Fitch: Dividend Recaps are Back for European LBOs

Improved financing conditions in the high-yield bond market and a selective risk appetite among loan investors will help drive more dividend recapitalisation of legacy deals by private equity sponsors, according to Fitch Ratings. However, the credit ratings agency (CRA) expects these deals to be much more conservatively structured than the recaps during the 2006-2007 boom.

Many leveraged buyouts (LBOs) are at or beyond the typical private equity investment period and dividend recaps remain tempting exit options, particularly as funds approach expiry. Initial public offering (IPO) markets are volatile, with strategic sales often subject to minority shareholder revolts, as in the case of G4S and ISS in 2011, and secondary buyouts subject to valuation disputes. Fitch therefore expects sponsors to opportunistically tap windows of high credit market demand to seek cheap funding for a dividend recap on their legacy assets.

The European high-yield market has hesitated to play a role in dividend recaps, although increasing European and global investor appetite for high-yielding assets means it may follow the US high-yield market and accept more of them. However, loans may remain the primary route for dividend recaps, at least in the near future, as loan market secondary prices continue to tighten and collateralised loan obligations (CLOs) choose to recycle loan prepayments and invest cash balances in new primary transactions.

There are a handful of deals reportedly under way, or which have already been completed. These include a planned €250m secured bond issue for Iglo Foods, a recently completed £260m loan for roadside assistance company RAC and a US$1bn private placement by motor racing promoter Formula One. Other successful recent issues include a US$275m pay-in-kind (PIK) toggle by Dematic and two high-yield bonds issued by Orange Switzerland in September to term out loan maturities and pay a dividend.

Whatever the source of funding, the CRA expects deals to remain much more conservative than those struck in 2006-2007 and dividend recaps to leave LBOs with leverage of between 4.5x and 5x on average, compared with the 6.4x in 40 deals that it analysed in 2006. RAC’s loan-funded dividend recap, for example, will lift leverage to around 5x, according to one press report, while Orange Switzerland’s leverage rose to around 4x.

Dividend recap transactions are also only likely to be viable for LBOs with a stable business model and global appeal, or which at least derive their sales from core European, rather than peripheral, markets. They will probably also need to have demonstrated strong operating performance and cash flow-driven de-leveraging in recent years.


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