IFR - 07.07.2018

Top news

Adjusted Ebitda masks higher leverage

„ Loans Private equity firms pushing boundaries on buyout financings

BY MAX BOWER, DAVID BROOKE

Investors in European leveraged
loans are increasingly worried
THATûPRIVATEûEQUITYûlRMSûAREû
making overly-aggressive
adjustments to portfolio
companies’ earnings to support
higher debt loads.
Ebitda is a benchmark
CASHmOWûlGUREûUSEDûBYûBANKERSû
to calculate a company’s
leverage and market deals to
investors, and adjustments
REmECTûASSUMPTIONSûABOUTû
companies’ future earnings
potential.
But investors are worried that
these adjustments and
projections may not be
achievable and are masking the
true amount of leverage and
DEBTûTHATûPRIVATEûEQUITYûlRMSû
are using, as well as the risk
inherent in transactions.
h'OINGûINTOûTHEûlNANCIALûCRISISû
you saw the same things

HAPPENINGû0RIVATEûEQUITYûlRMSû

have always pushed the

boundaries on what Ebitda they

will get lenders to buy into,“ a

fund manager said.

(IGHERû%BITDAûlGURESûALLOWû

companies to borrow more and

make overall leverage levels

appear lower. Without

adjustments, actual leverage

ratios would be far higher,

which would make deals

DIFlCULTûTOûSELLûTOûINVESTORSûANDû

RAISEûREDûmAGSûWITHûREGULATORS

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 €880m equivalent euro

and sterling buyout loan for

pharmaceuticals manufacturer

ZENTIVA had leverage of 7.1 times

based on adjusted 2017 Ebitda.

0RIVATEûEQUITYûlRMSûCITEûLOWERû

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

lNANCIALûCRISIS

But as resistance to aggressive

loan documents grows, many

investors are now criticising the

scale of current Ebitda

adjustments and are demanding

changes.

Finnish private healthcare

company MEHILAINEN’s €760m

Term Loan B was priced wide of

guidance and required a raft of

changes, including reducing the

adjustments made in the Ebitda

DElNITIONû3EEû,OANSûSECTIONûFORû

more details).

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-

HEADûOFûLEVERAGEDûlNANCEûSAID

One-off “add-backs”, where

companies claim a non-recurring

cost saving, are a bigger problem.

/NLYûûOFûTHESEûADJUSTMENTSû

were achieved on average and

nearly 20% of issuers achieved

none of their projected

adjustments, Moody’s said.

These unusual adjustments

are rising, driving the increase in

issuer Ebitda adjustments to an

Discount lingers after Dell’s US$21.7bn

buyout of VMware tracker

„ Equities, Bonds Deal avoids unpopular VMware merger or Dell IPO, but VMware foots the bill

BY ANTHONY HUGHES,
ELEANOR DUNCAN

Privately held IT company DELL
TECHNOLOGIES will simplify its
corporate structure and secure
an NYSE listing by buying out its
VMware tracking stock in a
US$21.7bn cash-and-stock deal,
though doubts linger as to
whether investors will back the
deal.
The deal follows a strategic
review that rejected both a Dell IPO
and a unpopular reverse merger
with VMware, the cloud computing
and virtualisation software provider
in which Dell owns an 81% stake
following its September 2016
merger with EMC.
Intended to track a 53%
economic interest in VMWare,

the tracking stock was created at

the time of the merger so Dell

did not have to pay as much cash

for EMC.

However, the stock has long

TRADEDûATûAûSIGNIlCANTûDISCOUNTû

to the market value of the

underlying VMware shares and

has also underperformed

VMware shares this year.

Dell, privatised by founder

Michael Dell and sponsor Silver

Lake Partners in a 2013 deal that

lumbered the company with

more than US$50bn of debt, is

offering VMware tracking stock

holders Class C shares in Dell or

US$109 a share in cash, the

latter a 29% premium to pre-deal

levels.

The cash component is

limited to US$9bn of the

consideration and is funded

by Dell taking its pro rata

share of a US$11bn special

dividend VMware has agreed

to pay alongside the deal.

VMware would therefore

remain an independent

entity without being saddled

with Dell’s debt load as it

would have been in a merger

scenario, though the special

dividend drains VMware

of nearly all of its spare

cash.

There is “a continued risk

that Dell could attempt to

transfer further amounts of

VMware cash upstream in

the event that additional

liquidity is required”, credit

ratings agency Moody’s said in a

statement.

APPROVAL NEEDED

Assuming the transaction is

approved by the holders of the

tracking stock, Dell would list its

shares on the NYSE in the fourth

quarter of this year.

!CCORDINGûTOûCOMPANYûlGURESû

tracking stock holders would

emerge with 21%–31% of Dell

(depending on how many take

cash), diluting Michael Dell to

nûFROMûûPREVIOUSLYû

and Silver Lake to 16%–18% from



Silver Lake has promised not

to sell its stake for 180 days after

the transaction closes. This helps

ensure its stake is not viewed as

an overhang when Dell lists on

the NYSE, though Silver Lake is

expected to look to sell at some

point.

“Private equity firms

have always pushed

the boundaries on

what Ebitda they will

get lenders to buy into“