GPs turn to dividend recaps

There has been a pronounced increase in the number of dividend recapitalisations as firms seek alternative means to realise value from their investments, according to a Moody’s report.

It’s tough to get exits away in the current market, which means sponsors are having to be more creative when it comes to taking money off the table. According to Moody’s Investor Services, there’s a growing trend for GPs to use dividend recaps as a means to return capital.

Normally, that would set alarm bells ringing – dividend recaps typically involve a private equity group replacing equity it has in a portfolio company with additional debt. In a difficult economic environment where growth is hard to come by, additional debt is potentially a liability most companies could do without.

Dividends [will] remain a popular way to extract returns from sponsored companies as global macroeconomic uncertainty limits private equity exits

Moody's Investor Services

However, the debt used to finance these dividends has been far less aggressive than was typical of the boom era years of 2006 and 2007, Moody’s said. “More than half of the 35 companies that executed dividend recaps this year saw leverage increase to 4x-6x as a result, a level consistent with the median for non-financial companies with single-B ratings,” the report said.

US speculative-grade companies increased dividend payouts more than 10 percent in 2011 and in the first quarter of this year, Moody’s said, with private equity firms a key driver of this trend. There have been at least 35 debt-financed dividend recaps worth more than $11 billion already this year by companies, 28 of which were owned by private equity firms, according to Moody’s.

The largest were Bain Capital and Thomas H Lee Partners-owned Clear Channel (almost $2.2 billion) and HCA (nearly $1 billion), which is backed by KKR, Bain Capital and Bank of America’s private equity unit.

A number of post-bubble deals have been recapitalised because debt used at the time of acquisition was minimal. As a result of being “under-levered”, the companies are therefore able to accommodate more debt now. Examples include Hellman & Friedman-owned Getty Images, Blackstone Group-owned SeaWorld Parks & Entertainments, and Irving Place Capital-backed Thermadyne, each of which saw leverage rise by at least one turn following their respective recaps, Moody’s said.

The recaps have, for the most part, had little effect on their credit ratings. Moody’s said this was because ratings often incorporated the expectation of further leveraging. The only four companies among the 35 to be downgraded were: SeaWorld; Atlantic Broadband Finance (owned by ABRY Partners and Oak Hill Capital Management); CCMP Capital Advisors-backed Generac Power Systems; and HIG Capital-owned Securus Holdings, Moody’s said.

“We expect dividends to remain a popular way to extract returns from sponsored companies as global macroeconomic uncertainty limits private equity exits through M&A and the IPO market remains soft. But activity will depend on market conditions. Debt capital markets were particularly open to dividend deals in February, March and April, but these transactions slowed markedly in June as speculative-grade spreads widened amid heightened global macroeconomic concerns.”