What is the recapitalization of dividends?
A dividend recapitalization (also called dividend summary) occurs when a company takes on new debt to pay a special dividend to private investors or shareholders. This usually involves a company owned by a private investment firm, which may allow a dividend recapitalization as an alternative to the company declaring regular dividends, on the basis of profits.
Understanding the recapitalization of dividends
The dividend summary has grown explosively, primarily as a means for private equity firms to recover some or all of the money they used to buy their stake in a company. The practice is generally not viewed favorably by creditors or ordinary shareholders as it reduces the credit quality of the business, while benefiting only a privileged few.
Before leaving a holding company, some private equity firms and activist investors choose to contract additional debt on the company’s balance sheet to make advance payments to their sponsors and / or managers. This reduces the risk for PE companies and their shareholders.
This special dividend, in addition to not financing the growth of the portfolio company, weighs more on its balance sheet in the form of leverage. Significant new debt could become a drag under adverse market conditions following the exit from the business.
However, the portfolio companies selected for dividend recapitalizations have always been generally healthy and able to support additional debt. This is usually due to new developments, driven by private equity sponsors, which produce stronger cash flows. Healthy cash flows allow private equity sponsors to get immediate partial returns on their investment, as other liquidity pathways, such as public markets and mergers, require more time and effort.
Dividend recapitalizations peaked during the 2006-2007 buyout boom.
Key points to remember
- Dividend recapitalization occurs when the holding companies of a private equity firm incur additional debt in order to pay dividends to investors.
- The dividend reduces risk for PE companies by providing quick and immediate returns to shareholders, but increases debt on the balance sheet of the holding company.
Example of recapitalization of dividends
In December 2020, Dover Corp. has announced that it will separate from its oil services business, Wellsite. Wellsite would become a separate business, focused on specialized equipment, particularly artificial elevators, which squeeze the final drops from oil wells after being fully drilled. As part of the creation of this separate entity, parent company Dover planned to issue a recapitalization of the dividend of approximately $ 700 million, leaving Wellsite with long-term debt of 3.4 X EBITDA. While the regular dividends go to preferred and common shareholders, in this example, the dividend is expected to fund a $ 1 billion buyout on behalf of Dover, backed by activist investor Third Point, LLC.