martes, 18 de noviembre de 2014

martes, noviembre 18, 2014

Last updated: November 14, 2014 5:47 pm
 
Credit markets play a risky dating game
 

WASHINGTON, DC - JULY 22: Stacks of twenty dollar bills pass through on machine at the Bureau of Engraving and Printing on July 22, 2011 in Washington, DC. The printing facility of Bureau of Engraving and Printing on 14th Street in Washington was until 1991 the only facility printing Federal Reserve notes until a western facility was opened in Fort Worth, Texas. (Photo by Mark Wilson/Getty Images)©Getty


In the competitive world of online dating, men and women will embellish their profiles to attract the best mates. Salaries are engorged, ages are diminished and heights increased as singles seek promising partners.

In credit markets a similar trend is playing out as companies flatter their bottom lines to attract the best financing deals from investors who are willing to play along in order to get a shot at a debt product with juicy yields.
 
Analysts, however, are warning that investors’ willingness to overlook such corporate earnings adjustments in their desperation to buy bonds, loans and other securities could come back to haunt them.
 
“Beauty – or the lack of beauty – is in the eye of the beholder,” says Scott McAdam, portfolio specialist at DDJ Capital Management. “In the late stages of a credit cycle where capital is cheap and there’s a lot of money chasing deals, companies will kind of get away with this.”

In a report published this week Mr McAdam argues that the credibility of a company’s “ebitda” – or earnings before interest, taxes, depreciation and other non-cash items – may be undermined by the appearance of aggressive earnings adjustments known as “add-backs”.
 
Such add-backs are often used ahead of a transformative deal – such as a merger or acquisition – that is expected to significantly cut a company’s costs or boost its revenue. They are presented in the bond offering marketing documents and loan agreements prepared by issuers and underwriters and can make companies appear more creditworthy than their historical cash generation would indicate.
 
Inflating earnings can encourage more investors to buy a bond or loan, resulting in lower financing costs for companies but it also means that investors may end up holding assets that do not yield enough to compensate for risk.

Mr McAdam says that in the extreme, debt investors end up taking on equity-like risk because ebitda has been exaggerated and thus total leverage, or borrowing, understated.

In one well-known example, software firm Travelclick secured $560m worth of loans while citing a debt load of 6.6 times ebitda. According to Moody’s, the rating agency, stripping out add-backs resulted in a debt load closer to 10 times ebitda.
 
Electronic dance music festival organiser, SFX Entertainment, would have negative cash flow without the use of add-backs. Despite the hefty adjustment, investors have lined up to buy SFX debt with the size of a bond deal sold earlier this year increased $20m to $220m thanks to strong demand.

With sophisticated parties on the other side conducting their own analysis of offering documents, it may be difficult to believe investors are being misled.


Credit markets


One experienced investor said that he carefully scrutinised add-backs – giving more weight to cost cuts than to revenue synergies and also evaluating the track records of management teams. But, he added, in a hot market, investors “were more willing to accommodate adjustments”.

Christina Padgett, head of leveraged finance research at Moody’s, says: “It’s not always [companies’] intention but just what the market is offering because there’s so much demand for high-yielding debt right now. It’s an issuer’s market.”

She says the problem of earnings adjustments has been compounded by a wider loan market trend towards deals that come with fewer protections for lenders, known as “covenants.” Such covenants typically require companies to disclose and maintain certain financial metrics – such as a particular debt to earnings ratio.

“One of the things that covenants did in the past was give information to investors and give them an opportunity to force a company to come back to them. Now issuers can make all kinds of financial and strategic decisions without going back to the lenders.”


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