Dividend recaps: this is not going to end well

An early proponent of dividend recaps - the financial two-step where equity capital is replaced by debt - was Thames Water.

Kiefer Photography via Shutterstock

You may not have heard of Belron. You almost certainly know of Autoglass, especially if you’ve had a stone smash your windscreen. A niche business, you might think, but Belron has just declared a E4.3bn dividend for its parent and private equity shareholders. This follows a E2.1bn dividend in 2021. Goodness, just how big and profitable can this business be?

Well, not that big or profitable. These dividends are not coming from earnings, but from bank borrowings. In the trade, they are called “dividend recaps”, where equity capital is replaced by debt - a sort of early payment from future profits, if you like. And if you think this rings a faint bell, you would be right. An early proponent of this financial two-step was Thames Water, as its then owners McQuarie paid themselves fat dividends from money borrowed by the company.

As all the world knows, that is not going to end well. Autoglass is hardly in the same category as Thames, but lots of businesses owned by private equity are doing the same thing, across many sectors of the economy. This trend reflects the dearth of targets for private equity funds as the cost of debt has risen from near-zero to today’s above-inflation rate. Selling the businesses on, either to another PE specialist or to the public markets, has proved tricky, so dividend recaps have been a kind of displacement therapy for the fortune-hunters.

This is all perfectly legal. It makes a few people very rich, and under today’s tax rules, produces only a moderate bill for them from HMRC. The lucky winners will have risked their capital (or some of it) but the real risk to the business and its workforce can take years to become apparent. Loaded up with debt, it is much less resilient if things don’t go to plan. 

In Belron’s case, the ratings agencies have downgraded all the company’s debt to reflect the shrinking risk capital in the business. Banks follow fashion like the rest of us, and they are all piling into the dividend recap business now, looking for places to put their surplus capital under easier lending regulations. Belron’s case is hardly unusual.

So the PE boys have got their money, and should the company run into trouble in the future, they will be long gone. So, too, will the executives in the banks that put up the money, along with their bonuses for doing the deal in the first place. Another team, perhaps even from the same banks, will move in to pick up the pieces and collect another round of fees.

Advocates for PE argue that they make the businesses they buy work better, displacing a fusty old management with a more aggressive, market-focussed team, but the evidence for this is equivocal, at best. Nevertheless, they have been lobbying furiously to keep their tax privileges. We shall find out soon enough how successful they have been.