Dividend recapitalizations have never been very popular in Asia, a reflection of the region’s relatively small leveraged finance market and more conservative lenders. But as several firms owned by private equity groups plan deals, bank lenders will be forced to take a stance on the structure.
Private equity firms typically use dividend recaps after acquiring a controlling stake in a company. The private equity firm wants to realise a return on its investment but doesn’t necessarily want to sell shares, which would reduce its stake. Instead, the PE firm encourages executives at the newly acquired company to take on new debt in order to pay a dividend.
Although this financing can be done through bonds, the majority of dividend recaps in Asia have been financed in the loan market. The notable exception was a $500m bond for Indian IT company Mphasis, part of which was used to pay a dividend to shareholders including Blackstone and GIC, Singapore’s sovereign wealth fund.
Until March, there had been only 10 dividend recaps in Asia, according to Dealogic data. The last high-profile deal was in 2018, when shoemaker Belle International syndicated a HK$30bn ($3.9bn) loan, part of which was used to make a divided payment.
But things are picking up. Corporate services provider Tricor Holdings, backed by UK private equity firm Permira, launched a HK$5.5bn deal in March. Taiwan’s GaleMed, a specialist in respiratory care, is aiming for $70m. Philippine tech company SPi Global, owned by Partners Group, is also understood to be considering a dividend recap loan.
This is good news for private equity firms – but should bank lenders be willing to go along with it?
Some banks think not. A group of Taiwanese banks that took part in Tricor’s previous loans have said they will pass on the divided recap. Other bankers said they are worried about the resulting increase in leverage ratios.
The arguments against dividend recaps are obvious. It is natural to think that new debt should only be taken on to fund growth, or to pay back older, more expensive debt. In the case of a dividend recap, neither is happening. A firm is weakening its capital structure in order to benefit one or more major investors.
That, in turn, raises questions about the business itself. If the best use of new funds is paying a dividend, rather than acquiring a smaller rival, expanding the number of employees or upgrading a company’s technology, how much growth potential does that business really have? The same argument is often thrown at companies that use idle cash to fund share buybacks. In both cases, it is a question worth taking seriously.
There are, however, some genuine advantages to dividend recaps. The most obvious would be that a wider use of dividend recaps can change the risk-reward calculus for private equity funds. Widespread adoption of dividend recaps could even encourage more private equity investment across Asia because they provide a way to realise partial profits without reducing control.
Dividend recaps allow private equity firms and shareholders to benefit when stock prices are depressed, or alternatively when they are expecting a big boom. Since Asia’s stock markets have been on a tear over the last year, most deals will be motivated more by optimism than a refusal to sell at low prices – but that in itself should be encouraging to potential bank lenders.
One reason borrowers are exploring dividend recaps is because interest rates are so low. When Permira launched its HK$2.8bn acquisition loan for Tricor in October 2016, three-month Hibor was about 59.3bp. It is now less than half that level. That gives borrowers the wiggle room to offer compensation to those lenders worried about the additional leverage.
None of this means dividend recaps should be an automatic yes for bank lenders. The fundamental question is whether paying money out to existing shareholders is the best use of funds. But divided recaps are increasingly becoming a natural way for private equity funds to realise some of their gains.
That means the real question for lenders should be: how much are these private equity firms contributing to a company’s growth prospects? That will depend on the individual private equity firm, and on the company it has bought. But lenders should not expect to enjoy the benefits of private equity know-how without paying a price.
This piece was first published in Asiamoney on March 30, 2021.