If a window opens up to make money, expect private equity to breeze in quickly. Reduced nervousness about inflation and a US recession has enabled a credit market thaw in 2023 after a brutal freeze last year. Both high grade and high yield issuers have sold debt, even if the coupons have climbed sharply.
No matter, private equity groups have taken the opportunity to have their portfolio companies issue leveraged loans. When these proceeds fund cash payments to their owners, this transaction structure is known as a “dividend recapitalisation”. In February, firms such as Cerberus and Dragoneer have benefited from nearly $2bn of total dividend recap volume. These types of payouts disappeared last year, according to figures from Leveraged Commentary and Data.
Critics of private equity do not like dividend recaps. The deals allow owners to pay themselves early on while re-levering a company, potentially made more susceptible to bankruptcy. Still, investors have willingly supported this structure in bull markets. In 2021, of a total $800bn of leverage loan volume, more than a tenth funded payouts to private equity firms.
One recent dividend recap involved a telecom equipment maker, SubCom, purchased by Cerberus Capital Management in 2018. The $470mn floating rate loan SubCom issued this month to fund the payout bears an initial interest rate of around 10 per cent. SubCom had already borrowed money in 2021, $730mn, to fund a dividend. Back then, though, interest rates were much lower.
SubCom is private but those dividend amounts already suggest that Cerberus will profit handsomely on its initial equity outlay. As it still owns SubCom, Cerberus could reap even more cash should it ever sell the company outright.
Recent US employment and inflation data hint that US rates will not fall soon. As a result credit markets have trembled and debt markets to pay for dividends may clam up again. But for sure nimble private equity owners will be ready sellers of debt for more dividend recaps should opportunities arise.
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