While valuation ratios are about the market’s opinion of a company’s future, debt ratios are about the company’s fixed legal obligations from its past.
In plain English, debt is a mortgage on the business. It’s a powerful tool—known as leverage—that allows a company to grow much faster than it could with its own money. However, this tool comes with a legally-binding contract to make fixed payments (interest and principal) on a set schedule.
What Are They For? Answering Two Critical Questions
Debt ratios are not about “good” or “bad.” A high-debt company isn’t necessarily worse than a low-debt one. The real estate industry, for example, runs on high debt, while software companies may have none.
Instead, debt ratios answer two separate questions:
- Solvency: How much debt does the company have relative to its own equity? (How big is the mortgage?)
- Coverage: Can the company afford the monthly payments on that debt? (Can they make the mortgage payment?)
If you believe these ratios are just ‘finance team’ work, think again. For antitrust professionals, understanding debt is indispensable. As we will show, these ratios are case-critical in three high-stakes scenarios:
- Advising clients on M&A strategy and financial viability.
- Assessing merger remedies, particularly divestitures, whether you are the legal counsel or the regulator.
- Handling investigations under the new Foreign Subsidies Regulation (FSR), where we already have real-world examples of these ratios becoming the central component of the final remedies.”
Key Ratios for Your Legal Toolkit
Solvency (Leverage) Ratios
These ratios measure how much of the company’s asset base is funded by “other people’s money” (debt) versus the owner’s money (equity).
1. Debt-to-Equity Ratio (D/E)
- What it is: The classic leverage ratio. It directly compares how much the company owes (debt) to how much it is worth on its books (equity).
- Formula: Total Debt / Shareholder Equity
- What it means: A ratio of 1.0 means the company is funded by $1 of debt for every $1 of its own equity. A ratio of 3.0 is high, meaning it has $3 of debt for every $1 of equity. This is a high-risk, high-reward strategy.
2. Debt-to-Assets Ratio
- What it is: This ratio shows what percentage of the company’s entire asset base is paid for with borrowed money.
- Formula: Total Debt / Total Assets
- What it means: A ratio of 0.6 (or 60%) means that 60 cents of every dollar of the company’s assets (its factories, cash, patents) is financed by debt. This is a direct measure of risk.
Coverage Ratios
These are the “can they breathe?” ratios. A company can have a lot of debt (high leverage) and be perfectly fine if it has massive, stable cash flow to cover the payments. This is where you find out.
3. Interest Coverage Ratio (ICR)
- What it is: It measures how many times over a company can pay its annual interest bill using its annual operating profit.
- Formula: EBITDA / Total Interest Expense
- What it means:
- An ICR of 10x is very healthy. (The company’s cash flow is 10 times its interest bill).
- An ICR of 2.5x is getting tight.
- An ICR of 1.1x is a red flag. It means a tiny dip in profits will result in the company being unable to pay its lenders, triggering a default.
4. Total Debt / EBITDA Ratio
- What it is: This ratio tells you how many years it would take the company to pay back its entire debt principal using its current profits.
This is the #1 covenant in nearly all major corporate loan agreements. A bank will write directly into your client’s loan contract: “The Borrower shall not permit its Total Debt to EBITDA ratio to exceed 4.0x at any time.” As the lawyer, you must know this number. If your client wants to buy another company (taking on its debt) or have a bad quarter (dropping its EBITDA), you must be able to advise them if that action will breach this covenant and trigger a default. And if you are negotiating a remedy in a merger review or under the FSR, you need to make sure that any additional debt or any divestitures won’t impact (too much) this ratio.
How Antitrust Lawyers Use Debt Ratios
For regulators and antitrust counsel, debt ratios are not just financial data; they are evidence of market structure and conduct.
1. Proving High Barriers to Entry
To win a monopoly case, you must first define the market and prove high barriers to entry exist. The capital cost to enter is the most common barrier.
