Korva is a scroll of the internet’s best ideas.
Debt to EBITDA compares what a company owes with the cash it earns in a year. Anything over six times is risky, and the most a bank will lend in a leveraged buyout is around the seven times seen in Paramount's purchase of Warner Brothers.
Caesars' buyout was done at eight times. At the operating company the ratio was set to spike from 14 to 16 times and ultimately got to 18, which would take 18 years to pay down at that level of operating cash flow.
The other numbers were as bad. Interest coverage, which is EBITDA over interest, fell to about half, so EBITDA covered only half of the interest owed. Annual free cash flow was negative $1 billion. From 2014 to 2016 the debt dropped by only $185 million, because the company kept borrowing money to stay afloat.
Why is six times debt considered risky?
The 2013 interagency guidance on leveraged lending, issued by US bank regulators, said debt above six times EBITDA raises concerns for most industries. The reasoning is that a company that highly leveraged must spend years of earnings on repayment before it is clear of debt. Any dip in earnings makes the interest harder to cover. Lenders and rating agencies watch this ratio closely.
How does interest coverage signal trouble?
Interest coverage divides EBITDA by interest expense. At 1.0, earnings exactly cover the interest bill. Below 1.0, the company has to borrow, sell assets, or draw down cash to pay its lenders. At about half, EBITDA covers only half of what is owed.
Why does EBITDA overstate available cash?
EBITDA leaves out interest, taxes, and the cost of replacing worn equipment. Casinos spend heavily on refreshing rooms and gaming floors to stay competitive. Free cash flow subtracts those costs, so it shows what is left for debt repayment. EBITDA stands for earnings before interest, taxes, depreciation, and amortization.
More from The Wall Street Skinny
