Recapitalization Meaning Types Examples

Recapitalization Meaning

Types of Recapitalization

There are various types as below:

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Leveraged Recapitalization: Issue of new debt to buy back the company’s existing shares. It leads to an increase in the debt component and a reduction in the equity component.Leveraged Buyouts: Same as leverage recapitalization but initiated by third parties to the company.Equity Recapitalization: More equity or preference shares are issued to buy back the debt and reduce the debt component.Nationalization: Government uses this mode. Capital infusion in the case of public sector units or by paying off compensation for a private company’s equity.

Example of Recapitalization

Around 2013, Dell went private. One of the main reasons for this was that Michael Dell wanted to grow faster and needed greater control over strategic decisions without gaining approval from several other stakeholders, and the Board of DirectorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. read more.

Further, going private would reduce the filing requirements of the SEC, reducing the time and costs of paperwork. To undergo this change, Dell had to take a bank loan, and the costs saved from reduced paperwork and dividend payments would pay off the debt quickly compared to what it would have been able to. Thus, it would be able to reduce the debt burden too. Also, it would bring greater flexibility to invest in R&D because it does not need to pay out enough dividends and retain them; this may lead to faster growth.

However, this is not the only recapitalization case in Dell’s history. In 2018, i.e., five years later, Dell sought to go public again through a VMware, Inc. stock swap deal, an alternative to the traditional IPO process. But, again, the motivation was the growing ties with VMware, Inc. and the expected growth in the new product lines.

Benefits of Recapitalization

Benefit from Tax Shield

Interest on debt is tax-deductible. Therefore, an increasing deficit in the capital structure leads to an increase in the interest burden and, in turn, lower taxes. That could only be a motivation when: –

The company is sure of good sales to pay the interest because interest is an obligation one must pay even without the company earning enough profits.Interest cost is lower than the cost of equityCost Of EquityCost of equity is the percentage of returns payable by the company to its equity shareholders on their holdings. It is a parameter for the investors to decide whether an investment is rewarding or not; else, they may shift to other opportunities with higher returns.read more of an all-equity company.

Reduce Interest Burden

Opposite to the previous motivation, when a company wants to reduce its interest burden, it goes for an equity recapitalization because it may not want to part with some of its profits or incur losses in paying the interest, which is an obligation independent of companies earning a profit. Even if the company makes a profit, it can retain it if it has growth opportunities to invest in. Therefore, under such circumstances, it has the freedom to payout any dividendsPayout Any DividendsThe dividend payout ratio is the ratio between the total amount of dividends paid (preferred and normal dividend) to the company’s net income. Formula = Dividends/Net Incomeread more.

Prevent Hostile Takeover Attempt

Several takeover defense mechanisms can lead to a recapitalization. The stock repurchase Stock RepurchaseShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company.read more is when the target company buys back its shares from the market to reduce its availability for an acquiring company to buy such shares. In GreenmailGreenmailGreenmail is an intentional purchase of a substantial number of shares in an organization with an ultimate objective to jeopardize it with a hostile takeover, which usually results in forcing the owners to repurchase the shares at a premium.read more, the target company buys back the shares held by the acquiring company, and if it extinguishes these shares, the capital structureThe Capital StructureCapital Structure is the composition of company’s sources of funds, which is a mix of owner’s capital (equity) and loan (debt) from outsiders and is used to finance its overall operations and investment activities.read more gets affected. In white squire defense, it buys back the shares of the minority and allows them to be friendly partners.

Also, there may be a situation where the target goes for a rights issue at a highly discounted price to increase the number of shares and make it difficult for the acquirer to acquire. To take any of these defenses, the target company may issue debt or other forms of capital, leading to a recapitalization. Otherwise, these result in a change in the capital structure.

Boosting Public Sector Units

When the government takes the nationalization route, it is mainly to help certain sick PSUs to overcome their deteriorating balance sheetsBalance SheetsA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more. For example, when banks have very high levels of non-performing assetsNon-performing AssetsNon-Performing Assets (NPA) refers to the classification of loans and advances on a lender’s records (usually banks) that have not received interest or principal payments and are considered “past due.” In the majority of cases, debt has been classified as non-performing assets (NPAs) when loan payments have been outstanding for more than 90 days.read more, the government infuses capital so that these banks don’t go bankrupt. At other times, when the economy is slowing, the government uses the capital infusion to boost lending activity by the bank. All these increase the government’s stake in the PSUs, a form of recapitalization.

Divestiture

The opposite of nationalization is DivestitureDivestitureDivesting refers to the act of partially or entirely selling organizational assets to generate funds urgently.read more. The government sells its stake to private parties with the motivation to reduce the government’s expenditure or losses or make such PSUs more efficient through privatization.

Control Desire

At times companies or management require greater control over the company. For this reason, they may reduce the debt because debt-holders impose restrictive covenants on the risks that can be taken by the company or on the new capital issues.

Refinancing

At times when the interest rates become more favorable, companies may issue new debt to recall old debt issued at a higher interest rate; this helps in reducing its + [Cost of Debt * % of Debt * (1-Tax Rate)]” url=”https://www.wallstreetmojo.com/weighted-average-cost-capital-wacc/”]WACC”WACC””The.

Reducing Administrative Costs

There are several costs associated with being a publicly listed company related to disclosures and regulatory requirements. Such is not the case in private companies. Therefore, the companies may sometimes go private to reduce such costs when they become unbearable.

Recapitalization in Real Estate and Private Equity

In real estate development, several parties come together, landowners, development partners, investors, etc. However, each participant has different investment horizonsDifferent Investment HorizonsThe term “investment horizon” refers to the amount of time an investor is expected to hold an investment portfolio or a security before selling it. Depending on the need for funds and risk appetite, the investor may invest for a few days or hours to a few years or decades.read more and expectations regarding the market and returns. At times, those having a longer time horizon and hopeful expectations recapitalize the stake of other participants for mutual benefit.

One can use recapitalization as an exit route in private equityPrivate EquityPrivate equity (PE) refers to a financing approach where companies acquire funds from firms or accredited investors instead of stock marketsread more. The private owners sell a portion of their companies to take advantage of growth opportunities that require greater capital or reduce their stake or burden and retain some stake to benefit from prospective future growth.

Conclusion

Recapitalization is altering the capital structure that would better suit the company’s needs, and the motivation behind it may vary from one company to another. Therefore, it may lead to the desired result or not and should think.

It is a common process. There are several real-life examples of capitalization as most companies require this tool at some point in their life cycle. The motivation to do so may bind to a different objective from time to time.