- The Argument: “This market is not contestable. A new entrant cannot challenge the incumbent because it would require $100 billion in capital to build a national 5G network (or a semiconductor fab, or an airline fleet). No company can do this without taking on a crippling amount of debt.”
2. The “Failing Firm Defense”
This is a classic defense in merger control. The merging parties admit the deal may be anticompetitive but argue it’s the only option because the target firm is about to go bankrupt.
- The Argument: “This merger is necessary to save a failing competitor. As you can see from their financials, the target’s Interest Coverage Ratio has been below 1.0x for three straight quarters. They are not generating enough cash to pay their lenders right now. Without this acquisition, they will default on their legal debt obligations, and their assets (and jobs) will be liquidated, which is a worse outcome for competition.”
3. Analyzing Predatory Conduct
Debt ratios can reveal a story of predatory intent. A dominant, cash-rich firm can strategically bleed a smaller, high-debt rival to death.
- The Argument: “This wasn’t ‘healthy competition’; it was predation. The dominant firm, Amazon, has almost no net debt and a massive cash flow. They launched a price war (e.g., offering a new service below-cost) in a market where their only rival was a startup funded by venture debt, holding a high Debt-to-Equity ratio. The dominant firm knew it could sustain losses for years, while the rival legally had to make its interest payments. The price war was designed to force the rival into default.”
Case Studies
Telefónica’s M&A Ambitions: Debt as a Constraint
Telefónica is a mature telecom. It’s like a utility. It has stable cash flow, but very low growth. To build its massive 5G and fiber networks, it had to take on enormous amounts of debt. As of recently, its net debt often hovers in the €25-€30 billion range and its debt/EBITDA ratio is around 3.8x.
This massive debt load creates a “leverage ceiling.” Why? Because rating agencies (Moody’s, S&P) have a hard line in the sand for a company like Telefónica. If its Total Debt / EBITDA ratio goes above a certain level (e.g., 3.5x or 4x), they may downgrade its credit rating.
A credit downgrade is a legal and financial disaster. It immediately increases the interest rate the company must pay on all new debt. Even worse, it can trigger covenants (rating triggers) in its existing bonds, forcing it to pay higher interest to all its current bondholders.
How Debt Ratios Drive Telefónica’s M&A Ambitions? Telefónica’s plans are completely dictated by this debt ceiling. Its executive team and lawyers are in a constant battle to reduce their leverage, a process called de-leveraging.
You’ll notice Telefónica’s recent “M&A” was about selling assets in Latinamerica, not buying them. Selling an asset for cash does two things: it provides Cash (which reduces Net Debt) and it may also remove that asset’s EBITDA. The goal is to make the Total Debt / EBITDA ratio go down.
But after selling those assets, Telefónica is scouting for new acquisitions. However its high debt ratios (3.8x in the last quarter) makes really difficult to absorb more debt without triggering a possible downgrade on its credit rating. Therefore, the only option is to raise capital from shareholders to obtain funds without rising its debt levels.
For a lawyer, Telefónica’s Total Debt / EBITDA ratio is not a financial metric; it is the boundary line of what is legally and strategically possible.
ADNOC-Covestro: Debt as Evidence of a Subsidy
This case is an example of how regulators use debt ratios to enforce new rules like the EU’s Foreign Subsidies Regulation (FSR).
ADNOC (Abu Dhabi National Oil Company) is a state-owned enterprise (SOE). It wants to acquire Covestro, a major German chemical company. This requires approval from EU regulators, who are now armed with the FSR.
The FSR is designed to prevent foreign, state-backed companies from using “unfair” government money (subsidies) to outbid private EU companies and distort the market. The regulator’s challenge is proving the existence of a subsidy.
How Debt Ratios Provide the Evidence:? How does a state subsidy look on a balance sheet? It looks like an unfairly low cost of capital.
