There Must Be Some Kinda Way Outta Here, Said The Junkie To The...

An Alternative Exit Route, or the 1980s Redux?

In the category of "trends pointing to private equity excesses", Henny Sender over at the WSJ (sorry, you may need a subscription) put up an article on the use of debt recapitalizations, something that reminds me of the 1980s (you remember, Drexel Burnham, Mike Milken, Gordon Geko, greed, etc. Writing about the recent liquidity event Intelsat provided its brand spanking new masters, Sender penned:

"The ink had barely dried on the sale documents about a year ago when the new private-equity owners of satellite operator Intelsat -- Apax Partners Inc., Apollo Management, Madison Dearborn Partners and Permira Advisers -- paid themselves a $350 million dividend financed with newly issued Intelsat debt."

At first glance, this is smacks of greed without the benefit of sound stewardship. Now, don't get me wrong, I'm all for greed in investments, as long as it is accompanied by sound management, especially if the livelihood of many would be at risk from a company's failure due to greed-fueled incompetent management. In some cases, the acquired company can afford to pay its owners a divided whether from cash or increased debt. In some instances, this is simply another exit route for investors, just as valid as a strategic sale or an IPO. It just so happens that during the first half of the first decade of the the 21st century, conditions have been favorable for this type of deal. (Hedge funds need paper, too!) But in other cases, increased leverage can negatively impact a company's ability to operate (higher cost of capital, reduced working capital, management not focused on running the business.)

It looks like some in the industry want to do for private equity what Drexel Burnham did for the buyout in the 1980s - sully its public persona, to say the least. It's no great surprise that hedge funds have been key to this practice, but then it looks to me like the hedge funds are just being hedge funds. I don't know why the private equity firms are doing it. Perhaps too many young MBAs? Bascially, the problem dividend recaps are those where managers are (1) overpaying going in, (2) then transfer some of the company's assets to themselfs via dividends and fees, (3) do little to nothing to add value to the company, (4) but instead add to the company's burdens (debt), and (5) then they pray they can get over on the public through an IPO.

On top of the dividend recap, some firms are charing fees that are not necessarily in the best interest of their portfolio companies. It seems that with LPs finding the stones to counter the use of fees to create a profit center for the GP, some GP geniuses have decided to collect those fees from their investees instead (or in addition to, if they can get away with it.)

For more on this topic, check out the article by Caren Chesler over at Investment Dealer's Digest: "The Wheels Come Off For Dividend Recaps."