Franchise whole business securitization is back

FranCast

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A novel financing technique is enabling companies to access credit at far cheaper rates and far more attractive terms than they could obtain in the bank debt market.

Whole business securitization, also called franchise royalty securitization, first appeared in 2006 and 2007, allowing franchise-based businesses to effect a complete makeover of their capital structure. 

 

The most highly publicized transaction using this new finance technology was the US$1.7 billion franchise and trademark royalties securitization closed in 2006, known as DB Master Finance, LLC.  This deal refinanced the leveraged buyout loan incurred when three private equity firms acquired Dunkin’ Brands, Inc.  By refinancing the LBO loan through a franchise securitization, the company was able to access the debt markets at an AAA/Aaa rating, whereas the direct corporate debt was rated B-.  The result of this rating uplift was a dramatic reduction in borrowing costs, to the tune of US$35 million per year.  Other franchise securitizations followed, mostly involving quick service restaurant (QSR) companies such as Sonic, IHOP, Applebee’s and Domino’s Pizza.

 

Then, just  as this form of financing was rapidly becoming the vehicle of choice for franchise companies to refinance their debt or to raise new capital for funding strategic corporate objectives, came the financial meltdown. As the financial markets froze and the market for any form of debt disappeared, franchise whole business securitization hit a wall.

 

Although large segments of the US economy are still struggling to come back from the meltdown and the recession, certain pockets have been recovering.  One of these is the market for whole business securitization.  Over the past seven months, a total of four whole business securitizations have been reported, aggregating in total principal raised more than US$1.5 billion.  Two of these transactions were refinancings of earlier QSR franchise royalty securitizations which had been closed prior to the meltdown.  Following are brief summaries of the highlights and the benefits achieved by these two transactions:

 

Sonic Corp Whole Business Securitization

  • Closed May 12, 2011
  • US$600 million deal size
  • Use of proceeds: refinanced 2006 Sonic WBS at 5.44 percent coupon for seven-year term
  • US$100 million BBB/Baa2 asset-backed revolver combined with US$500 million BBB/Baa2 term ABS
  • More flexible covenant package than regular-way bank debt/high yield bonds
  • Structuring advisor and lead bookrunner: Barclays Capital

 

Church’s Chicken Whole Business Securitization

  • Closed February 24, 2011
  • US$245 million deal size
  • Use of proceeds: refinanced entire capital structure at 6 percent yield for seven-year term
  • Cost savings for company of over 600 bps per annum relative to company’s pre-existing credit facility
  • US$25 million BBB/Baa2 asset-backed revolver and US$220 million BBB/Baa2 term ABS
  • More flexible covenant package than regular-way bank debt / high yield bonds
  • Structuring advisor and lead bookrunner: Barclays Capital

     

Although these post-meltdown whole business transactions are similar to the whole business deals which were closed prior to the meltdown, there are some important differences:

  • Since there are no monoline insurance companies left to wrap the senior notes, the new whole business securitization notes are being issued unenhanced.  This means that AAA/Aaa ratings cannot be achieved, and the senior tranche is sold without bond insurance but with low-to-mid investment grade ratings.
  • Due to the lack of monoline wraps, investors must take the time to understand the securities they are buying rather than relying upon the wrap or the rating agencies.  This can result in increased marketing periods, similar to traditional corporate debt.
  • Absence of AAA/Aaa ratings also has reduced the investor base, resulting in smaller deal size, with optimal deal sizes now ranging between US$250 million and US$1 billion, although larger deals may be executed for the strongest credits.
  • Another paradigm shift is that, since the monolines are no longer available to take the first-loss position and therefore assume the front-line decision-making role when deals move sideways, the new whole business deals generally have third-party servicers charged with working with noteholders and in certain cases taking action to address problem situations where the investors do not give direction to the trustee within a specified time frame.

 

With these changes, whole business securitization is rapidly becoming, once again, a vital tool for the franchise industry to harness the power of securitization technology to achieve substantial debt service savings.  Whole business securitization is not available to every franchise-based business operation.  Franchise companies most likely to qualify for whole business securitization in the current market are those which meet the following criteria:

  • Strong market share in its sector
  • Consistent earnings and EBITDA of no less than US$30 million annually (to achieve the critical mass necessary to execute such a complex financing)
  • Interest in lower-cost term debt financing to take out existing debt facilities
  • Need for debt capital to fund acquisitions or other strategic purposes

           

Although the QSR sector has been the most frequent user to date of franchise royalty securitization, other franchise sectors should also be able to take advantage of this technology to reduce borrowing costs. Moody’s published a report on hotel franchise fee securitization in 2008 predicting hotel franchise securitizations backed by franchise royalty fees would be forthcoming, and royalty securitization could also be used for convenience store and other franchise systems that are outside the QSR space.

 

For more information about our capabilities to help  franchise companies wishing to access the whole business securitization market, please contact:

 

            Ronald S. Borod (Securitization)

 

            Dennis E. Wieczorek (Franchise)