In a cover story earlier this year, we conducted a deep dive into EBITDA addbacks – a way of adjusting a borrower’s financial performance by taking into account supposed boosts to revenues that may or may not materialize.
While the borrower would claim these “projected” aspects were highly likely to happen, the skeptical view has always been that such assumptions often lack transparency and can be overly optimistic. One especially egregious example we unearthed – among many – was a retailer’s request for an addback based on the sales it would have achieved had it not been for Brexit uncertainty. To us, and sources we mentioned it to, this seemed a little “out there”.
But while it would be easy to assume that there are almost no limits to excess in a borrowers’ market, this would be misleading. Our research for the feature indicated that investors in the loans were not simply being led by the nose and were frequently pushing back against proposed terms that they didn’t like. This is reinforced by recent research into the European leveraged loan market from Xtract Research in its recently published 2019 Half Year Review.
This research showed there has been a steady decrease in the proportion of deals allowing uncapped addbacks to EBITDA based on projected cost savings and synergies. In 2017, nearly half of all senior facilities agreements reviewed by Xtract allowed EBITDA adjustments without a cap. Last year, this fell to a third and, in the first half of this year, took a further tumble to less than 20 percent.
It’s not as if borrowers aren’t trying their luck. The report notes that numerous deals have been brought to market this year with a request for uncapped adjustments to projected cost savings, but “in many (if not most) cases this was met with pushback and caps introduced”. Where caps were allowed, these were frequently whittled down from a proposed 25 percent of EBITDA to 20 percent. That may not be a huge difference, but it least shows some resistance is being offered.
In the overall scheme of things, it remains a borrower’s (and sponsor’s) market. The Xtract report covers not just addbacks but all sorts of other deal aspects – incremental debt, MFN protection and step-downs among them – that show aggressive features remain the norm. Only a material change in market circumstances will truly challenge the status quo. However, in spite of intense competition for deals, it is clear that some healthy negotiation is taking place before any signing on the dotted line.
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