(Reuters) — Private equity firms have used buoyant debt markets to take almost $3 billion in special payouts from European portfolio companies so far this year, quadrupling the same period in 2016.
Buyout firms typically invest in a company for up to five years before “exiting”, but if they are unable or unwilling to sell out they can turn to so-called dividend recapitalisations, funded by loans or bonds, to get a cash return.
Their use has been criticised in the past because it can saddle portfolio companies with high levels of debt, while private equity firms and their investors make a profit.
“Dividend recapitalisation is a legitimate instrument used by all kinds of businesses for short-term liquidity. In private equity it can be one way of enabling investors to realise some of the value they have created in a portfolio company,” Michael Collins, chief executive of industry body Invest Europe, said.
In Europe, these payouts to private equity have totalled 2.6 billion euros ($2.9 billion) so far this year, up from 650 million euros for the same period in 2016, data from S&P Global Market Intelligence showed.
Despite the rise, dividends paid to private equity in the region through bond markets and loans were way off the 11.32 billion euros paid in the whole of 2006, at the height of the previous credit boom. Out of 2.6 billion euros, around 1.6 billion euros came from loans and the rest via the bond market.
“It is not in the interests of fund managers to load an unsustainable level of debt onto a portfolio company given that the stronger and more valuable that company is the higher the return they will get at exit,” Collins said.
The rise in payouts has partly been fuelled by buoyant credit markets in Europe as well as investors seeking to buy non-investment grade debt as they look for higher yields during a period of record low interest rates.
“Fierce competition (in the debt markets) coupled with the liquidity, means private equity sponsors can still take money off the table for their investors by effecting a dividend recapitalisation of a portfolio company, when they are not in a position to exit that investment,” said Tom Whelan, head of private equity at law firm Hogan Lovells.
But the trend could already be nearing an end.
“I think there’s going to be a healthy exit environment and the balance may swing back to sales over recaps,” Whelan said.
DEBT IS CHEAP
Although full details of individual deals are not disclosed, Advent International-owned Allnex launched a dividend recapitalisation in March after huge demand from investors for the Belgian chemicals company to issue new debt.
The move was expected to net a 425 million euro payout to its owners.
And Spanish sports management company Dorna Sports financed a dividend payment of up to 300 million euros to its private equity owner Bridgepoint, marking the third payout from the company in six years.
The leverage ratios for Dorna and Allnex were not disclosed but if a company’s earnings have risen sufficiently during their period of private equity ownership, they may not be any higher than when the companies were bought.
Cheap debt is the oil in the gears for such deals and the pricing of leveraged loans has dropped to around 316 basis points in the second quarter so far from a 10-year peak of 450 basis points in the final quarter of 2011, according to LPC, a provider of information and data on syndicated loans and high yield bonds.
According to the S&P data, the sharp rise in dividend recaps has also coincided with a sharp fall in the volume of private
equity sales. Macroeconomic and political uncertainties across Europe have at times made it more difficult for buyout firms to trade their assets either via initial public offerings or sales.
Sales and listings of assets in the region have fallen to 78.5 billion euros so far this year, compared with 172.4 billion euros in the same period of 2016.
“In this market, while debt financing is cheap, valuations are high so maximizing value through a sale may not be feasible for all companies,” said Rajani Gupta, Leveraged Finance Partner at law firm Allen & Overy.
“Neither is the IPO market – which has picked up considerably in certain sectors, but remains volatile enough that may not be an available option either.” ($1 = 0.8934 euros)