Saudi Zain - Just What Did It Miss? Financial Covenants Not Payments

You've probably seen reports that Saudi Zain missed "commitments" under its US$2.6 billion  equivalent "Islamic" facility.  The natural assumption was that these were monetary commitments, e.g., principal or interest payments.

On Saturday, Saudi Zain's CEO, Saad AlBarak, told AlArabiyya that Saudi Zain missed certain EBITDA targets mandated by the facility.  Zain's lenders have waived the breach of the covenants in 2009 and required the company to provide a revised set of targets for 2010 for their approval.

EBITDA is bankerspeak shorthand for earnings before  (the payment) of interest, taxes, depreciation and amortization.  EBITDA is an attempt to capture the ongoing operating cashflow of a company.   Loans and other debts are settled with cash not net income which is accrual based and can often differ significantly from the firm's actual cashflow.  

Lenders include covenants like EBITDA targets as requirements in loan agreements for two reasons.

First, they provide a set of monitoring tools of the company's performance.  In this  case, the EBITDA targets help lenders to determine if the company is earning enough money to settle its obligations, including their loans.  

Second, since these are covenants, a failure to meet them by the company constitutes an event of default under the facility.  In that case banks have the right (but are not obliged to) to declare the borrower in default and accelerate the due date of the loan.  There are two reasons for using such covenants.  First, the covenants and the threat they might be used will focus the borrower's management on doing their utmost to make the company perform.  Second,  if the borrower does not meet the target, the banks have the right to accelerate the loan, if they want.  In such a case they can  require immediate repayment before value in the company is eroded.

It really does pay to be careful with press releases that contain disclosure that one has missed a covenant.  For some inexplicable reason the market gets excited about that sort of thing.  And when the wording lacks clarity the market imagines the worst.  It's also doubly important when one's auditor has included a matter of emphasis statement in his report as this should make any sentient creditor nervous. 

One might state that this sort of poor communication shouldn't happen.  As an old hand in the region, AA has gotten to the point of just hoping that it doesn't occur.