The whole-business securitization sector makes a relatively minor impact on the capital markets, in terms of volume. Just a handful of the deals come to market each year. Yet the asset class has given the capital markets a lot to talk about lately. In one year, both the DB Master Trust - better known as the Dunkin' Brands transaction from May 2006 - and the Domino's Pizza deal from last April pushed about $3.5 billion of asset-backed paper onto the market.
Now, Wendy's International is considering a securitization as part of several options to boost the company's value. A total sale of the company, however, is Wendy's International's main focus at this point. Two weeks ago, the company cut its 2007 earnings forecast and said it was considering putting itself up for sale. A couple of months before that, it said that it hired JP Morgan Chase & Co. and Lehman Brothers as financial advisers for a possible deal. No
dollar amount or timing was attached to a possible securitization, but equity analysts estimate that Wendy's International has a market capitalization of about $3.5 billion.
A securitization would make Wendy's the latest major corporation to use securitization as a key part of its recapitalization strategy. It would also solidify the latest trend of franchise restaurants tapping into whole business securitization to extract value out of their brands, thereby sustaining the sector's present growth momentum.
Market sources, however, say that the most recent deals are just the beginning, and that the whole-business sector could one day encompass revenues from the practice of outsourcing.
The structure of an outsourcing agreement, wherein an operating company pays an outside service provider to perform certain services and functions, could create an opportunity for securitization, Ron Borod, the Boston-based chairman of the structured finance group at law firm Brown Rudnick Berlack Israels, said.
The health of the operating company and the viability of the relationship between the operating company and the outsource service provider still depend on the operating company's ability to perform. In that sense, a packaging of some portion of the operating company's
revenue could be considered a whole-business securitization.
"That is just one small example," Borod said. "I am not predicting large volumes, but wherever you see substantial revenues from assets that still need heavy management to produce revenue, you've got the makings of a whole-business securitization."
As a source of revenue for whole-business securitizations, Borod said, restaurant franchises are "low-hanging fruit. The banking community will focus on restaurant chains, because those are ripe candidates for this type of technology."
Other companies that have used the whole-business securitization technique include Arby's, The Athlete's Foot and Sonic.
As restaurant franchise opportunities ripen for securitization, they also underscore the industry's tendency to mingle the areas of intellectual property (IP) and whole-business securitization.
"They are different concepts, but in the work that has been done so far, it just so happens that they have overlapped," Borod said. "Whole-business securitizations done in the U.S. at least have all involved some form of IP."
A transaction falls under the whole-business category when revenues generated for the deal's cashflow are materially dependent on the operations of the company.
"A company has to run the franchise operations in the right way to generate revenues," Borod said. "You cannot ever de-link the assets, the licenses from [the company's] operations."
Both the Dunkin' Brands and the Domino's Pizza deals have met the standards for consideration as whole-business securitizations. Some market observers say that the distinction between the two comes down to servicing operations.
"When is it an IP deal and when is it a whole-business securitization?" asked Eric Hedman, a director of structured finance in the new assets group at Standard & Poor's. "What you have are different degrees of operating risk and servicer involvement."
Further, the rating agency published criteria on what it called corporate securitizations, a category that includes revenue from film, trademark licensing and royalties on such things as music and pharmaceutical patents.
"The nature of a corporate securitization is such that the assets need to be exploited continuously to generate ongoing revenues with which to repay the debt," Standard & Poor's analysts wrote. "This ongoing operational requirement introduces a different type of performance risk than that of a typical securitization, in which the primary role of the servicer is to collect on existing receivables."
The rating on a corporate securitization generally begins with the sponsor's corporate rating. The rating process then considers, among other things, the competitive position of the particular business within the industry; the growth prospects of the industry; barriers to market entry (regulatory and/or commercial); cashflow stability, in terms of the business operator's historical record; and the predictability of demand for products and services, and of contractual revenues.
For the time being, restaurant franchises are indeed the Wall Street favorites for whole-business and intellectual property securitizations. Another reason is that the deals work well for companies that have large market shares in their lines of business.
Securitization has always been a cheaper source of financing for many companies, and it is likely to remain an attractive option for private equity firms that carry out leveraged buyouts of companies like Wendy's International. Those transactions incur expensive debt for private equity firms, as Borod noted, and the firms will continue to look to securitization as a cost-effective means of discharging that debt.
Investors have also become comfortable with the idea of bankruptcy-remote debt-the mark of securitization-becoming so entangled in the corporate debt and operating success of the sponsor company.
Indeed, the whole-business securitization market survived a major crisis of confidence after the Days Inn bankruptcy in the late 1980s. During bankruptcy proceedings, the judge almost decided to disregard the sale of franchise agreements to a special-purpose, bankruptcy-remote vehicle, because those agreements were crucial to the life of the company, Borod said.
That nail-biting event scared the securitization market and was blamed for stifling IP and whole-business securitizations for almost 10 years, Borod said. The thinking was that if franchise agreements or other identifiable contracts that underpin a whole-business securitization could be placed with a bankruptcy estate, it would checkmate the ability to securitize any corporate asset.
Eventually, the Guess Royalty Finance transaction, which priced in 2003, circumvented the core asset puzzle and renewed confidence in the securitization technique for whole-business and IP deals. In that transaction, arrangers pledged the cashflow from Guess? Inc.'s trademarks to an SPV, and not the trademarks themselves, Borod said.
At the end of the day, a company hoping to access the ABS market using the whole-business model must have a top-notch and sustainable business model, to allow rating agencies to rate cashflow generated by the business after taking into account operating expenses which must be incurred in order to generate these revenues, Borod wrote in a recent article about the sector.
"In other words, whole-business securitization - unlike the securitization of self-liquidating financial assets which are not dependant upon an operating company to generate cashflow - relies upon EBITDA rather than gross revenues to pay debt service on the bonds," Borod wrote.
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