Debt in Europe: Frothy recaps?

The credit markets may have cooled slightly in the second quarter, but the latest S&P figures show there was no slowdown in the volume of dividend recaps.

With the lending market still in pretty fine fettle, the refinancing window remains wide open for European GPs, who are taking full advantage of the opportunity to take some proceeds out of their existing assets. 

3i’s Action and IK Investment Partners’ Minimax Viking are among the companies understood to be currently in the pipeline, while Bridgepoint recently unwrapped a £375 million refinancing for sandwich business Pret a Manger, which will fund a £150 million pay-out to investors. 

Dividend recaps are still on the rise in Europe, according to fresh research by ratings agency Standard & Poor’s. In Q2, volumes reached €2.27 billion, compared to approximately €2 billion in Q1. 

In Q2, the majority of the total – about €1.5 billion – was financed by the bond market, with the remaining €770 million by the traditional loan market. That’s a substantial jump from Q1, where about €1 billion of recaps were financed via the bond market and the rest via the loan market, according to S&P. 

Overall, the agency said, total European leverage finance issuance rose to €41.8 billion in Q2, up from €37.2 billion in Q1. 

THE EASY OPTION

The relatively weak exit environment is one reason why GPs are turning to recaps, according to Ken Goldsbrough, a managing director at Houlihan Lokey. “It’s easier to do a dividend recap than it is to do a full sales process. So if sponsors feel they won’t be getting the right sales multiple, taking advantage of the hot debt markets can be a good way of taking money off the table.” They can also be an effective way to boost performance, he says. “If you do a recap or even two and you sell the company afterwards, you can do very well in terms of overall returns.”

While traditional banks have traditionally been reluctant to provide debt for dividend recaps – as they were deemed “a less good purpose” than investing in the growth of the business – general attitudes towards such refinancings are changing, according to Goldsbrough. “As the market becomes less bank-dominated, and there are more bond deals and credit funds and perhaps more American influence, there’s definitely [been] a bit of a sea change. Some lenders have been proactively offering recaps.” 

Nonetheless, although well-performing companies can often easily handle higher levels of debt than they’ve been carrying since the credit crunch, there are clearly risks involved with dividend recaps – particularly with companies that aren’t performing as well.

“We have seen some sponsors who simply have businesses in their portfolio that aren’t going anywhere. That’s where we see maybe more aggressive debt advisors trying to push banks into that kind of recapitalisation, when the underlying business is of quite a poor quality,” says Gary Edwards, head of growth and acquisition finance at Investec (he tends to decline those deals “relatively quickly”, he suggests). “If the banks generally have a lending appetite and there’s generally more liquidity, then two things happen: the quality of the credit starts drifting down and … pricing [starts drifting down].” 

RISK-ADJUSTED

In a report earlier this year, S&P warned that the increased issuing of dividend recaps by private equity firms can hamper a company’s recovery prospects. If too much debt is stacked onto the business, this reduces a GP’s flexibility in “running the business as [they] want”, says David Gillmore, head of analytics, European leveraged finance and recovery at S&P. “That means the company might not be able to maximise the value of the enterprise value in a future exit. Most people will try to avoid limiting flexibility too much, because that clearly is a risk.”
Yet the fact that dividend recaps are on the increase does not automatically mean that risk levels are getting excessive. 

“Some commentators are suggesting that the market is becoming a bit crazy again, like it was in 2007,” says Goldsbrough. “I don’t necessarily agree with that, because in recent months, some deals have been well received and some haven’t. So I think the [credit] market is doing proper due diligence.”

What’s more, any European macro-economic hiccup could change the picture very rapidly, Gillmore points out. “If stability and market confidence remain pretty high in terms of execution of deals, then there’s a chance that the current level of dividend recap activity will continue. But with any drop in confidence, this might be one of the first types of transactions to reduce as a result.”