Private equity-backed companies across Europe, the Middle East and Africa could take on an additional €41bn in debt before risking credit rating downgrades, according to a report by Bloomberg citing Moody’s Ratings and published by Private Equity Wire (https://www.privateequitywire.co.uk/private-equity-firms-have-e41bn-of-borrowing-headroom-for-dividend-recaps-moodys-says/). Moody’s expects dividend recapitalisation activity to remain elevated until dealmaking recovers, as buyout firms seek alternative ways to return capital to investors, according to Private Equity Wire (https://www.privateequitywire.co.uk/private-equity-firms-have-e41bn-of-borrowing-headroom-for-dividend-recaps-moodys-says/).
Moody’s: €41bn of additional debt capacity before downgrade risk
Moody’s framed the €41bn figure as additional debt capacity for private equity-backed companies across EMEA before risking credit rating downgrades, according to Private Equity Wire (https://www.privateequitywire.co.uk/private-equity-firms-have-e41bn-of-borrowing-headroom-for-dividend-recaps-moodys-says/). The ratings agency linked its expectation for elevated dividend recapitalisation activity to the pace of dealmaking recovery, according to the same report.
Recent dividend recap-related financings cited by Moody’s
Moody’s pointed to a transaction involving Spanish fuel retailer Plenergy, which raised a €400m leveraged loan earlier this month partly to fund a shareholder payout, according to Private Equity Wire (https://www.privateequitywire.co.uk/private-equity-firms-have-e41bn-of-borrowing-headroom-for-dividend-recaps-moodys-says/). Strong investor demand allowed Plenergy to reduce the loan’s interest margin from 400 to 375 basis points above the benchmark rate, the report said.
The report also cited health supplement manufacturer Sunday Natural, which secured a €515m financing package in late September to fund a shareholder distribution, according to Private Equity Wire (https://www.privateequitywire.co.uk/private-equity-firms-have-e41bn-of-borrowing-headroom-for-dividend-recaps-moodys-says/).
Credit impact and headroom observations
Dividend recapitalisations allow private equity sponsors to extract cash from portfolio companies by raising additional debt, and the strategy increases leverage and can heighten financial risks, according to Private Equity Wire (https://www.privateequitywire.co.uk/private-equity-firms-have-e41bn-of-borrowing-headroom-for-dividend-recaps-moodys-says/). Moody’s found that the latest wave of transactions has not resulted in widespread credit rating downgrades, largely because deals have been concentrated among companies with strong operating performance and sufficient cash flow to service additional borrowing, the report said.
Moody’s said companies undertaking dividend recaps had typically built up significant financial headroom in the year preceding a transaction compared with their peers, according to Private Equity Wire.
Pressure to return capital and limits on use of capacity
The findings were presented against what the report described as mounting pressure on private equity firms to return capital to investors, according to Private Equity Wire. The article cited Bain & Company as estimating that buyout firms hold approximately $3.8tn in unsold assets, and it said average portfolio company holding periods have increased to seven years compared with five years in 2010.
Moody’s expects dividend recaps to remain an attractive liquidity option for cash-generative businesses with limited reinvestment opportunities, particularly those held beyond the traditional four-to-five-year investment period, according to Private Equity Wire (https://www.privateequitywire.co.uk/private-equity-firms-have-e41bn-of-borrowing-headroom-for-dividend-recaps-moodys-says/). The report added that not all of the estimated €41bn in additional borrowing capacity is expected to be used for shareholder distributions.
Widely known context: Dividend recapitalisations are typically executed via incremental debt raised at the portfolio company level, and the proceeds are distributed to equity holders. Widely known context: Credit rating agencies generally evaluate recapitalisations by assessing resulting leverage and debt service capacity relative to operating performance.
