In Asia, private-equity firms are cashing out of the Asian companies they own by adding debt to those businesses

May 14, 2013

In Asia, Private-Equity Buyers Borrow to Cash Out

By Fiona Law

Some private-equity firms are cashing out of the Asian companies they own by adding debt to those businesses. The fact that borrowers can raise cheap funds and use the cash to pay dividends to shareholders is more proof that debt markets in Asia are booming. But by leaving the companies with more borrowings and less cash, the tactic also makes the debt riskier for investors who buy it. In a recent example, school operator Nord Anglia Education raised $475 million through two bonds sold this year and last year. One-third of the first $325 million issue was used to repay a loan to Baring Private Equity Asia, which owns the company. The second $150 million issue was used to finance Baring’s and Nord Anglia’s purchase of WCL Group Ltd., which runs international schools in the U.S., Spain and Qatar. In such deals, known as dividend recapitalizations, private-equity-owned companies raise cash by issuing debt. Part, or all, of the proceeds are distributed in the form of dividends to buyout groups. Bond buyers usually prefer that companies use funds raised by borrowing for projects that will generate cash, or to pay down existing debt.

In Nord Anglia’s case, “only a small amount” was used for dividend-recapitalization purposes, said a Baring spokesman, adding the two bonds were issued primarily to give the company greater financing flexibility, to reduce financing costs, cut debt and provide firepower for future acquisitions. The company runs international schools offering British-style education for around 10,000 students throughout Europe, the Middle East and Asia. Baring bought it in 2008.

Dividend recapitalization has been popular in the U.S. Companies there raised a record $20 billion raised last year for cash distributions to their private-equity owners, according to data provider Dealogic, far higher than the $3.7 billion raised in 2011.

In Asia, the financing arrangement was almost non-existent until two years ago. But since early 2012, when Asian debt issuance began to reach record levels and borrowing costs fell, dividend recapitalizations have emerged in half a dozen deals.

According to Christopher Lee, a corporate-ratings analytic manager at Standard & Poor’s, the emergence of such deals “is a sign that global liquidity is very strong, and thus the demand for [higher-yielding] investment products is robust.”

“Deals with [dividend recapitalization] features usually only emerge during bullish markets,” Mr. Lee said.

A slowdown in initial public offerings in Asia, the usual path private-equity firms use to cash out of investments, has also encouraged the use of dividend recapitalization. Low yields in the debt market make issuing debt inexpensive.

“As the market for IPO and acquisitions in the region slows down, it has been more difficult for private-equity investors to exit from the companies they acquired earlier,” said Bryant Edwards, a partner at Latham & Watkins. The law firm has advised on five Asian deals of this type since 2010, and says it is advising on another upcoming potential deal. Mr. Edwards declined to identify the companies involved.

Some bankers say the use of dividend recapitalization can be a signal the market is nearing a top.

“The sign that the market should be watching is how aggressive the structure of these deals could become, what level of multiples the borrowing is over the cash flow,” said Mark Follett, J.P. Morgan Chase & Co.’s head of high-grade debt capital markets for Asia, excluding Japan.

Still, bankers and analysts don’t expect this trend to surge. Because many big Asian companies are owned by a single large shareholder, making deals hard to do, private-equity buyouts are rarer in the region than in the West. That reduces the pool of companies that could be used in dividend-recapitalization transactions.

“So far, deals with dividend recapitalization features in Asia appear to be one-off cases,” said Gene Cheon, Asia head of corporate credit research at Deutsche Bank.