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PE firms keep deploying dividend recaps despite the risks

Adam Lewis

Dividend recapitalizations have never been a popular moneymaking technique for those outside of the private equity industry. For one, they usually only benefit a select group of investors or shareholders. And they typically damage a company's credit rating, which can irk creditors and common retail investors. Plus, once dividend recaps are complete, the company itself has to pay back the debt or it will eventually file for bankruptcy.  

But the tactic, which involves a firm adding debt to a portfolio company so it can give itself or its shareholders a quick cash payout, seems as common as ever, with no signs of slowing. Sure, Democratic presidential candidate Elizabeth Warren introduced legislation that would forbid dividend payments for the first two years a PE firm owns a company, but getting a bill passed in a US Senate controlled by the PE-friendly GOP simply isn't possible at the moment.

After another cut in interest rates by Federal Reserve chair Jerome Powell in late July, private equity firms aren't hesitating to cash in. Earlier this week, Bloomberg reported that a consortium led by Silver Lake and Singapore sovereign wealth fund GIC is planning a dividend recap that would pull out roughly $910 million from Utah-based genealogy company Ancestry to pay shareholders. The investor group is also reportedly seeking a one-time dividend payment of $150 million by the end of 2019. That would mark a huge win for Silver Lake and GIC, which backed the business in 2016 at an enterprise valuation of $2.6 billion, with Permira and Spectrum Equity also retaining stakes.

So far, the news hasn't drawn much backlash, perhaps because Ancestry has been a successful business and a cash cow to PE land, having paid out a reported $1.1 billion in dividends. But that wasn't the case for Sun Capital Partners, which has been the focus of intense scrutiny for its treatment of Shopko. The firm purchased the Wisconsin-based retail department store in 2005 for some $1.1 billion, then carried out a series of dividend recaps, including a reported $50 million bump in 2015. The business eventually filed for Chapter 11 bankruptcy in January and has since liquidated, drawing the attention of lawmakers, who expressed concerns regarding severance for the company's employees.

Another high-profile dividend recap came earlier this year when Sycamore Partners was planning to take $1 billion out of Staples, bringing the office supplies company's debt load to over $5.3 billion, according to Bloomberg. That's a massive figure, given that the retail-focused investor reportedly used just $1.6 billion of its own money for its $6.9 billion purchase of the business in 2017.

Not to be outdone, Hellman & Friedman and The Carlyle Group have reportedly reached out to creditors in hopes of taking a $1.35 billion dividend recap out of Pharmaceutical Product Development. The PE firms then took the company private for around $3.6 billion in 2011 before recapitalizing it with GIC and the Abu Dhabi Investment Authority at a $9.1 billion valuation two years ago. 

There have been a myriad of other dividend recaps in recent years, including for Petco, BJ's Wholesale Club and Payless, with the latter eventually forced into bankruptcy under a mountain of debt. 

Even though it sometimes proves fatal to a company's health, dividend recaps allow private equity firms to hedge against  potential losses, often regardless of how the portfolio company fares. And for that reason, they aren't going away. 

Featured image via PeopleImages/E+/Getty Images 
 

Related read: Sycamore set to take $1B out of Staples