Before the Federal Reserve raised interest rates in December for the first time in nearly a decade, private equity firms took advantage of the low rates to issue dividend recapitalizations. The process allows PE firms to deliver returns to their limited partners without exiting the company. But now that exit multiples are holding high, dividend recaps are becoming less prevalent.
“There’s been a noticeable drop off in leveraged dividends in the past six to nine months,” says Andrew Smith, president of Chicago-based investment bank Houlihan Capital, which is not related to publicly-traded investment bank Houlihan Lokey (Nasdaq: HLI).
“The M&A market is hot for good companies,” Smith says. “You either sell, or you do a leveraged dividend. Many companies are able to exit at big multiples, so that’s their first choice."
Dividend recap loans peaked during 2012 to 2014, but have since been on the decline, according to data from Houlihan. That’s not to say dividend recaps are over -- lower middle-market private equity firm Southfield Capital closed a divided recapitalization of portfolio company BioPharm Communications in May, for example.
But as long as the M&A markets are able to provide private equity firms with sizable exits, the number of leveraged dividend transactions will likely continue to decline. The recent interest rate hike also doesn’t tip the scale in favor of the dividend recap over the exit. “On any leveraged buyout model or any leveraged recapitalization model, increased interest rates are not the friend of the borrower,” Smith says.
But as dividend recaps decline in popularity, another iteration of the formula has popped up, and it involves corporate real estate. Some companies have started using the strength of their real estate portfolios to take out mortgage loans and then distribute the proceeds to investors – not exactly a dividend recapitalization, but a process used to the same effect.
“Corporate-owned real estate is alive and well, and we have several clients using the strength of the real estate markets to get a leveraged loan to value on their properties, and distributing the money to investors,” Smith says.