(IFR) – In another sign that the US junk bond market has turned the corner, syndicate desks are prepping a number of deals that pay juicy dividends to private equity sponsors.
Many investors are wary of so-called dividend recap deals, one of the most aggressive junk bond structures, because they see sponsors taking skin out of the game.
But as market tone improves, and cash keeps pouring into the asset class, leveraged finance bankers believe new deals will clear the market without too much trouble.
“There are real green shoots,” one banker told IFR. “Part of it is cash. There have been strong inflows.”
At least one dividend recap deal is already in the works: a US$670m bond from Apollo Global Management for its McGraw-Hill Education business.
The bond, expected to be announced soon, will run alongside a US$1.305bn leveraged loan already being marketed.
Apollo will receive US$300m from the proceeds of the sale after existing debt is refinanced.
Other dividend recap offerings should be surfacing soon.
“We have two or three ready to go in the next couple of weeks,” a second banker said.
SEEING THE FUTURE
As always, though, execution matters – and one recent deal got shelved after investors concluded that leverage was too high.
Sources said the trade, a US$485m second-lien best-efforts bond for logistics equipment leasing company TRAC Intermodal last month, stumbled because leverage was too high.
“I don’t think you are going to see a six-times levered name trying to bring a dividend deal to go in the sponsor’s pocket,” said Tom Stolberg, a portfolio manager at Loomis Sayles.
“People would have to have a pretty good impression of the issuer and the leverage.”
And while investors naturally demand a premium for dividend recap deals, the decision to buy may be determined by their confidence in a sponsor’s exit plans.
American Renal this week was the first sponsor-backed company to go public since First Data‘s $2.8bn IPO in October, though Apollo is planning an IPO for McGraw-Hill Education.
That underscores how weak the IPO market for sponsors has been of late, and many on the buyside say they don’t like dividend recap deals without an exit strategy in place.
“The only way it makes sense to me is if you can really tell me that this is a bridge to an IPO,” said Darren Hughes, co-head of high yield at Invesco.
“If that is the case, there is potentially quite a bit of upside,” he told IFR.
“But if it’s just a private equity sponsor who has been there for some time and just wants to take some dough out, I don’t want to be there.”
CASH IN HAND
But with cash levels high – in the region of 8% for some high-yield funds – dividend recap deals might be an appealing option for a buyside looking at waning supply.
After another jumbo LBO cleared the market this week, a US$3.14bn bond for security firm ADT that was also from Apollo, there are not a lot of trades building up in the pipeline.
The M&A bond pipeline is currently only about US$60bn, one of the bankers said, and even that is largely made up of a few very large trades.
Dell, for example, is expected to sell US$25bn of bonds to finance its acquisition of EMC, split between investment-grade and high-yield offerings.
The latter could be as much as US$18bn, the banker said.
Other big trades include a roughly US$2.275bn bond backing the buyout of Veritas by Carlyle, a US$5bn-$6bn debt financing for Energy Future Intermediate Holding Company (EFIH) and another US$6bn or so debt raising to finance the merger between Energy Transfer Equity and Williams.
“None of these big M&A deals are expected to come anytime soon,” said the banker.
And while investors wait on supply, fresh infusions of cash keep streaming into the asset class.
According to Lipper, high-yield funds have seen a net inflow of more than US$14.5bn in the past 10 weeks.