Dividend recaps - Why?

How do dividend recaps in anyway help the portfolio company? You basically use the company as collateral to borrow a ton of money, making them even more levered, and use that borrowed money to pay yourself. I know it's a way to get cash to investors and the PE firm, but besides that doesn't it increase the risk of bankruptcy to the portco and ultimately hurt operations?

Only thing I can think of is disciplinary role of debt but if the company was already levered in the first place (which after an LBO it is) it shouldn't really tighten operations. So why doesn't the company try to stop the recap, unless the PE firm has 100% of the say?

 

[quote=Gekko21]http://www.wallstreetoasis.com/forums/paying-dividend-to-buyout-firms#c…]

Read this.

Also, while it does increase the debt load of the company, it is not necessarily a bad thing provided the company's cash flows can service the debt. Think of it this way..is getting a second mortgage on your house always a bad thing? No, it just means that you you have less equity when you try to sell it in a few years.

"Greed, in all of its forms; greed for life, for money, for love, for knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."
 

Thanks Gekko -- I understand that, but can't a PE firm buy ANY company, good or bad, and just dividend recap it twice or three times, get the money, and let the company default? In that case don't PE firms have no incentive to make the company better (and with that, companies have no incentive to let themselves be bought out by PE firms)?

 
Nightman:
Thanks Gekko -- I understand that, but can't a PE firm buy ANY company, good or bad, and just dividend recap it twice or three times, get the money, and let the company default? In that case don't PE firms have no incentive to make the company better (and with that, companies have no incentive to let themselves be bought out by PE firms)?

Yeah, sorry don't know what happen with me quoting myself and then not answering your question.

Where do you think the money for the recap comes from? It comes from investor and banks (depending on how much they want to take on their books). A firm can do one dividend recap, but no bank is going to lend a company money if it looks like it will automatically default. The yield on the debt will be sky high---and even then the deal only gets done because investors are willing to take on the risk. Bruce Wasserstein blew up First Boston with his hyper aggressive takeover advice and First Boston was willing to take a lot of the risk their clients took onto the bank's books.

Also, while I am sure there is a give and take between the dividend recap and improving operations, improving a company and selling it at a higher price will generate higher returns than what little money can be generated on the dividend recap.

"Greed, in all of its forms; greed for life, for money, for love, for knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."
 
Nightman:
Thanks Gekko -- I understand that, but can't a PE firm buy ANY company, good or bad, and just dividend recap it twice or three times, get the money, and let the company default? In that case don't PE firms have no incentive to make the company better (and with that, companies have no incentive to let themselves be bought out by PE firms)?

Look up: fraudulent conveyance.

 
Nightman:
What about the company -- since they really don't benefit from the recap do they ever say NO, or do they not have control over their cap structure?

The company is owned by the PE firm, what is the company going to say no to?

And I am not sure if there is no benefit. There is the tax shield, also the money may be used to buyout a minority investor----I don't have first hand experience with Dividend Recap, so I can't speak about all the merits of a dividend recap.

"Greed, in all of its forms; greed for life, for money, for love, for knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."
 
Gekko21:
Nightman:
What about the company -- since they really don't benefit from the recap do they ever say NO, or do they not have control over their cap structure?

The company is owned by the PE firm, what is the company going to say no to?

Like Gekko said, there is a third party involved here in the form of lenders. Dividend recaps regularly fall through when the lender community refuses the deal-usually because the company has under performed or the new debt would be damaging to the company.

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 
firebi234:
hiit:
Debt financing is not so easy to get nowadays.

Of the 17 leveraged loans launched this week 10 were div recaps

The leveraged loan market is definitely open right now and a lot of sponsors are doing dividend deals ahead of potential tax changes.

On the other hand I can think of several dividend recap deals that have been pulled in the last few months because lenders pushed back.

