Loan Note: EBITDA addbacks under the spotlight; Ares-backed Guitar Center seeks way out of bankruptcy

S&P draws attention to ongoing concerns around EBITDA addbacks. Plus, Guitar Center seeks a way out of bankruptcy and the ACC measures the extent of covenant breaches. Here's today's brief for our valued subscribers only.

They said it

“We have to have fiscal policy, structural policy other than just relying on central banks to achieve healthy growth.”

Former Fed chair Janet Yellen, who is set to be nominated as Treasury secretary by US president-elect Joe Biden, speaking to Bloomberg’s New Economy Forum

First look

How addbacks have inflated expectations
In our cover story in June last year, EBITDA on steroids, we suggested the EBITDA addback was “one of the most worrying aspects of loan documentation”. A new report (paywall) on the phenomenon from S&P Global Ratings does little to dispel that notion.

It finds that – out of a “large sample” of M&A and leveraged buyout transactions between 2015 and 2019 – addbacks inflated EBITDA by an average of more than 28 percent. It says EBITDA, including addbacks, “generally does not provide a realistic indication of future EBITDA”.

An addback is essentially a sum of money ‘added back’ to a company’s profits. Among the reasons for doing so would be the synergy gains that would supposedly arise from an acquisition – the argument being that adding back those gains, or at least some of them, provides a more realistic picture of profitability.

One of the most controversial aspects of addbacks, which are often referred to as ‘adjustments’, is that an inflated EBITDA figure in effect enables a company to disguise the amount of leverage it is taking on. This is because total leverage is normally expressed as a multiple of EBITDA.

The S&P report finds that, of its sample, actual reported net leverage was 2.8 turns higher than forecast for 2018 and 3.3 turns above the levels predicted for 2019.

At the outset of the pandemic, it may have been hoped that deal terms and conditions would become more lender-friendly, with addbacks perhaps among the more hubristic aspects to be scaled back. In fact, as we reported, the health crisis gave rise to a further addition to the addback menu in the form of EBITDAC – earnings before interest, tax, depreciation, amortisation and covid – which excluded the impact of the coronavirus from company earnings.

Guitar Center hoping not to end on a sour note
It was back in April 2014 that Ares Management took control of music retailer Guitar Center through a debt-for-equity swap. But despite the deal having initially placed the company on an apparently sound financial footing, it has become just one of many struggling retailers hit badly by the pandemic. At the beginning of this week, it filed for Chapter 11 bankruptcy (see Seeking Alpha report here).

With electric guitar sales on the slide, it remains to be seen whether Guitar Center can turn its fortunes around. However, a new financing agreement has been reached, including both debt and equity investment, and the business says it hopes to emerge from bankruptcy by the end of the year.

Data snapshot

How covid is infecting portfolios. The pandemic has led to serious business disruption, and private debt portfolios have not been immune. New research from the Alternative Credit Council has found that significant numbers of private debt managers have seen, or expect to see, covenants breached during 2020, with 8 percent expecting more than half of their portfolio to be in breach.

Essentials

Four join BNP AM debt team
BNP Paribas Asset Management, the asset management business of BNP Paribas, has added four new hires to its private debt and real assets investment division, headed by David Bouchoucha – all of whom will be based in Paris.

Stéphanie Passet becomes chief investment officer for infrastructure debt, reporting to Karen Azoulay, head of infrastructure debt; Romain Linot becomes chief investment officer for real estate debt, reporting to Christophe Montcerisier, head of real estate debt; Mohamed El Jani has joined the structured finance team as an investment manager, reporting to Michel Fryszman, head of structured finance; and Irene Bárcena has joined the SME lending team as an analyst, reporting to Christophe Carrasco, head of SME lending.

Veteran trio put down roots at Sycamore
New fund managers are something of a rarity these days, although Dallas-based Sycamore Tree Capital Partners does include a lot of industry experience in the form of veterans Mark Okada, Jack Yang and Trey Parker. The three have all worked at one former firm – but which one? Find out more here.

New HK partner for White & Case
Global law firm White & Case has expanded its global debt finance practice with the addition of Daniel Abercromby as a partner in Hong Kong.

Abercromby advises private equity funds and their portfolio companies, as well as credit and other special situations vehicles, on a variety of financings in Asia-Pacific, with a particular focus on South-East Asia, India and Greater China.

LP watch

Institution: New Mexico State Investment Council
Headquarters: Santa Fe, US
AUM: $26.63bn
Allocation to alternatives: 18.33%

New Mexico State Investment Council has approved a $100 million commitment to ICG Senior Debt Partners IV, a contact at the sovereign wealth fund informed Private Debt Investor.

The $26.63 billion US sovereign wealth fund allocates 18.33 percent of its full investment portfolio to alternative investments.

New Mexico SIC’s recent private debt commitments have been mainly to senior and subordinated debt funds focused on investments in the corporate sector. Its chief investment officer is Robert Smith.

Institution: Cathay Life Insurance
Headquarters: Taipei, Taiwan
AUM: NT$6.63trn
Allocation to alternatives: n/a

Cathay Life Insurance has approved a $100 million commitment to Ares Private Credit Solutions II. The fund is managed by Ares Management and has a target of $4 billion.

The Taiwanese insurer’s recent private debt commitments have been mainly to senior, subordinated and distressed debt funds focused on investments in the corporate and infrastructure sectors across various regions.


Today’s letter was prepared by Andy Thomson with John BakieRobin Blumenthal and Adalla Kim.

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