What Is Dividend Recapitalization?
A dividend recapitalization (commonly referred to as a dividend recap) occurs when a company assumes new debt to pay a special dividend to its private investors or shareholders. Typically seen in companies owned by private investment firms, this strategy is an alternative to declaring regular dividends based on earnings.
Key Takeaways
- Dividend recapitalization involves a private equity firm issuing new debt to raise money for a special dividend to repay initial portfolio company investors.
- This approach provides early, immediate returns to shareholders while it increases the portfolio company’s debt load and can alter its balance sheet.
- A dividend recapitalization offers liquidity to private equity firms without needing an IPO, reducing risk exposure.
- While not common, a dividend recap is distinct from regular dividends that derive from company earnings.
Navigating Dividend Recapitalization
The use of dividend recaps has surged, particularly as a method for private equity firms to reclaim part or all of their investment in a business. This practice often draws skepticism from creditors and common shareholders, as it potentially diminishes the company’s credit quality while favoring a select few investors.
Before exiting a portfolio company, some private equity firms and activist investors choose to increase the company’s debt load to provide early payments to limited partners and managers. This distribute risk away from the private equity firms and their shareholders.
Special dividends resulting from these recaps, instead of promoting the growth of the portfolio company, weigh down the company’s balance sheet with additional leverage. In unfavorable market conditions, this substantial new debt can hinder the company’s performance post-exit.
However, portfolio companies chosen for dividend recapitalizations are often sound and capable of managing increased financial burdens. These companies usually boast strong cash flows, often due to recent improvements driven by private equity sponsors, enabling quick partial returns on investment. Other liquidity paths, such as going public or merging, require more time and effort.
Dividend recapitalizations saw significant momentum during the 2006-2007 buyout boom.
Illustrating a Dividend Recapitalization
In December 2017, Dover Corp. announced its decision to spin off its oilfield services division, Wellsite. The newly-independent Wellsite would specialize in equipment, particularly artificial lifts for fully drilled oil wells. As part of forming this separate entity, Dover planned a dividend recapitalization of approximately $700 million, resulting in Wellsite holding long-term debt equivalent to 3.4 times its EBITDA. Instead of going to preferred or common shareholders, in this case, the funds enabled Dover to execute a $1 billion buyback, endorsed by activist investor Third Point, LLC.
Related Terms: special dividend, creditor, common shareholder, private equity firm, activist investor.
