The Hidden Dangers of EBITDA in Leveraged Buyouts: Unveiling Underappreciated Risks

In the world of leveraged buyouts (LBOs), EBITDA has long been a proxy for a company’s ability to service debt. Yet, as recent academic research and real-world cases demonstrate, this metric often masks critical financial vulnerabilities. The Georgian Beer Company’s (GBC) struggle with debt servicing following its 2023 buyout underscores a broader trend: LBOs increasingly rely on aggressive leverage, pushing debt-to-EBITDA ratios to precarious levels and exposing firms to underappreciated risks.

Academic analyses reveal that post-LBO capital structures frequently involve debt-to-EBITDA ratios more than double pre-lease adjustment levels [3]. This strategy, intended to discipline management by constraining free cash flow, introduces fragility. For instance, a study of LBOs in emerging markets found that while high leverage can drive operational efficiency, it also amplifies exposure to economic cycles [2]. When industries are cyclical—such as brewing, which faces volatile raw material costs and shifting consumer demand—the ability to meet debt obligations becomes precarious.

GBC’s case exemplifies this risk. A leveraged buyout in late 2023, executed via bank guarantees, pushed its Scope-adjusted debt-to-EBITDA ratio above 4x [4]. Despite robust EBITDA growth from international brand integration, Scope Ratings downgraded its outlook to “Negative,” citing limited deleveraging capacity and refinancing dependence [4]. This highlights a paradox: even as EBITDA rises, excessive leverage can negate financial stability.

The limitations of EBITDA in debt servicing are further compounded by its exclusion of critical expenses like capital expenditures and working capital needs. A 2024 academic paper noted that LBOs often overlook these costs, creating a “perverse valuation effect” where short-term gains mask long-term strain [1]. For GBC, this means that while its EBITDA appears strong, its ability to reinvest in growth or weather a downturn is constrained by debt service obligations.

Emerging markets add another layer of complexity. In regions like the Middle East and North Africa (MENA), where institutional contexts differ from mature markets, LBOs face heightened refinancing risks [2]. GBC’s reliance on bank guarantees—a common tool in such deals—exposes it to liquidity shocks if lenders tighten terms. This aligns with broader research showing that LBOs in volatile markets often underperform due to overleveraging [3].

Investors must also consider the role of managerial equity participation. While equity stakes can align incentives, they do not eliminate risks tied to overleveraging [2]. In GBC’s case, even with strong EBITDA, the absence of a clear deleveraging path suggests that management’s focus may be skewed toward short-term metrics rather than sustainable capital structure optimization.

The takeaway for investors is clear: EBITDA-centric debt servicing models in LBOs often ignore structural weaknesses. As GBC’s case shows, high leverage can erode resilience, particularly in cyclical sectors or volatile markets. While EBITDA remains a useful metric, it must be contextualized with liquidity analysis, refinancing risk assessments, and sector-specific dynamics.

Source:
[1] The Perverse Valuation Effect on Mergers and Acquisitions [https://www.sciencedirect.com/science/article/pii/S0264999324002852]
[2] Managerial Shareholding and Performance in LBOs [https://www.mdpi.com/2227-7099/13/7/193]
[3] Decomposing value gains – The case of the best ... [https://www.sciencedirect.com/science/article/pii/S0929119922001602]
[4] issuer rating on GBC, revises Outlook to Negative [https://www.scoperatings.com/ratings-and-research/rating/EN/175314]