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Buyout Kings Embrace IOUs Over IPOs for Payouts: Credit Markets

Buyout firms typically extract profits from the companies they acquire by taking them public or selling them. In a world with zero interest rates, they’re finding it easier than ever to cash in through the debt market.

Borrowers backed by private-equity firms from Bain Capital LLC to Oak Hill Capital Partners LP have led sales of $3.4 billion of a type of junk bond this year that lets them pay dividends to their owners while allowing them to repay interest with additional debt, according to data compiled by Bloomberg. Issuance of the securities, known as payment-in-kind, or PIK bonds, is ahead of the pace this time last year, when an unprecedented $6.8 billion were sold to fund dividends.

Private-equity firms that have been holding onto their companies for longer are accelerating payouts by tapping into demand for risky, higher-yielding debt as central banks suppress interest rates globally. At the same time, buyout firms are exiting through IPOs at the slowest pace since 2009 in the U.S., according to researcher Preqin Ltd.

“Taking dividends is being allowed by the markets and it’s a preferred option for these firms when they can’t sell it,” John Rogers, a senior vice president at Moody’s Investors Service in New York, said in a telephone interview. “It opens up the ability to get a return on their investment.”


Oak Hill’s WaveDivision Holdings LLC sold $175 million of 8.25 percent PIK bonds yesterday in an offering that was boosted from an initially planned $150 million, Bloomberg data show. The Kirkland, Washington-based cable TV provider will use proceeds to pay a dividend to owners that also include GI Partners LLC.

Private-equity firms also are turning to other forms of risky debt to cash in. Junk-rated companies in the U.S. raised $36 billion through the syndicated loan market to support dividend payments this year after borrowing $65.4 billion to do so in 2013, Bloomberg data show.

Companies have taken advantage of the Federal Reserve’s easy-money policies by issuing record debt and pushing out maturities. Rather than refinancing at lower interest rates or to fund expansion, the dividend deals offer private-equity firms a way to recoup their investment while increasing the debt burden of the companies they control.

Few Defaults

“I can understand why the demand has increased because it’s an opportunity to get higher returns when everything else is compressed at around 4 or 5 percent,” Margie Patel, a money manager at Wells Fargo & Co. in Boston, said in a telephone interview. “The market is very, very favorably inclined to this type of security.”

Companies are giving buyers few reasons to worry about getting their money back after the refinancing wave and suppressed borrowing costs helped pushed default rates toward unprecedented lows. The rate for speculative-grade companies declined to 2.3 percent in May, near the lowest level since February 2008, according to Moody’s. The credit rater expects that measure will end 2014 at 2.1 percent, below the historical average of 4.7 percent.

BMC Software Inc. raised $750 million of 9 percent PIK debt in April to pay a dividend to shareholders including Bain, Golden Gate Capital Corp., GIC Special Investments Pte. and Insight Venture Partners LP. The group cashed in on the investment seven months after they acquired the provider of software that runs corporate computer networks.

IPOs Slow

Mark Peterson, a spokesman for WaveDivision at Pointer PR in Seattle, declined to comment on the PIK bonds. Alex Stanton, a spokesman for Bain, declined to comment.

PIK bonds issued to fund dividends this year have an average rating of CCC, which Standard & Poor’s describes as currently vulnerable to nonpayment. Debt with such ratings yield 9.26 percent, on average, compared with the typical 5.84 percent for $1.44 trillion across the entire speculative-grade market that’s tracked by Bloomberg. Junk debt is rated below Baa3 by Moody’s and lower than BBB- at S&P.

Private-equity firms have had trouble selling companies after the longest recession since the 1930s, according to Moody’s. Firms including Apollo Global Management LLC and KKR & Co. own about 40 percent of the 190 buyouts that were structured from 2004 to 2007.

The buyout companies have had better luck selling their companies to other firms than bringing an IPO, according to Preqin. IPOs accounted for 10 percent of investment exits this year in the U.S., the lowest level since at least 2009, while sales to strategic buyers make up 51 percent.

Regulator Warnings

Deals are being completed even as the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency warn that underwriting standards for speculative-grade issuers are weakening as investors become more willing to accept looser terms.

Yields on bonds tracked by the Bank of America Merrill Lynch U.S. High Yield Index have dropped to 5.74 percent. That compares with the 8.93 percent average over the last 10 years.

“Private equity firms’ whole mindset is to look where capital looks cheap,” Martin Fridson, a New York-based money manager at Lehmann, Livian, Fridson Advisors LLC, who started his career as a corporate-debt trader in 1976, said in a phone interview. The accessibility of debt markets “allay the concern over the delay” in bringing a company public.

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