In
corporate finance, a leveraged recapitalization is a change of the company's
capital structure, usually substitution of debt for
equity.
Overview
Such recapitalizations are executed via issuing
bonds to raise money and using the proceeds to buy the company's stock or to pay dividends. Such a maneuver is called a
leveraged buyout
A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money ( leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loa ...
when initiated by an outside party, or a leveraged recapitalization when initiated by the company itself for internal reasons. These types of recapitalization can be minor adjustments to the capital structure of the company, or can be large changes involving a change in the power structure as well.
Leveraged recapitalizations are used by privately held companies as a means of refinancing, generally to provide cash to the shareholders while not requiring a total sale of the company. Debt (in the form of bonds) has some advantages over equity as a way of raising money, since it can have
tax benefits and can enforce a cash discipline. The reduction in equity also makes the firm less vulnerable to a
hostile takeover
In business, a takeover is the purchase of one company (the ''target'') by another (the ''acquirer'' or ''bidder''). In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to t ...
.
Leveraged recapitalizations can be used by public companies to increase
earnings per share. The
Capital structure substitution theory In finance, the capital structure substitution theory (CSS) describes the relationship between earnings, stock price and capital structure of public companies. The CSS theory hypothesizes that managements of public companies manipulate capital stru ...
shows this only works for public companies that have an
earnings yield
Earning yield is the quotient of earnings per share (E), divided by the share price (P), giving E/P. It is the reciprocal of the P/E ratio.
The earning yield is quoted as a percentage, and therefore allows immediate comparison to prevailing long- ...
that is smaller than their after-tax interest rate on corporate bonds, and that operate in markets that allow share repurchases.
There are downsides, however. This form of recapitalization can lead a company to focus on short-term projects that generate cash (to pay off the debt and interest payments), which in turn leads the company to lose its strategic focus.
[U.C. Peyer and A. Shivdasani, "Leverage and Internal Capital Markets: Evidence from Leveraged Recapitalizations", ''Journal of Financial Economics'' Volume 59, Issue 3, March 2001, Pages 477-515]
Available free online
. According to these authors, leveraged companies increased their debt-to-capital ratio from 17% to 50% in a span of 12 years. Also, if a firm cannot make its debt payments, meet its
loan covenant
A loan covenant is a condition in a commercial loan or bond
Bond or bonds may refer to:
Common meanings
* Bond (finance), a type of debt security
* Bail bond, a commercial third-party guarantor of surety bonds in the United States
* Chemical bond ...
s or
rollover its debt it enters
financial distress
Financial distress is a term in corporate finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy. Financial distress ...
which often leads to
bankruptcy. Therefore, the additional debt burden of a leveraged recapitalization makes a firm more vulnerable to unexpected business problems including
recessions and
financial crises
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and man ...
.
See also
*
Capital structure substitution theory In finance, the capital structure substitution theory (CSS) describes the relationship between earnings, stock price and capital structure of public companies. The CSS theory hypothesizes that managements of public companies manipulate capital stru ...
*
Leveraged buyout
A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money ( leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loa ...
*
Dividend recapitalization
A dividend recapitalization (often referred to as a dividend recap) in finance is a type of leveraged recapitalization in which a payment is made to shareholders. As opposed to a typical dividend which is paid regularly from the company's earnings ...
References
External links
"Recapitalization" at Investorwords.com
Business terms
Corporate finance
Private equity
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