‘Buy Anything’ Debt Market Sees Private Equity Payday
(Bloomberg) -- It’s the latest sign of leveraged mania hitting bondholders: Companies across Europe are piling on debt at the fastest pace in at least four years to enrich their private-equity owners.
The controversial practice known as dividend recaps is growing as investors gorge on every credit risk, handing a windfall to buyout pros at Lion Capital LLP, Partners Group and Hellman & Friedman LLC, to name a few.
Private equity firms have always borrowed to buy companies. But they’re layering on extra debt to write themselves dividend checks at a time when central banks have driven borrowing costs to all-time lows to help foster a global economic rebound.
“If people want to put capital to work they’re just buying anything with a bit of yield, regardless of what proceeds are for,” said Mark Benbow, a high-yield fund manager at Aegon Asset Management. “Perhaps the market is just too complacent or perhaps believes the central bankers will always be there as a backstop. Whatever the reason, these deals are getting done very easily.”
More than 10 companies in the region have raised junk bonds this year in part to fund dividends, the highest year-to-date number since 2017, according to data provider 9Fin. Some 13 firms also sold loans to finance payouts in the first quarter of this year, a post-financial crisis high, according to data compiled by Bloomberg.
Some of this year’s transactions were rated CCC -- the lowest ranking of junk debt -- and paid relatively higher rates. But viewed alongside decades of history, the deals are still dirt cheap.
The dividend payouts are one way for buyout firms to take profits as they wait for the growth rebound to spur higher prices in the IPO market. By issuing dividend recaps they can take a cut now and keep their end investors happy while they bide their time to cash out completely.
“You have a lot of private equity involvement in the high-yield market, and sponsors don’t want to necessarily exit businesses now because we haven’t seen the full opening-up trade develop,” said Martin Horne, head of global public fixed income at Barings LLC. “Maybe they wouldn’t get the right multiple if they tried to get a full exit by normal mechanics.”
Alain Afflelou SA is the latest example. The French eye-glass retailer skimmed off a portion of bonds sold this month and used some of its own cash to make a 135 million-euro payment to owner Lion Capital, according to Andre Verneyre, Afflelou’s head of financial operations.
The senior notes received orders for an excess of three times the amount on sale, indicating that “investors know us very well and are happy to continue with us,” he said. Despite the new debt, gross leverage has remained steady as the company retired older borrowings, Verneyre said.
The deal followed dividend recaps for French real-estate developer Foncia Holding SAS and Swedish security systems maker Verisure Holding AB this year. In the U.S., Verizon Communications Victra tapped investors for a dividend twice in the space of just three months this year. The second $75 million transaction which priced last week was used to fund a $65 million dividend to its private-equity sponsor Lone Star.
Yet even in the latest wave of market froth, there’s been pushback from bond investors.
Lion Capital failed to pull off a deal to extract dividends from another one of its portfolio holdings, French frozen-food retailer Picard Groupe SAS. Investors demanded higher pricing on the 1.7 billion-euro deal in April and Lion walked away.
“We completed Afflelou but pulled Picard because we were being opportunistic and didn’t like the pricing,” said Lyndon Lea, co-founder of Picard’s majority owner Lion Capital. “There was no urgency because the proceeds were for a dividend, which is not time-sensitive.”
While the economy powers ahead and companies are growing, servicing the extra debt may not seem like much of a strain. The problem arises when the economic boom comes to an end, and fragile balance sheets are left struggling under the weight of large debt piles and falling revenue. In the U.S., the financial travails of the Payless shoe company were blamed in part on such payouts, and have been the target of criticism from Senator Elizabeth Warren.
In the public stock market, companies that have paid shareholder dividends are underperforming those that have been buying back shares. The S&P Europe 350 Dividend Aristocrats Index is up about 20% since the end of October, when the vaccine-fueled stock market rally started, compared with 37% for its buyback equivalent.
“It’s easier to keep adding debt when business multiples are so high as the market still thinks there is plenty of equity below the bonds,” said Benbow at Aegon. “Obviously when the cycle turns and the market cheapens up you realize that there is little to no equity left.”
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