Things were wild when it was a borrower’s market. Almost precisely a year ago, Private Debt Investor’s cover story in the June 2019 issue – titled “EBITDA on steroids” – exposed how EBITDA add-backs in loan documentation were incorporating some outlandish revenue assumptions in order for companies effectively to find a way of loading themselves up with more leverage.
As a quick reminder, addbacks are effectively a sum of money added back to the profits of a company. This is important because EBITDA is generally used as the key metric to calculate how much debt a company can reasonably absorb.
In the old days, when the interests of borrowers and lenders/investors were better balanced, addbacks could be quite sensible – for example, the synergistic gains to be made from an acquisition agreed but not yet quite completed. It was reasonable to reflect in the EBITDA highly probable future gains that were not yet being factored in.
But over the past few years, addbacks have been used with much greater frequency and have moved way beyond the boundaries of what was previously acceptable. Examples we gave in the cover story included the following actual or suggested addbacks: any and all related costs and losses of sales as a result of Brexit; synergies to be made from stores not opening for another six months; damages wrought by unfavourable weather, including hurricanes; and even – believe it or not – for losses arising from operational mismanagement.
Once covid-19 had begun wreaking its global havoc, those involved in the leveraged finance market were quick to express the view that we would never see such extremes again. With the borrower’s market having become a thing of the past, investors/lenders could begin to redress the injustices and align interests much more closely.
And then a strange thing happened when, last week, Blackstone-owned Schenk Process added back €5.4 million of profits in its Q1 reporting that would have accrued had it not been for the impact of covid-19. The move was dubbed EBITDAC (earnings before interest, taxes, depreciation, amortisation and coronavirus).
This raised the hypothetical prospect of companies with diminishing liquidity options seeking to use loose add back documentation – possibly a clause relating to something like “exceptional” or “extraordinary” circumstances – to raise additional debt.
Spooked by this prospect, the European Leveraged Finance Association wasted no time in issuing advice that borrowers in such a situation should seek waivers to existing terms rather than taking actions that may lead to a serious fallout with their stakeholders.
We will now wait to see whether other examples will follow, in spite of ELFA’s advice. If they do, then assumptions that certain types of borrower behaviour have been consigned to the past may need reassessing. One year on, maybe things are still a little wild.
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