Rethinking dividend summaries

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Dividend recapitalizations have never been very popular in Asia, a reflection of the region’s relatively small leveraged financial market and more conservative lenders. But as several companies belonging to private equity groups are planning deals, bank lenders will be forced to take a position on the structure.

Private equity firms typically use dividend summaries after they acquire a controlling stake in a company. The private equity firm wants to make a return on its investment but does not necessarily want to sell shares, which would reduce its stake. Instead, the private equity firm encourages the executives of the newly acquired company to take on new debt in order to pay a dividend.

While this funding can be through bonds, the majority of dividend recaps in Asia have been funded in the loan market. The notable exception was a $ 500 million 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.

As of March, there had only been 10 dividend recaps in Asia, according to Dealogic data. The last large-scale deal dates back to 2018, when shoemaker Belle International syndicated a HK $ 30 billion ($ 3.9 billion) loan, part of which was used to make a split payment.

But things are accelerating. Business services provider Tricor Holdings, backed by UK private equity firm Permira, launched a 5.5 billion Hong Kong dollar deal in March. GaleMed from Taiwan, specialist in respiratory care, is aiming for $ 70 million. Philippine technology company SPi Global, owned by Partners Group, is also understood as recital a dividend recovery loan.

This is good news for private equity firms, but should bank lenders be prepared to take it?

Some banks don’t think so. A group of Taiwanese banks that participated in Tricor’s previous loans said they would forward the split summary. Other bankers have expressed concern 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 incurred to finance growth or to pay off older and more expensive debt. In the case of a dividend summary, neither occurs. A company weakens its capital structure in order to benefit one or more large investors.

This, in turn, raises questions about the business itself. If the best use of new funds is to pay a dividend, rather than acquiring a smaller competitor, increasing the number of employees, or modernizing a company’s technology, what is the growth potential of that company? ? The same argument is often made to companies that use unused cash to fund share buybacks. Either way, this is an issue that deserves to be taken seriously.

There are real advantages to recapping dividends, however. The most obvious would be that a wider use of dividend summaries can change the risk-return calculation of private equity funds. Widespread adoption of dividend recapitalization could even encourage more private equity investments across Asia, as they offer a way to make partial profits without reducing scrutiny.

Dividend recaps allow private equity firms and shareholders to benefit when stock prices are depressed or when they expect a big boom. As Asian stock markets have collapsed over the past year, most trading will be driven more by optimism than a refusal to sell cheaply – but that in itself should be encouraging for potential bank lenders. .

One of the reasons borrowers are exploring dividend summaries is that interest rates are so low. When Permira launched its HK $ 2.8 billion acquisition loan for Tricor in October 2016, the three-month Hibor was around 59.3bp. It is now less than half of that level. This gives borrowers leeway to provide compensation to lenders worried about additional leverage.

None of this means that dividend recaps should be an automatic yes for bank lenders. The fundamental question is whether paying money to existing shareholders is the best use of funds. But split recaps are increasingly becoming a natural way for private equity funds to make some of their earnings.

This means that the real question for lenders should be: how much do these private equity firms contribute to a company’s growth prospects? It will depend on the individual private equity firm and the company it purchased. But lenders shouldn’t expect to reap the benefits of private equity know-how without paying a price.

This article first appeared in Asiamoney on March 30, 2021.

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