Adjusted Ebitda masks higher leverage on buyout loans

LONDON (LPC) - Investors in European leveraged loans are increasingly concerned that private equity firms are making overly-aggressive adjustments to portfolio companies’ earnings to support higher debt loads.

Ebitda is a benchmark cashflow figure used by bankers to calculate a company’s leverage and market deals to investors, and adjustments reflect assumptions about companies’ future earnings potential.

Investors are worried that these adjustments and projections may not be achievable and are masking the true amount of leverage and debt that private equity firms are using, as well as the risk inherent in transactions.

“Going into the financial crisis you saw the same things happening. Private equity firms have always pushed the boundaries on what Ebitda they will get lenders to buy into,“ a fund manager said.

Higher Ebitda figures allow companies to borrow more and make overall leverage levels appear lower. Without adjustments, leverage ratios would be far higher, which could make deals difficult to sell to investors and raise red flags with regulators.

The European Central Bank followed US regulators in capping leverage ratios at six times Ebitda, but this is a guideline, and even adjusted leverage levels are often higher.

A recent €880m equivalent euro and sterling buyout loan backing pharmaceuticals manufacturer Zentiva's ROSCD.BX acquisition by Advent had leverage of 7.1 times based on adjusted 2017 Ebitda.

Private equity firms cite lower average Ebitda levels as the sign of a healthy market and routinely use them to differentiate between current market conditions and the peak of the market before 2008’s financial crisis.

But as resistance to aggressive loan documents grows, many investors are criticizing the scale of current Ebitda adjustments and demanding changes.

Finnish private healthcare company Mehilainen’s €760m Term Loan B priced wide of guidance this week and required a raft of changes to clear the market, including reducing the adjustments made in the Ebitda definition. The deal funded CVC’s acquisition of the company.

Adjustments linked to the synergies expected from mergers and acquisitions have the best chance of being achieved, ratings agency Moody’s said in a June report.

“We’ve worked with one company where the M&A-related adjustments have been very high but the market accepted them as they have a track record of delivering,” a co-head of leveraged finance said.

One-off “add-backs”, where companies claim a non-recurring cost saving, are a bigger problem. Only 45% of these adjustments were achieved on average and nearly 20% of issuers achieved none of their projected adjustments, Moody’s said.

These unusual adjustments are rising, driving the increase in issuer Ebitda adjustments to an average of 14% last year from 9.6% in 2016, according to the ratings agency.

“We are getting more questions about Ebitda adjustments. As an investor it is not always easy to make a judgment given the poor level of detail often available,” a London-based analyst said.


Around 77% of the global leveraged loan market is covenant-lite, according to S&P. More middle-market loans have covenants, but aggressive Ebitda definitions are undermining limited protection for lenders.

“What is the value of covenants with this level of Ebitda adjustment? With this headroom there has to be such a deterioration in the business before it bites,” a lawyer said.

The direct lending market is also not immune to Ebitda adjustments. Core Equity Holdings recently acquired a stake in UK-based Portman Dental Care with around £100m in debt financing provided by Alcentra, based on an Ebitda figure of £20m, which had been adjusted up from £9m.

Portman has expanded rapidly in the last few years, almost tripling the number of practices since 2014, but many lenders balked at the adjustment, which more than doubled Ebitda.

“It’s a whopping multiple,” a second fund manager said.

Discipline on documentation is stronger in the private debt market compared with larger deals due to the riskier nature of the companies.

In the US, where the private debt market is deeper, 35% of middle-market loans had Ebitda adjustments, according to Covenant Review. Adjustments linked to synergies are capped at around 10%-15% in the middle market, based on projections for the next 12 or even 18 months.

But the list of exceptional items, including uncapped non-recurring payments, also leave lenders exposed to restricted payments and further debt issuance by sponsors, which can weaken investors’ position.