• M Konrad Borowicz

Whenever a company seeks financing and approaches bankers to arrange for it, it has to be pretty clear about what it needs the money for. I say 'pretty clear' because the market has developed generic labels to describe the various uses. The company can say "we are going to use the money to finance an acquisition of XYZ", which is pretty specific but they can also say "we are going to use the money for general corporate purposes", which is less specific and can really mean anything.

One interesting use of proceeds is for dividend recapitalization or dividend recap. In a dividend recap the money is borrowed, at least in part, to pay dividends on the company's stock. This is an interesting use of borrowed funds because, in theory, dividends are a distribution of income earned. If you're paying out dividends out of borrowed funds or capital, this suggests you're not doing all that well, which is maybe is not the signal you want to send to your investors. But, hey, if that's what you want to do as a company, there is generally nothing to prevent you from doing so.

(I say generally because there are some legal restrictions on paying dividends out of capital and there could be contractual restrictions in your covenants under your other debt instruments, but if you're planning to dividend up some cash out of borrowed money and you have run your covenant analysis, then - as the nice British expression goes - Bob's your uncle.)

It looks like this is something that SoftBank’s Vision Fund is going to do. The FT has a story today about the fund's plans to borrow $4 billion against its stakes in Uber, Guardant Health and Slack. The loan will be structured as a margin loan meaning that if the value of the unicorns' collateral drops, the fund will have to put down more cash. While this is a risk, this is pretty much the only risk for the fund. One of the nice things about margins loans is that the banks do not get recourse to the borrowers' other assets. This means the loans are not factored into SoftBank’s credit ratings. And isn't that great.

Now, why is the fund doing this, if this can be interpreted as a bad signal? Well, there are two possible explanations.

First, in some cases it may not be such a bad signal after all. In fact, in some cases it may actually be a good signal. If you're invested in a high-risk fund, like the Vision Fund, and you're getting a nice dividend, even if the underlying assets are not turning a profit, the dividend can be a reassuring signal because it suggests that the investment paid off, in some way. For example, while Uber is not a profitable company, the fund, a big shareholder in Uber, still made a profit on its investment after the IPO. It just so happens that it cannot realize it by selling the stock because prior to Uber's IPOs, Uber's shareholders were asked to sign the so-called lock-up agreements preventing them from selling their stocks for a certain period. So the margin loan is really a way of capturing the profit earned from the investment in Uber, which is something that will certainly appeal to the short-term investors in the fund, but I guess also to the long-term investors?

If you're with the fund for the long run, however, you may still be concerned about the prospects of the fund if you think (and you would not be wrong) that the dividend is really a product of clever financial engineering enabled by the low interest rate environment. The loan reportedly carries an interest rate of 150 basis points over Libor. That seems a little low considering how much risk the collateral carries. Perhaps the covenants make tighten the risk profile of the deal, but do they?

Which brings us to the second reason why the fund may want to do a dividend recap even though it could be interpreted as a bad signal - it may want to do it because it can. If the money is cheap, then why not? In fact, dividend recaps have become a common use of proceeds in this low interest rate environment of ours, which maybe is good or maybe not but definitely something macroeconomists should look into because it seems to have pretty significant implications for productivity and growth.

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