(Bloomberg) -- In a sign of how wide-open junk-debt markets have become in recent months, the private equity backers of a UK vehicle glass repair company are set to score one of the largest-ever payouts from a highly leveraged debt offering.
Belron International Ltd. sold more than €8 billion ($8.8 billion) of bonds and loans this week, which - along with some of the company’s own cash - will be used to hand over €4.3 billion to its backers including private-equity firms Clayton, Dubilier & Rice LLC and Hellman & Friedman. Transactions like these, known as dividend recapitalizations, are growing increasingly popular, with Belron’s loan marking a worldwide record.
The money management firms engineering these deals are looking for quick ways to boost returns and cut the money they have at risk in their investments, at a time when they have few other options for generating gains. They can’t easily sell the companies they’ve bought, because there aren’t many firms scouting for acquisitions, and the market for selling through initial public offerings has until recently been all but dead.
Meanwhile, debt investors are willing to finance these deals, often to lock in relatively high yields. But these transactions come with risk for debt and equity investors. Companies are boosting their borrowings, which can increase the chances they will fail to pay or refinance debt obligations and spiral into bankruptcy.
Record Year
US companies, including ones not backed by private equity, have taken out a record $70.2 billion of leveraged loans with dividend recapitalizations through Sept. 30 this year, according to data compiled by PitchBook. That’s $3 billion more than in 2021, the last time dividend recaps were this popular.
“There’s been such a lack of M&A activity and LBO activity that a lot of sponsors are looking at how to return cash to their investors, and if you’re not selling companies, one way to do it is to take dividends,” said Lauren Basmadjian, global head of liquid credit at the Carlyle Group.
Still, the move comes with risk. If a sponsor is too aggressive, the company could be put into a financially precarious position, said John McClain, portfolio manager at Brandywine Global Investment Management. Snack-maker Shearer’s Foods offered double-digit yields on bonds it sold in early September, merely months after CD&R acquired the company. The deal boosted the company’s leverage ratio, according to S&P Global Ratings, which assigned the debt offering a CCC+ grade, typically given to “currently vulnerable” firms. It was the first deal rated in the CCC tier in the US high-yield market since July — and kicked off a flood of such issuances.
“Investor sentiment is fairly euphoric driven by CCC out performance,” McClain said. “Low spreads and higher coupons are attractive to investors who missed the dredges of the market, so there is risk seeking behavior heading into the fourth quarter.”
Such is the appetite for yield that strategists at JPMorgan Chase & Co. have thrown in the towel on their bearish view on Europe’s credit market, thanks in part to the US Federal Reserve’s bumper interest rate cut in September and the surprise “bazooka” of monetary easing in China, according to a note dated Sept. 27.
“After several false alarms over recession over the past few years, our sense is that investors are primed to rapidly fade growth risks on even the smallest signs of an uplift,” strategists led by Matthew Bailey wrote in the note.
In Belron’s case, the debt deal will raise the company’s leverage ratio to 6.1x, up from 3.5x, according to Moody’s Ratings, which cut the firm’s grade further into junk. Belgian holding company D’Ieteren Group also owns a 50% stake in Belron.
The private equity machine, which fueled the high-yield markets during much of the easy-money era, slowed down in 2022 after the Federal Reserve hiked interest rates and led to a buyer-seller standoff in terms of valuations. But because those buyout firms have a mandate to return cash to investors, the leveraged loan market has been happy to provide a solution.
In September, $128 billion of leveraged loan deals and $37 billion of junk-bond deals were issued in the US, signaling a rush ahead of the US elections and a desire to lock in lucrative yields after the Federal Reserve started a rate-cutting cycle, according to data compiled by Bloomberg.
Dividend deals
The Belron deal is not the first time CD&R has scored a payout through a dividend recap. Last month, Focus Financial Partners, owned by CD&R and Stone Point Capital, sold $4.35 billion of loans and high-yield bonds to refinance existing debt and pay a dividend, Bloomberg reported.
“The market continues to be selective around credits, but for those up-in-quality names that investors like, you are seeing more accounts open to dividend deals,” said Chris Bonner, head of US leveraged finance and Capital Markets at Goldman Sachs Group.
Another force driving appetite for leveraged deals is an uptick in new collateralized loan obligations — volumes are up around 70% so far this year compared to last, according to data compiled by Bloomberg. And given CLO managers are the largest buyers of leveraged loans, that demand has led to a concurrent boost in loan activity, leading to the high levels of refinancings and repricings seen this year, Basmadjian said.
Though borrowing in the public market has become a favorite route for companies, it’s not the only way to snag cash without going through a sale.
Private equity sponsors have also used continuation funds, where managers slide hard-to-sell assets from an older fund into a brand-new one, or net-asset-value loans, meaning borrowing against their fund’s assets. Some of their limited partners have started to grow weary of those uses, with the Institutional Limited Partners Association issuing guidelines on NAV loans.
“The chatter around pressure for sponsors to return capital is only getting louder,” Bonner said. “In a world with lower M&A volume, I think we will increasingly see sponsors turn to dividend recaps to satisfy LPs.”
Though new acquisition deals are slowly coming to market, after the Fed’s decision to cut rates, which could help unclog the backlog, sponsors will keep churning out debt-fueled dividends.
“It’s a return of cap to LPs — you haven’t seen a pick back up in M&A so how else are you going to return capital?” McClain at Brandywine said.
--With assistance from Lara Wieczezynski.
©2024 Bloomberg L.P.
