KKR & Co. and Bain Capital LLC’s decision to pay themselves a $2 billion dividend from HCA Inc. shows that the 82 percent surge in high-yield bonds since 2009 is making it more attractive for buyout firms to pile more debt on their companies than to take them public.
HCA, the largest U.S. hospital chain, said yesterday it will sell $1.53 billion in high-yield debt to finance the payout to its private-equity owners, which also include Bank of America Corp. The firms earlier this year took $2.25 billion in two dividends from the Nashville, Tennessee-based company, which has yet to complete an initial public offering announced in May.
In leveraged buyouts, private-equity firms use mostly borrowed money to take controlling stakes in companies and use the cash flow to pay down debt. The firms say they are expert at making their companies more profitable, through steps such as expanding the businesses, shedding underperforming assets and improving productivity.
Now buyout firms, exploiting falling borrowing rates engineered by the U.S. Federal Reserve, are instead saddling their companies with extra debt to finance payouts at the fastest rate since credit markets froze in 2007. The so-called dividend capitalizations are an attractive way to get cash and return money to investors amid weak demand for private equity- backed IPOs.
“To keep the industry churning, you need to show returns, and this is one route to go for buyout firms if their goal is to raise another fund,” Christopher Wagner, who oversees about $3.4 billion in private-equity investments at the Los Angeles County Employees Retirement Association, said in an interview. “It appears that so much money is looking for yield, so we’re back to that point we were at before the crisis.”
HCA borrowed from its revolving credit lines to pay a $1.75 billion dividend in February and another $500 million in May, when the plans for an IPO of as much as $4.6 billion were disclosed. The company had $26.1 billion of debt as of Sept. 30, $409 million more than at the end of last year, according to HCA’s third-quarter report. With the latest dividend payment to its owners, the company’s debt will increase again.
In the LBO model, holdings are usually sold within three to five years to other companies or through an IPO, with investment firms sharing the gains with their clients. With dividend recapitalizations, cash is taken out of the company without necessarily making it more profitable.
“There’s a fundamental tension in private equity that has existed since the very beginning,” said Josh Lerner, a professor of investment banking at Harvard Business School in Boston. “There’s a tension between what’s in the best interest of companies and what’s in the best interest of investors.”
After a drought following the financial crisis, buyout firms are starting to make more purchases, with $194 billion of global acquisitions announced this year, compared with $92.7 billion in all of 2009, according to data compiled by Bloomberg.
Exiting investments remains tricky, especially through IPOs as public investors are leery of debt-laden firms. Private-equity backed offerings of U.S. companies this year have averaged a gain of less than 1 percent in the first month of trading, Bloomberg data show. All other IPOs have climbed 7.7 percent on average.
“The IPO may or may not happen, and why not take some money off the table because the debt markets are willing to let them do that,” Steven Kaplan, a professor at the University of Chicago Booth School of Business, said in an interview. “If they can do an IPO, great. If they can’t, they’ve taken $2 billion back.”
Buyout firms face a possible increase in dividend taxes next year. Taxes on dividends are slated to jump to as high as 39.6 percent from the current 15 percent, which was adopted in 2003 by then President George W. Bush and a Republican-controlled Congress. President Barack Obama’s budget, sent to Congress Feb. 26, would limit the increase to 20 percent.
Speculative-grade companies including Dunkin Brands Inc., bought by Boston-based Bain, Carlyle Group and Thomas H. Lee Partners LP in 2006, and Hellman & Friedman LLC-owned Getty Images Inc. issued at least $38 billion of leveraged loans and junk bonds to help finance payouts this year, the most since before the credit crisis, according data compiled by Bloomberg and Standard & Poor’s Leveraged Commentary and Data.
“This is an environment where investors are demanding cash back because they’ve been through a nuclear winter,” Anthony Tutrone, head of the alternatives unit at New York-based Neuberger Berman LLC, said in an interview. A dividend payment is a way for buyout firms “to take money off the table ahead of an initial public offering instead of trickling out payouts” though subsequent secondary offerings, he said.
HCA went private in a $5.1 billion leveraged buyout in 1989, and went public again in 1992, according to the company’s website. In 1994, HCA merged with Louisville, Kentucky-based Columbia Hospital Corp.
KKR, based in New York, and its partners bought HCA in 2006 for $33 billion, then the largest LBO on record. The deal was eclipsed by the takeover of Equity Office Properties Trust in 2007, and again by the $43 billion buyout of Energy Future Holdings Corp.
KKR, Bain and Merrill Lynch & Co., now owned by Charlotte, North Carolina-based Bank of America, contributed about $3.8 billion of equity in the LBO, according HCA’s 2006 annual filing with the U.S. Securities and Exchange Commission. With the dividend announced yesterday, the owners will have recouped about $468 million more than their initial outlay.
Officials at KKR, Bain and Bank of America declined to comment.
Ahead of Plan
“The decision to make this distribution reflects the company’s continued positive operating performance, increase in earnings, cash flow and improvement in debt coverage ratios, all of which remain ahead of our model,” Richard Bracken, chairman and chief executive officer of HCA, said in a conference call with investors and analysts.
The ratio of debt to earnings before interest, taxes, depreciation and amortization, a measure of cash flow, will be 4.88 after the payout, down from 6.4 at the time of the LBO, HCA said.
HCA has generated much of its cash through a combination of asset sales, tax refunds and cuts to capital spending, said Vicki Bryan, senior high yield analyst at Gimme Credit LLC in New York. Capital spending was more than 4 percent of revenue in the third quarter, compared with 6.8 percent in 2006, she said.
“This is how they are making their numbers look better,” Bryan said.
She said the HCA debt issue is evidence that the junk-bond market may be topping off where investors are being asked to take on very risky debt with no real collateral.
“Here’s another case where you’re seeing a good rate being given to very risky debt, equity holders getting yet another pay day and the bondholders are getting eaten alive,” she said.