Hi, an interviewer has asked me to calculate interest coverage and leverage ratios given a 10-k statement, basically to determine credit-worthiness of a company. This company is owned by 2 PE firms as well, and he has asked me to determine how this affects riskiness of a bond issued by this company
Interest coverage = EBIT/interest expense, so all I have to do is take EBITDA and subtract amortization and depreciation and divide by interest expense? is there anything more to this? (sorry I haven't taken an accounting class and am not too familiar with this stuff).
Also, is it in the best interest of PE firms that own a company to NOT give that company cash in order to pay upcoming maturities? i would assume that a PE firm owning a company would WANT to ensure that it pays its obligations...thanks
yes ebit/int expense. i also see it as ebitda/int expense or (ebitda-capex)/int expense.
if these levels are light (low multiples) it means the business a ) doesn't generate strong cash flow, b) is burdened with heavy debt and expensive paper (very possible since PE owned), or c) both. it would be more expensive for a company to issue debt if it's coverage ratio (and other credit metrics) paint a bad picture... riskier for investors... more likely company goes bankrupt and investors lose their money.
Ok, so what I'm doing is taking "adjusted EBITDA" on the firms 10-k, subtracting deprecation and amortization (to get EBIT from EBITDA), and dividing it by interest expense? i feel EBITDA/interest expsnse is a better measure for riskiness cuz DA is not even a cash expense, so it doesn't really represent how much cash the company generates to meet its obligations
you're doing it wrong - for many PE owned companies that publicly file, it's because they have public debt. Loan and Bond investors closely monitor Adjusted EBITDA because of covenants that restrict the companies - they have to post a minimum level of performance to avoid technical default.
EBIT is the wrong metric to use - use the adjusted ebitda figure that the company is providing because it's the covenant EBITDA off of which the true interest coverage ratio will be calculated.
Giving cash to a portfolio company to address an upcoming maturity or stave off default is called an "equity cure" in leveraged finance terms. there are a ton of implications for both debt investors and the PE guys, but 9 times out of 10 the PE guys will do everything possible to NOT kick in more equity/cash. It ruins returns (making the fund look bad for the next fund raise). If a looming maturity becomes a going concern (something to really worry about) banks will come in and refinance the debt, either with a fresh capital structure or by amending and extending the current loans.
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