Simmons Bedding Co. secured more wiggle room from its senior lenders by getting more time to repay its senior debt, undoubtedly easing the concerns of its Boston private equity owner, Thomas H. Lee Partners.

The Atlanta mattress manufacturer, though, illustrates where one source of new business for restructuring advisors is likely to come from in the coming year: companies that have undergone private equity-sponsored dividend recapitalizations. These transactions require a company owned by a buyout group to issue new debt, which is used to pay a dividend to its private equity owner.

In short, they saddle a portfolio company with additional debt.

THL has carried out two dividend recapitalizations of Simmons, which is receiving restructuring advice from New York turnaround and financial advisory specialist Miller Buckfire & Co. LLC. The company was carrying $987 million in long term debt maturities through June, according to its most recent quarterly filing with the Securities and Exchange Commission.

In fairness, Simmons forbearance extension pertains to tripped covenants on $540 million in bank debt carried by the company, rather than $300 million in toggle-note financing that was used to pay a $278.3 million dividend to shareholder THL and others two years ago.

But, debt that was used to support dividends, coupled with acquisition financing issued in the last several years, is expected to start maturing in 2010 and 2011, inevitably leaving some companies that participated in recapitalizations under additional pressure.

The recession, of course, has made it tougher for companies in many industries to meet debt payments.

William Wexler, a managing director at Southfield, Mich., international business advisory firm BBK, agrees and thinks a short-term outlook during the deal boom era is to blame.

"It was a short-term mentality with a theory that there would be a market on the other end in which to sell into," he says of the popularity of recaps.

Wexler, a restructuring veteran formerly from Huron Consulting Group LLC, says he worked on four restructurings of private equity companies involved in dividend deals in the last four years.

Structured with leveraged loans or high yield bonds the deals are advantageous to private equity investors because they can return capital on an investment in short order, artificially boost its fund's internal rate of return (a higher IRR can bolster fundraising prospects) and leave its stake in a business intact.

The debt issuances were especially prevalent in the M&A bull market when acquisition multiples soared. For example, there was $89.1 billion of leveraged loans issued globally and $49.7 billion domestically in 2007 that supported dividend recapitalizations, according to Dealogic, a New York financial data provider.

"The dividend recapitalization took advantage of the increase in valuations without conducting a full sale," says Scott Peltz, managing director of the national corporate recovery practice at RSM McGladrey Inc., who advises troubled companies. "You had more than enough lenders willing to lend on that basis," he adds.

Peltz says the recaps and abundant covenant-lite financing used in LBOs has created significant opportunities for restructuring advisors.

A study in the fall of 2006 involving 75 North American private equity firms indicated the transactions were quite popular before the credit crunch. PricewaterhouseCoopers, law firm Pepper Hamilton and mergermarket sponsored the report, which found that 97% of participants planned to undertake leveraged recapitalizations in 2007.

The firms' analysis discovered that in the 2003 to 2006 timeframe banks supplied $71 billion in financing for dividend recapitalizations in spite of a higher default rate when compared with the default rate for all leveraged loans.

Interestingly, 52% of respondents in the survey looked to dividend deals as a suitable alternative to going public and 16% thought the same as it concerned exiting an investment through an M&A sale.

Recaps, however, don't always turn out so well as generators of long-term "value creation" in portfolio companies.

Take Buffets Inc., a restaurant chain that had been owned by New York buyout firms CI Capital LLC, formerly known as Caxton-Iseman Capital LLC, and Sentinel Capital Partners. The Eagan, Minn., company paid out $114 million in one of two dividend deals before filing for bankruptcy in January 2008, leaving the financial sponsors with a nice profit as it collapsed into Chapter 11.

Recap transactions began fading as the debt markets tightened up in late 2007 and disappeared in 2008 in the wake of Lehman Brothers' collapse. The deals aren't expected to return anytime soon either, according to BBK's Wexler.

"Clearly, lenders are still focused on existing exposure and managing existing credits, good, bad and otherwise," he says.

It's hardly a secret that the buyout community has been roundly criticized by portfolio managers for heaping debt on companies through recaps.

Financial sponsors contend that recaps aren't done with companies that are unable to support new borrowings with existing cash flow.

A report by Wall Street high-yield strategist Martin "Marty" Fridson on recapitalizations and LBOs released in May 2008 assessed the relationship between dividend recapitalizations and distressed companies.

Fridson's study challenged the idea that the dividend deals led to credit problems or greater defaults. In 83 deals where sponsors reaped dividends over a period that began in 2002, he found only 16 companies were distressed.

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