The Daily Technical #42: When would a DCF be an inappropriate valuation method?

Good morning. Welcome to the 42nd edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
What is a dividend recapitalization?

A dividend recapitalization (or dividend recap) occurs when a financial sponsor, having acquired a company via an LBO, raises additional debt intending to pay themselves a dividend using those newly raised proceeds.

In most cases, a dividend recap is completed once the sponsor has paid down a portion of the initial debt raised, which creates additional debt capacity. Therefore, dividend recaps allow for partial monetization and sponsors can de-risk some of their investment, unlike an outright exit via a sale or IPO.

As a side benefit, the dividend recap would positively impact the fund’s IRR from the earlier retrieval of funds.

Common Mistakes

1. Omitting Key Steps: A frequent error is skipping over the process of how and when a dividend recap occurs. Ensure you explain the specific conditions required for a recap to make sense.

2. Glossing Over Benefits: Explain how de-risking and improving IRR specifically benefit the financial sponsor.

Key Takeaways / TLDR

• A dividend recap involves raising extra debt post-LBO to pay dividends, allowing sponsors to partially cash out.

• Timing and the financial health of the company are crucial—watch out for risk of taking on more debt despite the IRR benefits.

• Ensures sponsors can de-risk without a full exit, striking a balance between sustainability and profit.

TODAY’S QUESTION
When would a DCF be an inappropriate valuation method?

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THAT’S A WRAP
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The HirePrep Team