As rates in the high-yield market fell during the first quarter, a frenzy of sponsor-backed companies refinanced their debt to take advantage of cheap capital. Many private equity owners took dividends out of the deals as their companies took on more leverage.
But one such transaction, the dividend recap of Atlantic Broadband Inc. in March, stands out. In fact, it's being called a dividend "precap" because it allows another PE firm to buy the company without having to create a new financing structure.
Under the terms of the precap, if another financial sponsor were to acquire Atlantic Broadband, it would be able to access the same capital structure its current owners used for the recapitalization that paid their dividends.
That means if the capital markets continue to deteriorate -- as they have since the first quarter -- a buyer would have access to a more attractive capital structure not available elsewhere, says Jeff Cohen, the co-head of U.S. syndicated loan capital markets at Credit Suisse Group.
"In our view, this allows new prospective buyers to stretch a little more on terms, because they have no downside risk to the cost of capital," Cohen says. "It's something we think other sponsors will be interested in."
Atlantic Broadband's dividend precap appears to be the first of its kind. Owners Abry Partners LLC and Oak Hill Capital Partners LP took a $345 million dividend from the $1.06 billion first-lien credit facility that refinanced the nine-year-old investment's debt. That dividend, along with around $280 million in distributions they have received since 2007, more than doubled the firms' return on the original $216 million equity injection.
Dividend precaps work by avoiding a change-of-control provision found in most credit agreements that require a new capital structure if a deal gets done soon after a dividend recap. Typically, when a buyout or recapitalization happens, it triggers a credit agreement's change-of-control provision, technically sending a loan into default and requiring the buyer to obtain new financing.
Precap deals avoid that change-of-control provision, for a price. Typically, investors require a slightly higher spread -- 25 to 75 basis points -- to account for the precap's flexibility. Those additional basis points, in good credit markets, are usually a minor addition to the low cost of capital.
For sellers, the benefit of the precap is obvious: They get to show a small return to limited partners in the short term, with the promise of a possible sale soon thereafter. A detail in the agreement attempts to make the dividend precap more attractive to potential acquirers, too. The buyer would be allowed to obtain the same debt package used to refinance and pay the seller a dividend -- with its low interest rates and all.
These benefits are likely to be tested soon, since Atlantic Broadband is thought to be on the block. Sources told The Deal magazine in early May that the Quincy, Mass., company, the 14th-largest cable operator in the country, has retained Credit Suisse to explore a sale.
To get the benefits of the dividend precap, a buyer would have to fit some specific guidelines, including being a private equity firm, Cohen says. It would have to write a "healthy equity check," he adds, in part ensuring that a company's leverage at the time of purchase is no higher than when the dividend was paid. Post-dividend ratings from agencies such as Moody's Investors Service also can't change at the time of purchase. The company, of course, must remain in compliance with all of the covenants in the original contract as well.
Finally, the buyer has to be a firm of rather substantial size -- likely with assets under management of more than $1 billion, Cohen says. "The size of the buyer is one of the primary ways in which lenders can establish the buyer's credibility," he says.
Not all sponsor-backed companies qualify for dividend precaps. Typically, only stable businesses that have been performing well and have been in a single firm's portfolio for years will have the dividend precap opportunity. To be sure, that makes the field for potential precaps narrow. And it remains to be seen if the idea is intriguing enough to persuade a buyer on the fence to get a deal done. Still, if the cost of debt continues to rise, it very well makes a package like Atlantic Broadband's the most attractive capital on the market.
David Holley reports on leveraged finance for The Deal magazine.