LONDON Dividend recapitalizations are gaining prominence in the European leveraged loan market due to a lack of buyout activity, raising concern among investors - who are facing increased risk as a result of sponsors taking money out of credits and increasing leverage ratios.
European loan investors have traditionally frowned on dividend recaps, and their appearance has generally been restricted to bull markets. However, they have re-emerged since the end of 2012 as the continued lack of M&A activity has prompted sponsors to look at alternative ways to get value out of assets.
Funds need to stay invested in deals as they come to the end of their reinvestment periods - refusing to agree to a dividend recap could mean being repaid - and the lack of M&A opportunities means there is little chance to put that liquidity to work elsewhere.
"Borrowers have the CLO community over a barrel as they take advantage of technical market conditions. If a lender refuses a dividend recap, they could get repaid, which isn't great if they need to be invested as there is little else out there to put money into," a leveraged investor said.
"Fundamentally you lend to a company on one basis and then get told at a later stage that through the dividend recap there is going to be less equity in the deal and a higher leverage ratio. Would an investor agree to the revised terms when the original deal took place? Most probably not."
Several M&A opportunities have fallen by the wayside as a result of a gap between seller and buyer expectations. Last week, the sale of German insulation firm Armacell INBSCE.UL stalled when bids from Charterhouse CHCAP.UL and Pamplona were deemed to be too low, leading Bahrain-based private-equity firm Investcorp INBSCS.ul to consider a dividend recap instead.
Bankers are pitching ways to conduct the dividend recap on Armacell and will find out this month whether Investcorp plans to push ahead with it.
"A successful dividend recap is all about the right time and the right deal. The right time is now. Armacell is a very good debt story, but the equity story is unclear: it should be capable of getting a dividend recap away," a banker said.
In the first quarter of 2013, UK pet-shop chain Pets at Home PETHO.UL and Spanish metal packaging firm Mivisa MIVIS.UL both conducted dividend recaps.
"Mivisa was a pretty good yardstick in the sense that, if you have a good sponsor and a strong asset, people are more open to it. If an asset is performing well then people are more open to letting sponsors take money out of a credit if they can't sell it," another banker said.
The pipeline of credits considering a dividend recap is growing to include companies such as tax-free shopping business Global Blue, while British payment processing company WorldPay is undertaking a dividend recap by raising a new 700 million pound-equivalent loan ($1.07 billion), of which 340 million pounds will be used to pay a dividend.
Both companies have performed well, have managed to reduce leverage and are liked by their investors, making them strong candidates for a dividend recap.
For some other companies, which have also performed well, it is too early for the sponsors to sell as they haven't owned the credit for long enough. In these cases, sponsors are also considering dividend recaps, in order to take advantage of a strong technical market where pricing is low and investors are compliant.
"Dividend recaps will be seen even for companies that are performing well but it is way too early to sell them, so owners can still get value and take advantage of the market," the second banker said.
($1 = 0.6514 British pounds)
(Editing by Christopher Mangham)