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 

Generally speaking recaps occur when firms have improved their credit profile by either paying down debt or improving cash flow. You have both sides principal and willing lenders who are trying to boost their returns. Principal by taking cash out in the form of a recap (tvm) and lenders willing to lend the money in the most "profitable" deals that they can. Both are operating under the legal doctrine fraudulent conveyance (for example look up the Tribune shit show). So while leverage may get crazy and some recaps aren't warranted (my opinion) they won't get too crazy because both sides will open themselves to lawsuits.

 

Both middle-to-strong B companies, one around $200mm and the other just under $1bn. PM me if you want some more details.

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 

They are basically never GOOD for portfolio companies, but the point is to take on only enough debt that the company that healthily sustain. Of course the company would be better served if it took on that debt to reinvest in the company instead.

PE firms do it because it is a form of liquidity (to pay themselves), because they can.

If you want to cut through the technical BS, that is pretty much what it is.

 
fk:
They are basically never GOOD for portfolio companies, but the point is to take on only enough debt that the company that healthily sustain. Of course the company would be better served if it took on that debt to reinvest in the company instead.

PE firms do it because it is a form of liquidity (to pay themselves), because they can.

If you want to cut through the technical BS, that is pretty much what it is.

Another point to mention is that in quite a few of these transactions that I have done a good number of the employees/mgmt team had equity stakes so it just wasnt the PE that was getting paid.

 
Best Response

Sometimes, things that appear sinister or are portrayed in the media as such bear some additional (and deeper) thought if you really want to have a fair perspective.

To play devil's advocate, if you owned a portfolio company and did a dividend recap, wouldn't it be perfectly reasonable to you that all you are doing is re-levering the company to it's max leverage/minimum equity state? In other words, presumable the state at which you bought it. Or the state at which it would sell to a new buyer today.

Why should a new buyer have that right whereas you do not, simply because you paid down debt, or grew cash flow, or had debt markets become more accommodating since you purchased?

To me, this has always seemed like the media argument that research are entirely shills for a company because the preponderance of stock ratings are "buy" or "strong buy". Well, if you assume that banks primarily deploy research in support of underwriting clients, and that they are somewhat selective in terms of who they choose to bring to market, and that they have a tendency to drop coverage on bad companies... Well, should you really expect a bell curve for research ratings?

The best advice I can give you is that you should always question what seems obvious. Often it sounds reasonable, until you really think it through.

 
GenghisKhan:
Sometimes, things that appear sinister or are portrayed in the media as such bear some additional (and deeper) thought if you really want to have a fair perspective.

To play devil's advocate, if you owned a portfolio company and did a dividend recap, wouldn't it be perfectly reasonable to you that all you are doing is re-levering the company to it's max leverage/minimum equity state? In other words, presumable the state at which you bought it. Or the state at which it would sell to a new buyer today.

Why should a new buyer have that right whereas you do not, simply because you paid down debt, or grew cash flow, or had debt markets become more accommodating since you purchased?

To me, this has always seemed like the media argument that research are entirely shills for a company because the preponderance of stock ratings are "buy" or "strong buy". Well, if you assume that banks primarily deploy research in support of underwriting clients, and that they are somewhat selective in terms of who they choose to bring to market, and that they have a tendency to drop coverage on bad companies... Well, should you really expect a bell curve for research ratings?

The best advice I can give you is that you should always question what seems obvious. Often it sounds reasonable, until you really think it through.

Except you typically relever the port co's back up to post-transaction leverage levels, which is usually much higher than before the PE firms enter the picture.

I totally get your point and am not arguing there is anything sinister going on. It is capitalism. Just trying to give the OP a clear answer.

OP is confused because publicly, PE firms describe their business as buying companies, making them better and healthier, and then selling them for a profit. Dividend recaps happen post-acquisition and pre-divestiture, so he doesn't understand how it fits into that description (making companies healthier between purchase and sale).

My answer is simply that it doesn't, but they do it because they can without hurting the port co. Of course they could take those recap proceeds, reinvest in the port co's, and make them even healthier. But they don't, and as you state, why should they? PE firms are in this business to make a profit. Just want to clarify that PE firms take dividends to make a profit, and has nothing to do with adding value to the port co. Again, nothing wrong or sinister about it.

