Buyout firms continue to take dividends from their portfolio companies, and the ratings agencies continue to sound alarms about a practice that can leave companies perilously close to default.
In the first half of 2007, portfolio companies around the world borrowed more than $77 billion to pay their owners dividends, according to investment bank Freeman & Co. That’s already close to the $85 billion worth of dividend recaps structured last year, and ahead of the 2005 figure of $65 billion.
Among recent examples,
The two recent payouts caught the eye of ratings agency Moody’s Investors Service, in particular because both occurred within 18 months of their acquisitions. In both cases, the ratings agency, which called the dividend recaps “unexpected,” downgraded their corporate family rating to “B3” from “B2.” Companies rated in the single “B” range are considered speculative and subject to high credit risk, while those in the “Caa” category, the next step down from “B3,” are judged to be of poor standing and are subject to very high credit risk, according to Moody’s.
Avista Capital and MidOcean both declined to comment for this story. However, Avista Capital Co-Managing Partner and CEO Thompson Dean, in an interview with Buyouts last month about his firm’s recent fund close, touted WideOpenWest as a great example of how the firm has been able to quickly return money to its investors.
But that’s little comfort to Moody’s, which believes the frequency of dividend recapitalizations by financial sponsors undercuts the oft-chanted industry mantra of LBO firms being long-term value investors. “The current environment does not suggest that private equity firms are investing over a longer-term time horizon than do public companies, despite not being driven by the pressure to publicly report quarterly earnings,” Moody’s said in a report it released earlier this month called “Rating Private Equity Transactions.”
Along with the Avista Capital and MidOcean transactions, some older deals also made Moody’s list of quick capital extractions, including the $700 million dividend recap of WMG Holdings Corp. in December 2004 by
“The reason for these dividends—whether pressure to increase returns, because the market’s liquidity allows for such transactions, or something else—is not always apparent,” Moody’s said. “Future performance of many of these transactions will likely hinge on the economy remaining relatively stable and the credit markets remaining forgiving as these transactions will need to be re-financed over the coming years.”