Dividend Recrap?

Two weeks ago we ran a blind item asking which PE-owned retail business was about to file for Chapter 11. Certainly the answer could have been “half of them,” but we gave the hint that this company’s sponsor is getting used to this sort of thing.

That company finally filed yesterday: It was Anchor Blue Retail Group, backed by Sun Capital Partners. For those of you counting, that’s Sun Capital’s seventh company to go under this year. It had six bankruptcies last year.

Of course, the firm’s response to this number is that Sun Capital pays so little for its acquisitions of struggling companies that the performance of its funds is not adversely affected by the bankruptcies. Well, this situation is no exception. Sun Capital actually made money on its investment in the now-bankrupt Anchor Blue Retail Group.

The firm invested a mere $2.32 million from its third fund in the company in 2003. In 2005, the firm took a dividend recap on Anchor Blue. In it, Sun Capital sold a 25% stake to Ares Management for $30 million. Ares also provided mezzanine debt to Anchor Blue. Sun invested an additional $16 million in the company, and all was going well until the economy tanked and Anchor Blue’s sales fell off. The company filed for Chapter 11 yesterday with a $20 million DIP loan from Wachovia.

After all is said and done the firm will come out with a decent return from the deal even though the company failed. In a time of populist outrage, one could argue that that looks kinda bad.

The dividend recap-turned-bankruptcy situation isn’t limited to Anchor Blue. It happened just last week with JLL Partners. The buyout firm had made 2x its money on structured settlement business J.G. Wentworth through dividend recaps, only to see the company fall into bankruptcy. At least in JLL Partners’ case, the firm injected $100 million of new equity into the company as part of the pre-packaged bankruptcy arrangement. I’m assuming the capital came from a different fund than the one benefitting from the recap, but either way it is a sign of good will in a potentially inflammatory situation. For the record, Sun Capital will also re-invest in Anchor Blue as part of the credit bid from lenders. It’s not clear how much the firm plans to chip in. Sun Capital made similar moves with other recent bankruptcies: The firm has plans to re-invest in Big 10 Tire Stores Inc., a bankrupt company that it purchased in 2006, and the firm has already re-acquired Fluid Routing, a portfolio company that went bankrupt in February.

Not long ago, Vyvyan Tenorio of The Deal took a look at the age-old dividend recap debate, noting that Moody’s Investor Services plans to search for evidence that dividend recaps lead to bankruptcies. The ratings agency has apparently singled out Apollo Management as one of the “most aggressive” takers of dividends. Surely between Apollo and the hordes of other firms taking dividends when capital was easy, Moody’s will have no shortage of examples to study.

Previously: Sun Capital’s cross-funding strategy, and details on the firm’s equity investments.