• M Konrad Borowicz

Dividend recaps recap

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 meant to describe the purpose of financing. You will find them in the 'use of proceeds' section of offering memoranda or term sheets. So 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 to finance for general corporate purposes", which is less specific and can really mean anything.


One interesting use of proceeds is for dividend recapitalization. In a dividend recapitalization 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 through your counsel, then - as the nice British expression goes - Bob's your uncle.)


It looks like this is something that SoftBank’s Vision Fund is trying to do. The FT has a story today about the fund's plans to borrow $4bn against its stakes in Uber, Guardant Health and Slack. The loan will be structured as a margin loan meaning that if the value of 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 is such a bad signal? There are two answers.


First, in some cases it may not be such a bad signal at all. In fact, in some cases it may actually be a good signal. If you're invested in a high-risk fund, like Vision Fund, and you're getting a decent dividend, even if the underlying assets are not turning a profit, this can be pretty reassuring if you're with the fund for the long-run. 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. However, it cannot access it because prior to Uber's IPOs, Uber's shareholders were asked to sign 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 that profit, which certainly appeals to short-term investors in the fund, but I guess also to long-term investors as well?


But if you're with the fund for the long run, you may still be concerned about the prospect of the find if you consider that your nice dividend is really a product of clever financial engineering enable through low interest rates. The loan reportedly carries an interest rate of 150 basis points over Libor. That seems awfully low considering how much risk the collateral carries. While it could be that the rate is low, because the covenants are tight, but, let's face, that's unlikely. Instead, it's just the result of the fact the interest rates are low. Which brings us to the second reason why the fund may want to do this even though it could be interpreted as a bad signal - they do it because they can. If the money is cheap, then why not? In fact, dividend recaps have become a common use of proceeds in this environment, which maybe is good or maybe not but definitely something macroeconomist should look into because it seems to have clear implications for productivity and growth.



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