Thursday, November 18, 2010
A couple of days ago Felix Salmon did a video-blog on Bernanke's bubbles. I'd embed it here, but the folks over at Reuters have apparently decided that Felix is still a little too new to the whole video-blog thing to let anyone embed this post. Believe me, he's all over the place. He'll get better.
In any event, the substance of his talk got me thinking. Then, I started seeing bubbles. Bubbles everywhere, especially in dividend recapitalizations. A dividend recap is pretty simple really. The company takes on debt and then immediately sends that debt out to its shareholders as a special dividend. The dividend recap can be used by managers of public companies to "mimic" a leveraged buyout without actually doing an LBO. The effects are generally the same. The target is heavily levered following the transaction and managers are faced with very hard constraints in order to make regular interest payments on the debt taken to pay the special dividend.
Last week, KKR and Bain Capital took a $1.53 billion special dividend from their investment in HCA. Now, they didn't take that dividend from profits. They leveraged up HCA - taking advantage of historically low interest rates - to pull more cash out of the company by way of a dividend recap. The investors already took out $2.25 billion last Spring in a similar maneuver. It now looks like investors will be able to take out more than $400 million more than their initial investment through this dividend recapitalization.
Of course, with the low cost of credit, the dividend recap at HCA is not the only PE target looking to get cash back to investors through added leverage. Bain and its partners at Dunkin' Brands are planning on taking out $400 million through a dividend recap. Then there's PETCO, and Burlington Coat Factory among others. KPS Capital has taken $500 million out of its invested firms through dividends recaps this year.
The FT looked at dividend recaps and notes that they are nearing pre-financial crisis levels:
Other dividend deals have emerged this year, financed by loans and junk bonds of more than $40bn, the most since 2007 and a rate that is on track to top the dollar amount of deals sold for dividends in 2005.
What's making all this possible? Apparently, in the face of historically low interest rates, the global search for yield continues. That means that investors are willing to hand out cash to pay off PE investors who might otherwise not be able to exit their investments via an IPO or M&A transaction.
I'm have a bad feeling about this and I'm seeing bubbles everywhere. If PE investors have to lever up their targets in order to escape them, something has gone wrong. Of course, the PE investors still have an equity position, but the leverage eliminates any downside risk by pulling money off the table. Of course, it shifts all the downside to the credit markets, but I suppose the lesson from the credit bubble is who cares what happens to investors in credit markets. Right?