Method
Creation multiples: what you are really paying
A bond at 60 is not cheap or expensive until you work out the price it puts on the whole business. One line of arithmetic does that.
Equity investors ask what multiple they are paying for a company. Credit investors should ask the same thing, and when a bond trades well below par the question has a precise answer. It is called the creation multiple.
The idea
If you buy a class of debt and the company later restructures, there is a good chance that class ends up owning the business. So work out the price you would be paying for the business if that happened:
Creation multiple = (debt ahead of you at face value + your class at market price − cash) ÷ EBITDA
Debt ahead of you counts at face because it has to be paid in full, or reinstated, before your class gets anything. Your own class counts at what you paid, because that is your cost. Cash comes off because it belongs to the business you would own.
A worked example
A company has $150mm of EBITDA, $50mm of cash and this debt:
| Class | Face | Price |
|---|---|---|
| First lien term loan | $500mm | 92 |
| Second lien term loan | $200mm | 55 |
| Senior unsecured notes | $250mm | 15 |
Buy the first lien at 92 and you create the company at (0 + $460mm − $50mm) ÷ $150mm, or 2.7x.
Buy the second lien at 55 and you create it at ($500mm + $110mm − $50mm) ÷ $150mm, or 3.7x.
Buy the unsecured notes at 15 and you create it at ($700mm + $37.5mm − $50mm) ÷ $150mm, or 4.6x.
Leverage through the unsecured notes is 6.3x at face. The market is telling you it thinks the business is worth something between 3.7x and 4.6x, because that is where prices fall off a cliff.
How to use it
Compare it with what the business is worth. If comparable companies trade at 6x and you can create this one at 3.7x through the second lien, you have more than two turns of cushion before you lose money. That cushion is the investment case.
Compare classes with each other. Moving from the first lien to the second lien costs you one turn of creation multiple. In exchange your upside goes from 8 points to 45. Whether that is a good trade depends on how confident you are that value clears 3.7x.
Watch the denominator. The multiple is only as good as the EBITDA under it. A business whose earnings are falling 20% a year is not cheap at 3.7x of last year’s number. Run it on the EBITDA you expect at the time of a restructuring, not the one in the last press release.
Where it misleads
A creation multiple assumes your class ends up with the equity. Three things break that assumption.
- New money. A company that needs cash will borrow it on a super-priority basis, and that debt lands ahead of you at face. Add your estimate of it to the numerator.
- Leakage. Advisers, unpaid suppliers and pension claims all take value on the way through a restructuring. Five to ten percent of enterprise value is a common allowance.
- Time. Getting from a 55 price to owning a business can take two years, with no coupon in between. Interest keeps accruing on the debt ahead of you and your own money needs a return, so the multiple you really pay is higher than the one you calculate today.
None of this makes the number less useful. It is the fastest way to turn a bond price into a statement about value, and that statement is something you can check against the real world.
Every capital structure table on this site shows a “Created at” column for each class. It is this calculation, updated with the prices on the page.