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Adjusted Ebitda masks higher leverage on buyout loans

London

INVESTORS in European leveraged loans are increasingly concerned that private equity firms are making overly aggressive adjustments to portfolio companies' earnings to support higher debt loads.

Ebitda is a benchmark cashflow figure used by bankers to calculate a company's leverage and market deals to investors, and adjustments reflect assumptions about companies' future earnings potential.

Investors are worried that these adjustments and projections may not be achievable and are masking the true amount of leverage and debt that private equity firms are using, as well as the risk inherent in transactions.

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"Going into the financial crisis, you saw the same things happening. Private equity firms have always pushed the boundaries on what Ebitda they will get lenders to buy into," a fund manager said.

Higher Ebitda figures allow companies to borrow more and make overall leverage levels appear lower. Without adjustments, leverage ratios would be far higher, which could make deals difficult to sell to investors and raise red flags with regulators.

The European Central Bank followed US regulators in capping leverage ratios at six times Ebitda, but this is a guideline, and even adjusted leverage levels are often higher.

A recent 880 million equivalent euro and sterling buyout loan backing pharmaceuticals manufacturer Zentiva's acquisition by Advent had leverage of 7.1 times based on adjusted 2017 Ebitda.

Private equity firms cite lower average Ebitda levels as the sign of a healthy market and routinely use them to differentiate between current market conditions and the peak of the market before 2008's financial crisis.

But as resistance to aggressive loan documents grows, many investors are criticising the scale of current Ebitda adjustments and demanding changes.

Finnish private healthcare company Mehilainen's 760 million euro Term Loan B priced wide of guidance last week and required a raft of changes to clear the market, including reducing the adjustments made in the Ebitda definition. The deal funded CVC's acquisition of the company.

Adjustments linked to the synergies expected from mergers and acquisitions have the best chance of being achieved, ratings agency Moody's said in a June report.

"We've worked with one company where the M&A-related adjustments have been very high but the market accepted them as they have a track record of delivering," a co-head of leveraged finance said.

"We are getting more questions about Ebitda adjustments. As an investor, it is not always easy to make a judgment given the poor level of detail often available," a London-based analyst said. REUTERS