When most people think of intellectual property securitization, they think of music royalties, although that is really just the tip of the iceberg.

In fact, if industry pros such as Robert D'Loren, from CAK Universal Credit Corp., or David Pullman, from The Pullman Group, are even near the mark, intellectual property securitization will become a commonplace alternative to traditional financing - both corporate and non-corporate - throughout the next decade.

Near term, watch for franchise royalty securitizations (see Arby's later in story), technology and/or computer companies financing, biotech intellectual property financing, telecom intellectual property financing, television syndication securitization and more.

The idea, from D'Loren's perspective, is tied to the growing relationship between intangible assets and the modern corporation's market value, a phenomenon that is increasingly being looked at by authors and university researchers, including Baruch Lev, a professor at New York University.

For instance, in the early 1980s, tangible book value represented more than 60% of industrial firms' market values, D'Loren said. By 1992, that ratio had dropped to 38%. Recent studies estimate that book value of tangible assets now account for between 10% and 15% of companies' market values.

"If 90% of the book value, which translates to market value, of all the companies in the world can be attributed to intangible properties, what does that tell you about the future of finance?" D'Loren asked.

The gist is that, according to D'Loren, the modern company owns its customers, as opposed to physical capital. D'Loren dubs this the "value net model," replacing the old economy's supply chain model.

"The value net model creates a syndicate of companies to accomplish a goal," he said. "At the top of this upside-down pyramid, requiring most of the focus of the company, is the customers. Instead of pushing to the customers, you pull the customers."

Further down the pyramid is human capital, then working capital.

"At the very low end of the pyramid, contributing next to nothing, is production, because in a value net model, you plug production players in and out to achieve the greatest efficiency."

D'Loren used WalMart as an example. WalMart makes a strategic alliance with a brand, then sources manufacturing out to the lowest bidder on an annual basis.

This paradigm shift in the industrial world will significantly change corporate finance, D'Loren argues, because companies that aren't able to borrow against property or production will find borrowing against intangible assets and intellectual property cheaper than issuing corporate debt.

CAK, which is minority-owned by Deutsche Bank and Prudential Securities, is positioning itself to be a forerunner in underwriting corporate intellectual property assets.

Music Made a Quiet Roar

If anything, the number of music deals since the 1997 debut of Bowie Bonds has been disappointingly few, investors have said, with just a handful of deals getting done, including both the "controlled rights" and the non-controlled or "creator/artist" deal types.

"There are very few artists that command the revenue-generating capability to support a transaction," said Jennifer Quisenberry, a managing director at Structured Finance Advisors, which is an active participant on the buyside of intellectual property deals (see profile, page 1).

According to Quisenberry, there have also been occasions when artist deals have not gone through because artists can be wary of losing the rights to their royalties.

"As part of any securitization, the artist would have to come to terms that he or she could lose the catalog if the revenues did not meet a certain level," Quisenberry said. "We have had firsthand experiences with a couple artists who get very close, who contemplate it and turn back because the possibility of losing the catalog is not something they can come to terms with."

Though music royalty deals are often lumped together as one type of securitization, the two major deal types are actually quite different.

Deals structured like the Bowie Bonds, out of the Pullman camp, are true intellectual property deals, and considered non-controlled, as the borrower/artist does not have direct control over the revenue stream.

Those deals are based on a specified existing catalog of a given artist.

However, in the other type of music royalties deal, the deal is backed by the futures of a record label (which is more of a corporate financing), and the corporation is responsible for the exploitation and distribution of the product. In this case, the rights are similar to an operating asset (such as their tangible asset brethren: shipping containers, aircraft... etc.).

In a controlled rights deal, the trust has the ability to assume control of the receivables and move them to a new operator, should the corporation prove incapable of managing the assets profitably.

In this case, the security is still the intellectual property of the trademark, but there is also an ongoing business risk, said Jay Eisbruck, a ratings analyst at Moody's Investors Service.

Addressing controlled rights deals, D'Loren said, "As it turns out in entertainment, there are only a handful of independent record labels. Quite frankly, there's only six or seven of them and we've already done three of them. And for the major record labels, asset-backed securitization is not an attractive alternative because they can issue corporate debt at lower rates."

D'Loren is taking his technology and moving into other industries.

As for Pullman's creator/artist securitizations, the potential to grow is still strong, as he moves his technology into other sectors of entertainment, such as television syndication and screenplay royalty rights.

For example, certain participants in a syndicated television show - such as an actor or a producer - own pieces of the show, or a specified number of points that determines the royalty given to participants each time the show is aired. The Pullman Group will structure a loan to an artist backed by the various revenue streams associated with that artist's name.

Pullman will then package a number of these loans, structure bonds, and sell them to investors.

"We have a reputation of really protecting our artists and their assets, because they're sensitive to that," Pullman said, addressing the issue that some artists have been hesitant to let go.

Pullman is also targeting other types of creator/artist intellectual property, such as biotechnology patents, patents from inventors, medical equipment patents and so on.

Promising Futures &

Whole Companies

The technology that has been developed since the debut of entertainment royalty securitizations is already being applied to new types of intellectual property - including licensing deals, and branding rights associated with whole company securitizations, biotechnology, consumer targeted franchises, the telecom sector and other industries.

With the advent of whole company securitizations (see story page 14), a new "franchise" sector is being developed. Currently, Arby's is trying to bring a deal to market backed by the revenue stream associated with its logo, the 10-gallon hat. Morgan Stanley Dean Witter is lead banker on the deal.

CAK's D'Loren said his team will start bringing its version of the franchise royalty deal in the first quarter 2001. Beyond that, D'Loren is targeting computer and technology companies, and eventually telecom companies.

Unlike the telecom deals said to be developing in Europe, where at least one deal agented by West LB is under way, D'Loren's telecom vision is based on "contractually obligated income streams", as opposed to booked receivables.

D'Loren would not elaborate further, citing trade secrets.

"The problem that we have worked to solve is, How do you lend on an intangible asset, when, if that asset is not managed properly, there can be very serious and sometimes rapid diminution of value?'" he said. "The structure that works, that mitigates the potential for bankruptcy delays, is a securitization structure, where there is a true sale to a bankruptcy-remote entity."

"In many cases, because of the structures, you can enable companies to issue debt at four to five notches above their underlying ratings," D'Loren added.

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