‘Fake Ebitda’ Masks Risk in Debt-Laden Companies
(Bloomberg) — During the days of easy money, one of the most widely tracked numbers in credit markets became an unfortunate punchline.
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Ebitda, which stands for earnings before interest, taxes, depreciation and amortization — a figure that’s akin to a company’s cash flow and, thus, its ability to pay its debts — was instead mocked as a marketing gimmick. When bankers and private equity firms asked investors to buy a piece of their loans funding buyouts and other transactions, they would layer on so-called add-backs to earnings projections that, to some, defied reason.
“Ebitda: Eventually busted, interesting theory, deeply aspirational,” one Moody’s analyst joked in 2017. Sixth Street Partners co-founder Alan Waxman had a more blunt assessment, warning an audience at a private conference that such “fake Ebitda” threatened to exacerbate the next economic slump.
Now, amid rising interest rates, persistent inflation and warnings of a potential recession on the horizon, research from S&P Global Ratings is underscoring just how far from reality the earnings projections are proving to be.
As Bloomberg’s Diana Li wrote on Friday, 97% of speculative-grade companies that announced acquisitions in 2019 fell short of forecasts in their first year of earnings, according to S&P. For 2018 deals, it was 96% and 93% for 2017 acquisitions. Even after the economy was flooded with fiscal and monetary stimulus after the pandemic, about 77% of buyouts and acquisitions from 2019 were still short of their projected earnings, S&P’s research shows.
The bigger worry is that years of rosy earnings projections is masking the amount of leverage on the balance sheets of the lowest-rated companies. By 2019, before the Covid-19 pandemic sent markets tumbling the following year, add-backs were accounting for about 28% of total adjusted Ebitda figures used to market acquisition loans, Covenant Review data at the time showed. That was up from 17% in 2017.
The S&P analysts this week said the latest data reinforces their view that those Ebitda figures are “not a realistic indication of future Ebitda and that companies consistently overestimate debt repayment.”
“Together, these effects meaningfully underestimate actual future leverage and credit risk,” they wrote.
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–With assistance from Alice Huang, Bruce Douglas and Diana Li.
(Updates to add chart.)
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