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What is Dividend Recapitalization?

Dividend recapitalization, also known as a dividend recap, is a financial strategy employed by companies to generate immediate liquidity by incurring new debt and paying special dividends to private investors or shareholders. This practice has gained popularity among private equity firms as a means to recoup their initial investments in portfolio companies. While it offers several benefits to the stakeholders involved, it also carries certain risks and potential drawbacks. In this article, we will delve into the concept of dividend recapitalization, explore an example to illustrate its application, and discuss its implications for companies and investors.

Understanding Dividend Recapitalization:

Dividend recapitalization serves as an alternative to a company declaring regular dividends based on its earnings. Instead, private equity firms issue new debt to raise funds, which are then used to distribute special dividends to the investors who originally funded the purchase of the portfolio company. This strategic move provides early and immediate returns to shareholders while reducing the risk for private equity firms. By leveraging the portfolio company's balance sheet, the dividend recapitalization enables private equity firms to unlock value without requiring an initial public offering (IPO), which may carry inherent risks.

The dividend recap has gained momentum as a means for private equity firms to regain their investment capital in a business. However, this practice is often viewed unfavorably by creditors and common shareholders, as it can potentially reduce the credit quality of the company and benefit only a select few. The decision to pursue a dividend recapitalization should be carefully evaluated, considering the overall impact on the company's financial health, growth prospects, and stakeholder interests.

Example of a Dividend Recapitalization:

To illustrate the application of dividend recapitalization, let's consider the case of Dover Corp., a company that announced a dividend recapitalization as part of a spin-off process. In December 2017, Dover Corp. planned to separate its oilfield services business, Wellsite, into a distinct entity. As part of this process, Dover undertook a dividend recapitalization of approximately $700 million. The resulting long-term debt of 3.4 times earnings before interest, taxes, depreciation, and amortization (EBITDA) was assumed by Wellsite.

In this example, the dividend funded a $1 billion buyback on behalf of Dover Corp., with the support of activist investor Third Point, LLC. This leveraged recapitalization involved issuing new corporate bonds to finance the buyback, effectively rebalancing the company's capital structure. While regular dividends typically benefit preferred and common shareholders, the dividend recapitalization strategy allowed Dover Corp. to provide liquidity to its investors and potentially enhance shareholder value.

Implications and Considerations:

Dividend recapitalizations can have several implications for companies and investors. On one hand, they offer immediate liquidity to investors and allow private equity firms to realize partial returns on their investments. By accelerating the distribution of funds, dividend recaps provide an alternative exit strategy for private equity firms, enabling them to recoup their capital without relying solely on public markets or mergers.

However, it is essential to recognize that dividend recapitalizations increase the company's debt burden and alter its capital structure. This increased leverage can impact the company's creditworthiness, financial flexibility, and ability to pursue growth initiatives. Moreover, the reduced share price resulting from the changed debt-to-equity ratio may make the company appear less attractive to potential acquirers. Therefore, it is crucial for companies to carefully evaluate the trade-offs between immediate liquidity and long-term financial stability.

Summary

Leveraged Recapitalizations involve issuing new corporate bonds to finance a share buyback or large dividend, essentially rebalancing the capital structure of the business.

Dividend recapitalizations will cause the share price to reduce, largely because the company’s debt-to-equity ratio has changed. This can be used to make the company look unattractive to potential acquirers. Recapitalizations are restructuring of a company’s capital. Dividend recapitalizations are sometimes called dividend recaps.

The company will take on a large new amount of debt by issuing a block of bonds, and will use the capital from the issue to pay a large dividend to stockholders. Sometimes this can be abused when there are relatively few shareholders in a private equity firm, and they essentially take a large loan out to pay themselves instead of redeeming their shares.

The large dividend will lower the share price in a way similar to the reduced share price after a traditional dividend’s ex-dividend or payment date, but, in this case, it has more to do with the fact that the fundamental capital structure of the company has changed and the shares have less inherent value.

The shares with reduced price are sometimes referred to as “stubs,” especially if the price is reduced to 25% of the pre-dividend price, but f the dividend plus the stub price is larger than the share price before the dividend, the recapitalization is considered successful.

This strategy is sometimes used as a defensive strategy to avoid a hostile take-over, making the company look less attractive by taking on more debt.

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Disclaimers and Limitations

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