Introduction
Operating leases are one of the most nuanced areas in valuation, sitting at the intersection of accounting standards, enterprise value calculations, and multiple selection. The adoption of ASC 842 (US GAAP) and IFRS 16 in 2019 brought operating lease liabilities onto the balance sheet for the first time, fundamentally changing how these obligations appear in financial statements and raising important questions about how to treat them in the EV bridge and in valuation multiples.
For lease-heavy industries (retail, airlines, restaurants, healthcare services), the treatment of operating leases can shift the implied valuation by 10-20% or more. Getting this right, and more importantly being consistent, is essential for credible comparable company analysis.
The Accounting Change
Before ASC 842/IFRS 16, operating leases were off-balance-sheet. The lessee recorded only a rent expense on the income statement, with no liability on the balance sheet (the future lease commitments were disclosed in footnotes). This meant operating leases were invisible in the standard EV calculation.
Under the new standards, lessees now record a right-of-use (ROU) asset and a corresponding operating lease liability on the balance sheet. The income statement treatment differs between US GAAP and IFRS:
- US GAAP (ASC 842): Operating leases continue to record a single, straight-line lease expense within operating expenses. This lease expense is above EBITDA, meaning it reduces EBITDA just as rent expense did before.
- IFRS 16: All leases are treated like finance leases. The expense is split into depreciation (of the ROU asset) and interest (on the lease liability), both of which are below EBITDA. This means EBITDA under IFRS 16 is higher than under ASC 842 for the same lease.
- Right-of-Use (ROU) Asset
An asset recognized on the balance sheet under ASC 842/IFRS 16 representing the lessee's right to use a leased asset for the term of the lease. The ROU asset is initially measured at the present value of future lease payments (matching the lease liability) and is amortized over the lease term. For valuation purposes, the ROU asset itself is rarely the focus; the operating lease liability (on the other side of the balance sheet) is what matters for the EV bridge when using the lease-adjusted approach.
How to Treat Operating Leases in the EV Bridge and Multiples
The key principle is consistency between the numerator (EV) and the denominator (financial metric). There are two valid approaches, and the choice depends on which metric is used:
Approach 1: Standard EBITDA (Do Not Add Leases to EV)
Under US GAAP, the operating lease expense is included in EBITDA (it is an operating expense above the EBITDA line). Since the cost of the leases is already captured in the denominator, the corresponding liability should NOT be added to the numerator (enterprise value). Adding lease liabilities to EV while also including the lease expense in EBITDA would double-count the obligation.
This approach is simpler and is appropriate when the entire peer group reports under US GAAP and lease obligations are not a major differentiator across peers.
Approach 2: EBITDAR (Add Leases to EV)
EBITDAR adds back rent expense to EBITDA, creating a metric that is neutral to whether a company owns or leases its real estate. If using EBITDAR as the denominator, the operating lease liabilities must be added to enterprise value in the numerator, because the cost of the leases has been removed from the metric.
| Approach | EV Adjustment | Metric | Best For |
|---|---|---|---|
| Standard (no lease adjustment) | Do not add lease liabilities | EV / EBITDA | US GAAP peers; industries where leases are immaterial |
| Lease-adjusted | Add operating lease liabilities to EV | EV / EBITDAR | IFRS reporters; lease-heavy industries (retail, airlines, restaurants) |
- EBITDAR
Earnings before interest, taxes, depreciation, amortization, and rent expense. By adding back rent, EBITDAR eliminates differences between companies that own their properties (with higher D&A but no rent expense) and companies that lease (with no property D&A but significant rent expense). EBITDAR is the standard metric for lease-heavy industries, particularly retail, airlines, restaurants, and healthcare services. When using EV/EBITDAR, operating lease liabilities must be added to enterprise value to maintain numerator-denominator consistency.
Practical Guidance by Industry
- Retail, restaurants, airlines: Use EV/EBITDAR with lease liabilities in EV. These industries have massive lease portfolios that are central to their business model, and comparing companies on an EBITDA basis would penalize those that lease more versus own.
- Technology, professional services: Use standard EV/EBITDA without lease adjustments. Leases (primarily office space) are typically a small portion of total expenses and do not significantly differentiate companies within the peer group.
- Healthcare services: Depends on the sub-sector. Hospital operators and outpatient facility companies often have significant real estate leases, warranting EBITDAR. Healthcare IT and services companies typically do not.
- Mixed peer groups (US GAAP + IFRS): Use EBITDAR with lease liabilities in EV to eliminate the accounting-driven difference in EBITDA between the two standards.
Where to Find Operating Lease Data
For US public companies, the operating lease liability is reported on the balance sheet under ASC 842 as a separate line item (often split into current and non-current portions). The total operating lease liability is the figure used in the EV bridge when applying the lease-adjusted approach.
The lease footnote in the 10-K provides additional detail: the maturity schedule of future lease payments (by year), the weighted average remaining lease term, and the discount rate used to calculate the present value of the liability. This maturity schedule is useful for assessing the scale and duration of the company's lease commitments relative to peers.
For the EBITDAR calculation, the total rent expense (or operating lease cost) is typically disclosed in the lease footnote or in the income statement footnotes under ASC 842. Under IFRS 16, the equivalent figure must be reconstructed by adding back the depreciation on ROU assets and the interest on lease liabilities that were previously reported as a single rent line item.
Financial data providers (Bloomberg, Capital IQ, FactSet) generally report operating lease liabilities and EBITDAR as standard data fields, though the analyst should verify these against the primary filings, particularly for companies with complex lease structures or recent accounting transitions.
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