EBITDA adjustments, or add-backs, have been a hot topic in the global leveraged loan and high yield bond markets over the past few years as private equity shops undertaking large M&A deals increasingly rely on this technique for financing.
Of course, these adjustments – where a PE shop or acquiring entity can add an expense back to profits, significantly improving a transaction’s pro forma numbers – are not without controversy. Debt investors complain vociferously that, via add-backs, actual risk is being masked, as borrower leverage down the road will be understated if the rosy earnings numbers detailed now don’t actually come to pass.
The largest portion of these add-backs comprises synergies, or the potential financial costs savings of combining two companies.
But just how much risk do these adjustments/synergies add? If a transaction’s debt/EBITDA ratio has crept higher based on adjusted EBITDA alone, how much riskier are these deals if EBITDA adjustments are stripped out?
A significant amount, apparently, when looking at the more aggressive deals in market, and when considering synergies. For example, a relatively slim 8% of U.S. leveraged loans backing M&A had pro forma debt/EBITDA of 7x or higher this year, including synergies, up from 5% last year and on par with 2014. While this metric has risen in recent years, it remains far below the 2007 record of 17%.
Assuming, however, that expected synergies are not achieved, the share of M&A transactions levered at 7x or higher jumps to 17% this year, up from 14% in 2017 and just a few percentage points below the 2007 record of 19%. – Marina Lukatsky