- The Legal Argument (by the Regulator): “This deal distorts the market. A private competitor, like Germany’s BASF or America’s Dow, would have to fund this €12-€15 billion acquisition by taking on massive commercial debt at, say, 6% interest. Their Debt-to-Equity ratio would skyrocket, and their Interest Coverage Ratio would be dangerously low. They would be disciplined by the market.”
- The “Smoking Gun” (The Ratios): “ADNOC, however, faces no such discipline. As an SOE, it can get billions in financing from state-owned banks at 1% interest, or even as an interest-free capital injection. We can see this in their financial structure.”
A regulator’s lawyer would compare ADNOC’s debt ratios to its private peers. If ADNOC’s Debt-to-Equity ratio is 5.0x while the industry average is 1.5x, or if its Interest Coverage Ratio is 50x (because its interest is near-zero), that is the prima facie evidence that it is operating with an “un-commercial” financial advantage.
For a regulator, a company’s debt ratios are the key to proving that a financial advantage is not the result of fair competition, but of a market-distorting state subsidy.
e& / PPF Telecom
This 2024 decision (Case FS.100011) is a masterclass in modern financial regulation and is essential reading for any antiturst lawyer. It demonstrates how regulators can transform a standard financial ratio into a binding legal remedy. In this case, the Net Debt/EBITDA ratio was used by the European Commission as a “tripwire” to neutralize the threat of foreign subsidies.
The Case
The UAE-based, state-backed Emirates Telecommunications (e&)—which is 60% owned by the UAE’s sovereign wealth fund (the EIA)—was acquiring PPF Telecom Group, a major operator in several EU countries (Bulgaria, Hungary, Serbia, and Slovakia). The deal, valued at EUR 2.15 billion plus earn-outs, represented a major strategic entry by a state-backed entity into the EU’s critical telecom infrastructure market.
The Antitrust/Regulatory Problem
The European Commission (EC) launched an in-depth investigation under the FSR. The core problem was not market share, but a massive financial distortion that would make a level playing field impossible.
The EC found that e& benefited from an “unlimited guarantee” from the UAE government. Legally, this was because e&’s own articles of association dis-apply the UAE’s national bankruptcy law. For a lender, this means e& cannot default in the normal commercial sense. This is the ultimate “deep pocket,” eliminating all real financial risk and giving it an almost-zero cost of capital.
This state guarantee was the primary reason e& enjoyed a stellar AA- credit rating and an exceptionally low Net Debt/EBITDA ratio of only 0.9x. This ratio is a sign of a virtually unleveraged, risk-free balance sheet.
The EC found that this “subsidized financial capacity” would distort the EU market. The new, state-backed company could use this advantage to:
- Out-invest competitors: The telecom market requires massive, constant capital expenditure (e.g., 5G rollouts).
- Overbid in auctions: It could pay supra-competitive prices for critical assets like 5G spectrum.
- Engage in aggressive pricing: It could sustain losses indefinitely to drive rivals out of business.
This threat was existential because e&’s European competitors were already highly leveraged. The EC’s own analysis (Table 2, para 357) showed competitors were struggling with high Net Debt/EBITDA ratios: United Group (4.6x), 4iG (4.1x), and SWAN (3.8x)—all well above the 3.5x level typically considered on the limit of a healthy ratio.
The Remedy: A Ratio Becomes a Legal Tool
The EC approved the deal but attached a “Financing Commitment” designed to surgically sever the subsidy from the European market.
e& (and its parent, the EIA) was prohibited from providing any financing—whether debt or equity—to its new EU company (the “Target Group”) (para 7, 9). The only way e& could send money to its EU arm was for “Emergency Funding,” and only if two strict conditions were met:
- The EU company was in an “acute liquidity crisis.”
- Its Net Debt/EBITDA ratio had ballooned to 4.0x or higher (para 408).
This remedy is a landmark. The EC looked at the distressed 3.8x-4.6x ratios of the EU competitors and essentially told e&: “You are only allowed to use your state-backed magic money when your EU company looks just as financially distressed as its European rivals.”