(Bloomberg Opinion) — During the days of easy money, one of the most tracked numbers in the credit markets turned into an unlucky auction.
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Ebitda, which stands for earnings before interest, taxes, depreciation and amortization, a figure that is similar to a company’s cash flow and therefore its ability to pay its debts, was derided as a marketing gimmick. When bankers and private equity firms asked investors to buy a portion of their loans to finance purchases and other transactions, they would add so-called add-ons to earnings projections that, to some, defied reason.
“Ebitda: eventually busted, interesting theory, deeply aspirational,” a Moody’s analyst quipped in 2017. Sixth Street Partners co-founder Alan Waxman made a more forceful assessment, warning the audience in a private conference call that such “fake Ebitda ” threatened to exacerbate the next economic downturn.
Now, amid rising interest rates, persistent inflation and warnings of a possible recession on the horizon, S&P Global Ratings research underscores just how far off the mark earnings projections are proving to be.
As Bloomberg’s Diana Li wrote on Friday, 97% of speculative-grade companies that announced acquisitions in 2019 missed 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, some 77% of 2019 purchases and acquisitions still fell short of projected earnings, S&P research shows.
The biggest concern is that years of optimistic earnings projections are masking the amount of leverage on the balance sheets of lower-rated companies. By 2019, before the Covid-19 pandemic sent markets tumbling the following year, rebalancing accounted for about 28% of total adjusted Ebitda figures used to trade acquisition loans, Covenant Review data showed in that moment. That was an increase from 17% in 2017.
S&P analysts said this week that the latest data reinforces their view that these Ebitda numbers “are not a realistic indication of future Ebitda and that companies consistently overestimate debt repayments.”
“Together, these effects significantly underestimate actual future leverage and credit risk,” they wrote.
Elsewhere:
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Adani Group’s bonds rose last week as executives tried to reassure debt investors that the conglomerate will address its debt maturities in the coming months. Options included issuing private placement notes and using cash from operations to pay down Adani Green Energy’s bonds due next year. Bonds had fallen to distressed levels after the Adani group was attacked by short seller Hindenburg Research.
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Apollo Global Management and Goldman Sachs are planning private credit funds that will compete with Blackstone for wealthy European clients. While investors have long been able to participate in US private credit through business development companies, regulations and complexity have limited people’s access to such funds in Europe until recently.
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A rally in China’s debt-laden developer bonds, fueled by a series of policy measures to ease tensions in the nation’s property sector, is now running out of steam amid a persistent housing slump. A Bloomberg index of US dollar-denominated junk bonds in China posted a loss for the second straight week, shattering a record 13-week gain.
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Trouble is brewing in another corner of China’s credit market. Local government financing vehicles (LGFVs), which became the main buyers of half-finished projects from developers in arrears, have been caught in a funding slump. The situation prompted a senior financial official in one of China’s poorest provinces to make a rare public appeal to investors to buy bonds from his LGFVs.
–With assistance from Alice Huang, Bruce Douglas, and Diana Li.
(Updates to add graphic).
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