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Primrose school owners tap whole-biz ABS market for cash-out refinancing

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Asset-backed securities investors have a new sector to consider in franchise-fee securitizations: early childhood development.

Primrose School Franchising Co. is marketing $275 million in bonds backed by a whole-business securitization of royalties and revenues from the firm’s rapidly expanding 405-school franchised network of accredited early childhood/pre-K education and day care centers in the United States.

According to a presale report from Kroll Bond Rating Agency, proceeds from the Primrose Funding LLC Series 2019-1 notes will refinance existing debt and raise proceeds for a potential equity distribution to the company’s owners.

The capital stack includes a $10 million Class A-1 series of variable funding senior notes pari passu with $265 million in Class A-2 series bonds, with each tranche given a preliminary BBB by Kroll.

The collateral includes existing and future franchise and development agreements, curriculum and other franchise fees plus intellectual property.

For the 12 months ended June 30, Primrose (founded in 1982) had generated $822 million in revenue through its entirely franchised chain with more than 300 individual operators (more than 98% operate fewer than five schools). Royalties made up 90% of the revenue mix in the second quarter of this year.

While same-school sales growth has slowed below 5% in the last three years, the centers have experienced positive same-school sales in 14 of the last 15 years.

The Primrose franchise has grown from a network of 276 schools in 2013, according to Kroll.

Operators typically enter into 10-year franchisee agreements with two 10-year renewal operations.

Operators pay an initial franchise fee for each school opened, and pay Primrose a royalty rate of 7% of gross sales on a monthly basis. The company is actively engaged in franchise expansion development.

The schools have an enrollment capacity of over 75,000 students as of June this year.

Barclays Capital and Credit Suisse are joint bookrunners on the transaction.

Primrose is an affiliate Road Capital, which has tapped whole-business securitization for a variety of its sponsored franchise brands, including Jimmy John’s, Arby’s Driven Brands, CKE Restaurants, Sonic, Massage Envy and FOCUS Brands.

Issuing entity Primrose Funding will structure the deal with several common whole-biz investor protections, including a 50% excess cash flow sweep (or potentially early amortization) if the principal and interest debt service coverage ratio falls below 1.75x.

Much of the risk in the Primrose franchise is enforcement of educational and childcare licensing standards of the organization, and of course local and state rules and laws. The childcare industry is also subject to potential event risks involving child safety or abuse that could tarnish the brand, Kroll noted.

Primrose schools have extensive security measures, such as on-premises keypad lock systems only staff and parents are permitted to use.

“Primrose holds its franchisees to high standards of childcare, which has helped Primrose to differentiate itself and outperform its competitors,” according to the Kroll report. “At the same time, such standards may require significant oversight and management by individual franchisees in the day-to-day operations of each location.

“Although [Primrose] provides curriculum, programs, and systems to assist franchisees, the Primrose business model is relatively more complex to operate for franchisees than other franchise models.”

Primrose also competes in a “highly fragmented” childcare industry made up of 725,000 for-profit centers in the U.S., with the top 50 making up less than 12% of that capacity. Kroll cited market research from IBISWorld estimating the U.S. childcare industry generated $55 billion in revenue in 2018. The revenues are expected to climb to $57 billion this year.

Primrose operates in 29 states. Most franchisees have been operating locations for more than a decade. The largest concentrations of schools are in Texas (126 schools, or 31.1%), Georgia (11.4%) and Ohio (7.7%).

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Whole business securitization