Fitch predicts return of dividend recaps

The controversial boom-era practice of dividend recapitalisation is returning, according to ratings agency Fitch, as private equity firms seek alternative ways of returning money to investors in a difficult exit environment.

A dividend recapitalisation involves buyout firms burdening their portfolio companies with additional debt in order to fund dividends. It was used by a number of private equity firms at the height of the buyout market in 2006 and 2007.

In a note released this week, Fitch said that the combined factors of improved appetite from high-yield bond investors and “selective risk appetite among loan investors” – meaning that they are more willing to provide loans to fund recaps – has created conditions for an increase in dividend recapitalisations. This time around, however, terms are likely to be more conservative than recaps during the boom era, Fitch said.

Private equity firms have traditionally paid dividends with proceeds from the exit of investments. However, firms are struggling to sell or list European portfolio companies due to valuation mismatches and volatile equities markets.

Fitch said: “Many leveraged buyouts are at or beyond the typical private equity investment period and dividend recaps remain tempting exit options, particularly as funds approach expiry.”

The note said that initial public offerings, one of the main exit routes for private equity investors, were fraught with peril due to the volatile public equity markets and the possibility of minority shareholders derailing the process.

Fitch said that it therefore expected private equity firms to “tap windows of high credit market demand to seek cheap funding for a dividend recap on their legacy assets”.

The rating agency added that while appetite from high-yield bond investors was improving, leveraged loans were the “primary route” for dividend recaps in the near future.

Collateralised loan obligation fund managers have begun using the income from repaid loans to invest in new transactions, the agency said. It added that conditions had also improved in the secondary loan market.

A number of private-equity backed companies have completed dividend recaps in recent months, including UK roadside assistance group RAC, backed by Carlyle Group, which completed a £290m dividend recap earlier this month; motor sport promoter Formula One, backed by CVC Capital Partners; Triton Partners-owned German logistics group Dematic; and Orange Switzerland, owned by Apax Partners.

Iglo Foods is also planning a €260m bond issue to fund a dividend to its owners Permira, according to Fitch.

Fitch said that dividend recaps would likely leave companies with leverage multiples of between 4.5 and five times earnings before interest, tax, depreciation and amortisation on average, which is more conservative than the 6.4 times Ebitda average in 2006.