By Aaron Weinman
Blackstone Inc. and Warburg Pincus just piled more debt onto their portfolio company IntraFi to fund a payout to themselves. For the seventh time in three years.
A financing like this, known as a dividend recapitalisation, would have been improbable just a few months ago, but much has changed. Investors are clamoring for any kind of debt offering a floating rate as the Federal Reserve looks increasingly concerned about inflation. Private equity firms are eager to put the deals together, to pull money out of the companies they own and can’t exit from.
Over the last four weeks alone, ten borrowers have launched more than $3.5 billion of leveraged loans and junk bonds to fund distributions for their owners. Those deals account for half of this year’s entire dividend recap volume, according to data compiled by Bloomberg.
“The market is looking for supply, and we’re increasingly pitching these deals where they make sense for the credit,” said Brian Tramontozzi, head of North America leveraged finance capital markets at JPMorgan Chase & Co. “Investors tend to get comfortable with dividends because they already own the credit, they have the business modeled.”
A representative for Warburg Pincus declined to comment, while a spokesperson for Blackstone didn’t comment. IntraFi didn’t respond to a request for comment.
With nearly 80% of this year’s US loan issuance tied up in refinancing or repricing existing debt, the supply of new loans remains sparse. According to David Saitowitz, head of US liquid credit at ICG, this scarcity is precisely what drives the volume of dividend recaps higher.
And with credit spreads hovering near record tights, investors are eager to deploy capital amid rising optimism over a potential end to the US-Iran war. The environment allows sponsors to “take advantage of attractive spreads as they return capital to investors,” Saitowitz added.
There’s likely more to come in the third quarter as sponsors race to lock in returns before year-end.
“Against a manageable new money pipeline, dividend deals are expected to amplify in the months ahead for performing assets,” said Cody Gunsch, Morgan Stanley’s head of North American leveraged finance capital markets.
Private equity firms have routinely used dividend recapitalizations to book profits and take skin out of the game after they acquire companies. But because deals often layer debt onto already-burdened balance sheets without boosting earnings, they’ve drawn warnings from ratings agencies over climbing leverage and interest expenses and met resistance from investors.
Capital Hoard
Private equity firms have struggled for several years to offload the companies they bought at a profit and return capital to investors. Apollo Global Management Inc.’s Co-President Scott Kleinman warned this month that private equity will “have to start capitulating for sure on valuations” to shift assets built up in the boom era of easy money.
According to a recent report from Bain & Co., a growing number of private companies are “essentially trapped in portfolios.” That’s stretched holding periods for assets.
Private equity firms are opting for dividend deals as they expect to own assets for longer than the historical three-to-five years, according to Michael Best, a portfolio manager for senior-secured loans at Barings.
“Private equity are loathe to give up good, performing credits right now,” Best said. Sponsors are elongating their holding periods due to a combination of higher interest rates and stagnant market valuations, which have ended the era of the quick, lucrative flip, he added.
In the case of IntraFi, its latest dividend recapitalization in late May came less than a year after it raised more than $2 billion in the leveraged loan market, partially for a dividend.
Among the others, security solution provider ADI Global raised $1 billion in bonds and loans this month to pay a dividend tied to the company’s spin-off from home safety business Resideo.
Brookfield Infrastructure Partners-backed Colonial Enterprises also raised $425 million for a dividend just a year after it bought the business, which operates the Colonial Pipeline.
Unlocking Cash
Buyout firms and their clients are also relying on alternative methods to unlock cash. They’re rolling older assets into continuation funds and selling stakes on the secondary market. But even continuation vehicles are facing pressure as limited partners scrutinize those deals, according to the report from Bain.
According to Barings’s Best, private equity firms also don’t want to get into bidding wars against other sponsors when it’s challenging to sell assets at a valuation palatable to both buyer and seller.
“So you want to take something off the table,” he said, regarding dividends. “And if the credit markets are open and under supplied, then it’s an easy way to get that done.”