How Companies Are Accounting for Covid-19
(Bloomberg) -- Some companies are adopting an innovative approach to accounting for the impact the coronavirus pandemic has had on their earnings: they’re leaving it out. At least eight borrowers have tweaked the figures in recent months to show investors how healthy their business would be if it weren’t for the damage wrought by Covid-19. Investors and market watchdogs have spoken out against the practice, warning that turning the commonly used Ebidta (earnings before interest, depreciation, taxes and amortization) into Ebidtac (c for coronavirus) can give a misleading impression.
1. What is Ebitda and why is it so important?
Ebitda is a key measure of companies’ financial performance for lenders because it’s seen as a relatively direct reading of a company’s ability to generate cash. It’s especially important in the credit market, because bond covenants -- clauses within bond contracts meant to protect lenders by setting benchmarks for performance -- are measured using net debt vs Ebitda. If a company’s earnings are artificially high, making it seem more creditworthy than it is, that may give borrowers greater flexibility to evade covenant restrictions on raising extra debt or making other investment decisions that creditors would like to block. Bondholders watch Ebitda closely because a decline can be a sign that a company’s debt load is unsustainable.
2. How does Ebitdac work?
Ebitdac is a measure that’s emerged in recent months as a way for borrowers to show what their performance might have been had it not been for the impact of the pandemic. It’s not the first time companies have included adjustments or “add-backs” in their Ebitda figures. Investors have previously criticized adjustments that include potential earnings from future mergers and acquisitions or possible savings.
3. Who’s using it?
German manufacturer Schenck Process, owned by private equity firm Blackstone Group Inc., used the term “adjusted Ebitdac” when reporting financial results in May. The company reported 18.3 million euros ($20.6 million) of earnings when removing the impact of Covid compared with 12.9 million euros for the traditional Ebitda figure. Other firms have deployed the same technique of removing the impact of coronavirus from adjusted Ebitda, while choosing not to use the new acronym. U.S. packaging firm Greif Inc., German beauty retailer Douglas and Spanish gaming company Cirsa all included Ebitda adjustments for the coronavirus pandemic in recent months.
4. Why use it?
Proponents say it provides continuity with past results: If the turmoil from coronavirus is going to be merely a temporary disruption, stripping out the impact provides a more apples-to-apples comparison with pre-covid earnings. Adjusting Ebitda, they say, makes sense when one-time events obscure a business’s underlying health. But the big question is whether the pandemic will be a blip or a siege, that is, how long the effects will have an impact on companies’ balance sheets.
5. Are lenders going along with this?
In some cases, yes. Banks have shown leniency when it comes to waiving covenants that rely on a certain amount of earnings vs debt. In the case of U.S concert producer Live Nation Entertainment Inc., its banks agreed to use earnings figures from 2019 to test this year’s covenants, effectively turning a blind eye to an earnings dive in 2020.
6. What do regulators say?
They’re growing increasingly wary. Europe’s top markets watchdog, the European Securities and Markets Authority, has called for “caution” against presenting the impact of the virus separately in profit and loss statements. The Financial Reporting Council, which regulates U.K. auditors and accountants, has warned that measures which attempt to show “normalized” results are likely to be “highly subjective” and “potentially unreliable”. Ratings firm Moody’s Investors Service has added its voice into the mix, saying Ebitdac probably includes “a number of hypothetical and highly subjective adjustments.”
7. What do investors say?
Investors groups are against the measure. The European Leveraged Finance Association, which represents more than 30 institutional fixed income managers in the region, issued a report in May that called Ebitdac “inappropriate” and warned it could lead to “fictitious figures.” This week the group said it’s working on creating guidelines on covenant transparency and that Ebitda disclosure will be one of the target areas. U.S. investor group Credit Roundtable has also discussed the development and feels it “distorts” and “misrepresents” earnings, according to David Knutson, the group’s vice chair.
The Reference Shelf
- Matt Levine’s piece on Ebitdac for Bloomberg Opinion.
- A statement from the International Organization of Securities Commissions on importance of disclosing Covid-19’s impact.
- A report from the European Securities and Market Authority calling for transparency in earnings during the pandemic.
- An explainer on high yield bonds by PEI and law firm Milbank
- A book by hedge fund founder Rajay Bagaria: High Yield Debt: An Insider’s Guide to the Marketplace.
©2020 Bloomberg L.P.