What is it?
Dividend recapitalization is a transaction in which a company borrows in order to pay a large (or “special”) dividend. In doing so, the company significantly changes its capital structure, as net debt increases while equity is dramatically reduced.
This type of dividend
contrasts sharply to an ordinary dividend. An ordinary dividend is relatively small and supported by the ongoing earnings of the business and, therefore, doesn’t change the capital structure materially.
The dividend recap is one of two of the so-called leveraged recap techniques, the other one being the leveraged share buyback.
Why is a dividend recap done?
The corporate balance sheet after a dividend recap looks like the typical balance sheet following an LBO (i.e. a dividend recap is a form of leveraged transaction).
Therefore, two main changes occur:
- The ownership of the business has not changed, but the existing shareholders have ended up with more cash in their pockets and a reduced equity claim on the business (and less capital at risk!).
- The company is now much more levered and, hence, will need to pay more attention to generating cash flows to support the additional debt burden (cost control, efficiencies etc).
Why do a dividend recap?
The dividend recap is a popular tool among private equity funds to capitalize some of its profits while maintaining the ownership. The dividend recap brings the company back to its post-LBO capital structure and the sponsor effectively does the LBO again, while extracting cash in the process. A dividend recap (or indeed a leveraged share buyback) is, therefore, an alternative exit strategy to the more traditional exit strategies, such as an outright sale or an IPO.
However, the recap mechanism isn’t just used by financial sponsors. Ordinary corporates might choose to do a dividend recap too. Reasons for this could include:
- Increased use of tax shield
- Room for maneuver without affecting the existing credit rating
- To force management to greater efficiencies and cash flow focus
- To benefit from low-interest rates
In order to get a leveraged recap done the company needs to have access to credit. Therefore, availability of cheap credit will be a key driver of dividend recaps. In addition, interest rates need to be sufficiently low to make the recap attractive.
What companies should not do dividend recaps?
Normally, the high leverage generally resulting from a dividend recap should be avoided by companies that have high operational risk or that already have high leverage or a weak credit rating.
One good example of a recent dividend recap in the private equity space is Bridgepoint’s investment in Dorna.
The Spanish holding company Dorna, which owns both MotoGP and the Superbike World Championship, allowed shareholders to take 3 payouts from dividend recaps between 2011 and 2018. The recaps totaled approx. Euro 2bn, according to Reuters. These transactions are an excellent example of a cash flow rich company operating in a popular and growing sector.
The company was acquired by Bridgepoint from CVC in 2006 for about Euro 500 mill. In November 2018 Bridgepoint appointed financial advisors to sell its remaining stake.