Short memories finance private equity payouts

November 3, 2010

Buyout barons are paying themselves on the back of the market’s short memory. Dividend recapitalizations are on pace to exceed the volume seen in 2007. Dunkin’ Brands and Getty Images mark the latest efforts by private equity firms to get ahead of potential changes to American tax laws. But in their zealous quest for Treasury-topping returns, investors seem to have forgotten recent lessons.

The ability to replace equity with debt has come back with a vengeance. Buyout firms managed less than $2 billion of such dividend recaps over the last two years, according to Thomson Reuters LPC. This year, there have been $15 billion of them, with at least $5 billion more queued up.

Private equity has good reason to rush these deals out the door. Selling portfolio companies onto public markets has been constrained, making it ever harder to return funds to investors. What’s more, the threat of tax hikes means they’re eager to write these checks before more winds up going to Uncle Sam.

Some big names are enticing lenders. Bain Capital, Carlyle and Thomas H. Lee are in the market with $2 billion of loans and bonds for the parent company of Dunkin’ Donuts, partly to give themselves a cash dividend. And Hellman & Friedman is paying itself $500 million after borrowing $1.3 billion for portfolio company Getty Images. Demand was so high, in fact, that the interest rate was cut 50 basis points to 4.25 percent over Libor.

Investors haven’t entirely overlooked the dangers of lining private equity pockets at the potential expense of the companies’ health. SK Capital Partners recently was forced to cancel a $922 million dividend for Ascend Performance Materials, a nylon maker it had acquired last year with a mere $50 million of equity.

Still, dangerous signs have re-emerged. High-yield bond investors bought $150 million of payment-in-kind toggle notes, which enable interest payments to be made with more debt instead of cash, so Madison Dearborn could finance a dividend on the back of BWAY Holding, a container maker.

In some cases, of course, this may be less a case of amnesia than impatience. Too much cash and too few opportunities could be aligning the goals of private equity firms and debt investors. Neither group can seem to help themselves.

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