Buyout Firms Tap Junk Debt for Payouts as Exits Stall
(Bloomberg) — Private equity firms are once again tapping the European junk debt market to pay themselves dividends as market volatility fueled by the Iran war and AI anxiety limits their ability to cash out.
Brookfield-backed REIT Befimmo, Lutech SpA and Cooper Consumer Health — which is owned by a consortium of firms including CVC — are among a number of junk-rated borrowers that have recently issued so-called dividend recapitalizations, with more expected in the near future, according to people familiar with the matter.
Typically the sign of a frothy market, dividend recaps offer a way for private equity firms to monetize their assets when a sale or IPO looks challenging. But in doing so they layer yet more debt onto their portfolio companies, many of which are already highly levered. The fact that such deals don’t boost earnings mean that they are generally seen as negative by credit ratings agencies because they raise interest expenses and leverage.
“This is top-of-the-market behavior showing up in a market that isn’t hot, which is a red flag,” said Sabrina Fox, a leveraged finance expert and founder of Fox Legal Training. “Sponsors are pulling out dividends because the docs let them, and the leverage going back onto these businesses comes at exactly the wrong point in the cycle.”
S&P Global Ratings, for example, cut Befimmo’s credit rating outlook to negative hours after the company announced it would raise €475 million through a bond sale, €75 million of which was earmarked for a dividend. The ratings agency said it expected the proposed transaction to increase the company’s leverage.
Spokespeople for Brookfield, CVC and Lutech declined to comment. Representatives of Befimmo and Cooper Consumer Health didn’t immediately respond to requests for comment.
Dealmaking Doldrums
Hopes were high for dealmaking this year, with Goldman Sachs even forecasting record M&A activity back in September. But concerns over AI’s impact on the software industry and then the war in the Middle East have upended forecasts of a bumper 2026.
“With M&A volumes below initial expectations for this year, sponsors are increasingly turning to dividend recaps as an alternative route to liquidity,” said Hadrien Servais, leveraged finance partner at law firm Simpson Thacher & Bartlett LLP.
Despite some concerns over leverage, many of the credit funds and collateralized loan obligations that originally invested in the borrowers appear happy to finance such deals, due to the amount of dry powder they have at their disposal and their limited opportunities to deploy.
“The willingness of lenders to support these transactions reflects both the amount of capital available in the market and the continued competition for high-quality credits,” he said.
Credit spreads — and credit risk — blew out in March following the outbreak of hostilities, curtailing high yield issuance as investors and borrowers hunkered down. But now the market is stabilizing somewhat amid a fragile ceasefire, private equity sponsors are looking to raise dividends while the window for some opportunistic financings is open.
Europe vs. US
Following the success of a handful of euro-denominated deals, others are now looking to tap the market, with some expected to launch as soon as next week, the people said, speaking on condition of anonymity.
“If the stars align with a liked credit, strong market and OK coupon, it can get done,” said Catherine Braganza, a senior high yield portfolio manager at Insight Investment Management.
While dealmaking is subdued on both sides of the Atlantic, the recap trend is currently limited to Europe. That’s due to the fact the cost of funding is crucial for dividend recaps — particularly for the relatively small firms that borrow in the junk debt market.
“Europe is quite attractive vs. the US as the cost of funding is much lower, due to lower bund yields vs treasuries” according to Mahesh Bhimalingam, Global Head of Credit Strategy at Bloomberg Intelligence.
(Corrects ownership of Lutech in second and sixth paragraphs.)
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