 

There also comes a breaking point where the chance of default is high. Given that the sponsor has skin in the game., they works like to boost returns without getting their equity wiped out by a reorganization.

 
thaTHRILLA:
There also comes a breaking point where the chance of default is high. Given that the sponsor has skin in the game., they works like to boost returns without getting their equity wiped out by a reorganization.

Maybe I'm misunderstanding your point, but you think a sponsor will be able to lever a portco to do a dividend recap if chance of default is high? Lenders aren't idiots, they won't lever up a company if they're going to default.

 

fk I think you should pay more attention to GenghisKhan, who happens to be an md. It is not as simple as leverage=PE profits=evil capitalism at work. Leverage is a good thing in moderation, and the PE firms are not destroying the portco's value by levering- that would be stupid since they make most of their money in the exit, not the recap.

The cost of capital decreases to a certain point the more debt you put into a company. If the company has stable cash flows and meets all covenants, it will likely reduce debt ratios to the point where it is appropriate to relever and pull out some return to the PE firm.

 
LeveragedFiend:
fk I think you should pay more attention to GenghisKhan, who happens to be an md. It is not as simple as leverage=PE profits=evil capitalism at work. Leverage is a good thing in moderation, and the PE firms are not destroying the portco's value by levering- that would be stupid since they make most of their money in the exit, not the recap.

The cost of capital decreases to a certain point the more debt you put into a company. If the company has stable cash flows and meets all covenants, it will likely reduce debt ratios to the point where it is appropriate to relever and pull out some return to the PE firm.

Been around long enough to know that GenghisKhan is an MD. I don't disagree with him and was just clarifying my post. And I'm familiar with the concept of cost of capital...thanks for the refresher though...?

I think you need to read my post again...I explicitly state that dividend recaps aren't evil, and that dividend recaps are designed to not hurt port co's. But to argue that dividend recaps are done primarily to HELP the portcos by optimizing their cap structure is just false. I don't think thats what Genghis was implying but that seems to be what you are.

Not sure why some people are so defensive about this. PE firms are companies operating to make money. Is it so crazy that they would engage in an activity that makes them money and that doesn't hurt their portco?

And I realize the terms hurt and help are super general, just don't feel like typing out an essay

 

No need for any back and forths on my postings. I generally don't get snarky about people's reactions to my posts, so there is generally no need for anyone else to (although I do appreciate the support!).

My posts sometimes reflect being my personal opinions, which are colored by own experience and world view. They also sometimes suffer from the biggest thing I lecture my juniors about - imprecision in my language. Normally I would be more careful, but for a forum like this I generally do not proofread, edit or even pay much attention to detail. I also write on my 3G iPad, which compounds my near-incompentence in typing ability even under ideal circumstances.

Couple that with posts that are hastily written in places like in a car on the way home from nursery school fundraisers, or while I listen to conference calls in my den, and you should not be surprised that some people will sometimes misread what I intended to say.

 

I have a n00b question.

The PE firm raises debt to buy a firm. The firm that is bought assumes the debt and the interest expenses. Doesn't that sound messed up?

Ya sure. the PE firm owns the firm now. So if it goes bankrupt, does the PE firm have to bail it out? Not from what I've heard...

 

Go read up on basic organizational structures. Also during the downturn many PEs provided equity cures to remedy covenant defaults. Most times it would be foolish to simply let the portfolio company default or trip covenants.

 

Another thing I didn't think to mention is that sometimes it's easier to monetize the portfolio company's value through a dividend recap versus an equity sale. Right now, for example, getting debt financing is far easier than doing an IPO or finding a strategic buyer. By doing a dividend recap the sponsor gets some of their value now and retains the equity for an exit down the line in better circumstances.

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 

fk, read your post again and realized that it wasn't as black and white as some other posts on here. I still do take issue with your distinction between pulling out dividends and reinvesting those funds into the portco. It is not always ideal to put all net income into retained earnings, and it seems like PE firms get a bad rap for doing the recap.

 

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