors with an incredible 30% annual return for over 20 years. I mean, it was a huge success. But, as Munger would later note, Malone was a unique genius.
He could perform this financial tightrope walk . The problems started when everyone else saw his trick and started trying to copy it. And that brings us to the heart of Charlie Munger's entire argument. He believed that the very foundation of EBITDA was built on a dangerous fantasy . A fantasy that we can call the illusion of depreciation.
So let me explain to you the logic of the EBITDA proponents. They say, look , when a company reports earnings, it has to deduct depreciation. But no real money, no cash, leaves the bank under this item in the quarter. So it's just paper costs. We have to add them back in to see the real cash flow. But Munger considered this idea completely absurd.
And this slide perfectly demonstrates two different universes. The EBITDA camp sees this as just a harmless accounting entry . Munger, on the other hand, saw the specter of real money that had already been spent. He argued: If you spend $20 million on a new fleet of trucks, that money is gone. They won't come back.
Pretending that these costs don't matter by adding depreciation back in is like pretending that these trucks were a magical gift that would never wear out or need replacing. This is simply ignoring the basic laws of physics. Okay . Now look here, because here everything becomes crystal clear. We have two companies.
If you look at EBITDA alone, they look the same, right? Both earn $40 million. A private equity firm might say they are worth the same. But then you look at the next line. A company with large assets, like a railroad or a factory, has to spend $25 million a year on what is called maintenance capital expenditures.
This is real money that is needed simply to maintain operations and replace worn-out equipment. A company with light assets, such as a software business, spends only 1 million. And that brings us to this number—$24 million . Let this realization sink in for a moment. This is the difference in real money that the first company has to spend just to stay at the same level.
This is the price of entropy, of things breaking down. And this is a huge chasm that EBITDA completely hides from. John Malone may have created EBITDA for a very specific and, one might say, legitimate reason. But then, in the 1980s, Wall Street took it into its own hands. And during the leveraged buyout boom, this indicator turned from a tool into a weapon.
It became a way to justify setting increasingly insane prices for companies. And if you thought EBITDA was a bit of an exaggeration, then “adjusted EBITDA” is completely beyond reasonable. You see, companies started thinking, "Hey, if we can add depreciation , why not stop there?" What other annoying expenses can we just pretend don't exist?
That's how this whole game of creative accounting began . And here's how it roughly works. Your company has to pay a huge legal compensation. No problem. Just call it a one-time expense and add it back. Are you buying another company? Perfectly. Feel free to add back the expected savings you hope to receive before you've even saved a cent .
Oh, and also paying employees with shares. Yes, let's add that back too. Pretending that these are not real expenses, even though it erodes the value of the shares for all other shareholders. Munger had a great phrase for this. He called it a symphony of adjustments . And for him, it was n't just bad math.
It was a moral failure. It was a contagious culture where the truth was hidden under a bunch of adjustments, and everyone felt pressured to play the same game. OK. So far we have talked mostly about theory. But now we will visit the real crime scenes. We'll look at real companies where this obsession with EBITDA hasn't just misled people.
It led to outright fraud and ultimately to complete collapse. So, let's talk about Adelphia Communications. It was one of the largest cable companies in America, and the founding family used EBITDA as the perfect smokescreen for their crimes. They hid billions— billions with an “M ”—of debt off the balance sheet and used all sorts of accounting tricks to artificially inflate EBITDA reports to make the company appear much healthier than it actually was.
And the result—just look at this. It was a real disaster. Investors who trusted these numbers and believed the story the company was telling watched their shares depreciate to zero. The company hid over $2 billion in debt. And when the dust settled, investors lost over 60 billion. It was a crime, plain and simple, and made possible by a rate that encourages ignoring debts.
Now you're probably thinking, "Okay, but that was 20 years ago." We've all learned our lesson by now, haven't we? Well, let's look at a more modern case. Altice USA, another giant cable company, is now facing what analysts call a “ debt maturity wall” while reporting positive adjusted EBITDA every year.
This , this slide, is a paradox in a nutshell. Just look at the conflict above. Altice reports a decent $84 million in quarterly adjusted EBITDA. But then you scroll down to capital expenditures. This is real money they have to spend on network upgrades and competition. This is a huge amount. And the result of this, well, you see below.
Their free cash flow, the real funds left over after paying all bills, is negative. And here he is. This is Charlie Munger's entire argument, which is unfolding right before our eyes today. The company tells Wall Street it has made over $800 million, when in reality it is burning money. She spends more than she earns just to pay off debt and maintain assets.
Two things that EBITDA was specifically designed to ignore. So, I think if there's one conclusion to be drawn from all of this , it's this . EBITDA is not a measure of profit. This is a measure of what a company's profits could be in an ideal fictional world. In a world where you don't have to pay back borrowed money and technology never breaks.
But, of course, we do n't live in that kind of world. And that brings us to the present. The AI revolution is happening, and it's built on billions and billions of dollars invested in very real, physical things . Servers, giant data centers, all kinds of infrastructure. This means that there will be huge depreciation expenses on the statements for many years.
So the main question that remains is this. Will the financial world fall into the same old trap again? Will they use EBITDA to make these incredibly expensive businesses artificially cheap? Or have we finally learned our lesson about Charlie Munger's "shitty profits" ?
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