Over the course of this year, several household name fast-food companies have issued bonds that are referred to on Wall St. as ‘whole business securitizations’. These bonds are so named because they are secured by intangible intellectual property assets (e.g. franchise fees, trademarks) that are indivisible from the value of these companies as going concerns.
Among the companies that have issued such bonds are Domino’s Pizza, Dunkin Brands, Jimmy John’s, TGI Friday’s and Church’s Holdings.
To quickly grasp the logic of these complex transactions, it is helpful to consider their heritage. The process of ‘securitization’ originated with the original issuer of mortgage-backed securities Federal National Mortgage Association (FNMA), whose roots go back to the New Deal. FNMA’s original business model, which remains part of its current model, was to buy mortgages insured by the Federal Housing Administration (FHA) from lenders. These purchases enabled the lenders to fast forward a profit on these loans and gave them a fresh round of capital with which to make additional loans, thereby increasing the pace at which new homes could be financed.
In the 1980’s, the methodologies developed in the mortgage market were adapted and used to issue bonds backed by almost any type of loan portfolio and the noun ‘securitization’ and the verb ‘securitize’ were born. The terms each imply that a specific security (a bond) is issued and that the bond is backed by some type of performing financial asset as collateral (or security in the broadest sense of the term).
Today, almost every automobile loan, credit card receivable in the country serves as collateral for some type of securitized bond. Most of the country’s residential real estate, commercial real estate, automobile leases and loans, and student loans are similarly ‘securitized’.
In the late 1990’s, the first ‘whole business’ securitizations were done in the United Kingdom by some well-known pub companies. Unlike a successful mortgage lender sitting on portfolio of hard assets, the value of a company like Domino’s Pizza rests on the intangible (but no less real) strength of its brand. The company’s cash flow consists largely of the fees that it receives from its franchisees. The franchisees pay these fees because the value of this international brand, represented by its trademarked names, logos, color schemes, uniform communication style, is built on decades of organizational quality control and marketing.
The gist of the structuring done for these transactions is akin to a pre-planned bankruptcy in that it involves getting the company to legally commit to the disposition of certain of its intangible property in the event that there are defaults on corporate or transaction debt in the future.
If an investor is confident in the strength of a company’s brand, these deals are inherently sensible and akin to a corporate bond that is secured by property, plant or equipment.
And where investors demonstrate such confidence, the process of securitizing the “whole business” is sensible for the issuer as well, in that it enables the issuer to achieve higher debt ratings and achieve much lower borrowing costs.
This is exactly the type of happy experience that Domino’s Pizza had earlier this year with its $1.9 billion whole business securitization. This deal was so well received by investors that the company wound up increasing the size of it and achieving a debt rating higher than its corporate debt rating, enabling it to save many millions in borrowing costs.
However, not every company with a well-known brand would be able to achieve similar success for a variety of reasons. First, the value of every brand is already reflected to some extent in its owner’s operating performance. Only exceptionally powerful brands have an intrinsic value such that they can be prudently accorded value separate and apart from the corporate credit strength of the company. Second, not every company with a stellar brand is organized such that the investors would be comfortable that they could extract the brand and its value in the event that management succeeded in bankrupting the operating company. It is more likely that the value of the brand would evaporate right along with the corporation’s financial health.
The example of Domino’s is instructive on this point. The Domino’s brand is iconic at this point in time. Its establishment, troubles and successful re-positioning are taught in business schools and its stock price and market value are near all-time highs.
In addition, Domino’s latest deal is its fourth whole business securitization. The company and its investors have lived with the administrative burdens inherent in using a securitization, have grown accustomed to them and publicly discuss them as part of the company’s storied identity.
Most would-be issuers of whole business securitizations should anticipate a similar slow path to overnight securitization success.