Conversations about private debt have moved from the general to the highly specific. Were the relationship between borrowers and lenders in approximate equilibrium, it’s easy to imagine the main talking points being the likes of interest rates, political volatility and the ups and downs of fundraising – the kinds of issues that rarely go out of fashion. Instead, EBITDA adjustments have moved from being agenda item number 20 (let’s say) in your average face-to-face meeting with a private debt GP to item number one.
What EBITDA adjustments symbolise is how far the balance of power has shifted to borrowers amid a highly liquid and competitive debt financing market, in which – even if borrowers are met with resistance on the terms of a deal – they can always find someone else pushing themselves forward to sign up on the spot. Although these terms are most readily associated with the syndicated leveraged loan market, many have found their way down into the smaller end of the loan market where private debt firms typically play.
The main problem with EBITDA adjustments is in allowing companies to use an inflated EBITDA figure as a way of justifying the assumption of increasing amounts of leverage – and ultimately skewing the level of risk. The adjustments relate to expected earnings rather than actual earnings and have been a feature of the landscape for some time – but, up until now, based on reasonably conservative assumptions.
One of these assumptions was that additional, adjusted EBITDA should be restricted to a percentage of actual EBITDA, often around 20-25 percent. But at the European Covenant Trends Breakfast Briefing hosted by Xtract Research last week, data showed that, in 2018, 50 percent of US loans and 33 percent of European loans which featured adjustments had no cap at all on the amount of synergies that could added to EBITDA.
One panellist at the briefing made the point that the reasonableness of including synergies may depend on their nature. Some cost synergies are quickly realisable – one example given was the rapid financial gain made by telecom business TalkTalk when it moved HQ from London to Manchester – and these will likely be given a fair hearing by investors. But, in some deals, synergies are being factored in that are not due to be realised for several years.
One other point to note from the Briefing: it’s not all one-way traffic. Deals are rarely completed without some degree of investor pushback, and EBITDA is an area where (perhaps because it’s perceived as particularly egregious) borrowers are prepared to concede some ground. For example, they are generally happy to see synergy timeframes reined back to between 12 and 18 months.
However, the point was also made that investors had expected more of 2019 than it has so far delivered. Despite winning the odd individual skirmish, the war is still a long way from being won. It’s still, and will remain for some time, a borrowers’ market.
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