Leveraged recapitalization

A strategy where a company takes on significant additional debt with the purpose of either paying a large dividend or repurchasing shares. The result is a far more financially leveraged company.

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Corporate strategy to fend off potential acquirers by taking on a large amount of debt and making a large cash distribution to shareholders. For example, XYZ Company, selling at $50 a share, may borrow $3 billion to make a one-time distribution of $20 a share to stockholders. After the distribution, the stock price will drop to $30. By replacing equity with $3 billion in debt, XYZ is a far less attractive takeover target for a raider or other company than it was before. Also called leveraged recap for short.

In corporate finance, a leveraged recapitalization is a change of the capital structure of the company—usually to substitute debt for equity. Such a maneuver is sometimes called a Leveraged buyout (LBO), but leveraged recapitalization specifically refers to an internal restructuring, while leveraged buyouts are generally made by outside parties such as private equity firms.

Leveraged recapitalizations are used by privately held companies as a means of refinancing, generally to provide returns to the shareholders while not requiring a total sale of the company. These types of recapitalizations can be minor adjustments to the capital structure or may involve a change of control. Carrying debt comes with a lot of advantages in the form of tax benefits and cash discipline as compared to equity. The reduction in equity also makes the firm less able to be acquired in a hostile manner. However, this often leads companies to focus on short-term cash flow projects, and they tend to lose their strategic focus. As shown in the research article: Leverage and Internal Capital Markets [1], the leveraged companies had increased their debt to capital ratio from 17% to 50% in a span of 12 years.

See also

• Economics
• Mergers and Acquisitions
• Microeconomics
• Takeover
• Industrial organization

References

Downes, John; (2003). Dictionary of Finance and Investment Terms. Barron's. ISBN 0-7641-2209-6. 

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