Read Whole%20Biz%20Securitization.pdf text version

by Caren Chesler

ecuritizing an entire business finally seems to be catchWhole business securitizations took off abroad ing on in the U.S. This financing technique has already been adopted by a host of companies around the world over a decade ago. Now, thanks to adventurous from pub chains to cell phone companies. But American rivals have been slower to appreciate the benefits. That's changing as private equity firms and some finessing of the private equity firms push for more innovative ways to finance their acquisitions and as the structure is finessed to appeal details of these deals, they're finally finding a more to American investors. True, whole business securitization, or WBS, is hardly foothold in the U.S. one of the dominant asset classes. " It's a particularly cost-effective and efficient securitization technique, for a subset of the corporate world," says Greg Richter, head of specialty finance at Credit Suisse. "It's just not a very large subset." Only about $80 billion of such deals have been sold outside the U.S. since the first whole business securitization in the mid 1990s, according to Barclays Capital. There are no reliable figures for the U.S. market, but it is much smaller. It's not that America had completely shunned WBS as a financing tool. But until the last year or so it was largely restricted to quirky niche deals, like the $55 million securitization 10 years ago of the royalties from David Bowie's 287-song catalogue. That pales in comparison to the multi-billion dollar deals abroad. Last year venture capital firm Softbank used a whole business securitization to raise $12.4 billion of the $15.5 billion price tag for cell phone operator Vodafone's Japanese business. It hasn't stopped there. "The pipeline is starting to look big," says James Martin, vice president at Merrill Lynch in London. "There are two or three pretty substantial transacgetty image tions that will potentially happen this year." Acquisitions tend A hole business does a whole business to drive the business. As much as a quarter of total non-U.S. WBS volume has come from private equity firms funding their purchases of UK pub groups. Two other large takeover-driven deals are expected this year, as well. Airport operator BAA, which was bought last year by Spanish construction company Ferrovial, is set to pledge the assets of Heathrow, Gatwick and other airports to raise perhaps £10 billion ($20 billion). Australian private equity firm Macquarie could tap the WBS market for as much as £5 billion to fund its purchase of Thames Water. While U.S. deals are not yet approaching such a size, they are growing. The catalyst was last year's $1.7 billion whole business securitization of Dunkin' Brands. Bain Capital, Carlyle Group and Thomas H. Lee took the fast-food chain private, and the three leveraged buyout firms financed almost three-quarters of the deal by securitizing franchise fees generated by the company's Dunkin' Donuts, Baskin Robbins and Togo's restaurants. " I definitely think people are looking at the Dunkin' financing," says Sandra Horbach, managing director at the Carlyle Group. "Most people would have said before we did that deal that you could never

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do a whole asset securitization of that size on a company like Dunkin'." Sure enough, several other deals have since come to market -- primarily restaurant companies. Drive-in chain Sonic closed an $800 million franchise securitization deal in December. IHOP did a $200 million deal backed by substantially all of the intellectual property and franchising assets of its pancake chain. And in April, Domino's Pizza sold $1.85 billion in asset-backed securities, funded by franchise fees from its stores. Interestingly, none of the deals was financing a takeover. All three companies are using the proceeds to replace more expensive unsecured debt and to buy back stock. Domino's is also expected to pay a special dividend to its shareholders -- the largest of which is Dunkin' co-owner Bain Capital. The benefits are not hard to see. WBS can shave between 100 and 200 basis points off a company's interest payments. For Dunkin' that meant being able to reduce funding costs by about $35 million a year, says Horbach, thus helping the three LBO shops to put an extra turn of leverage on the coffee and donuts business, and outbid rivals. So why has it taken so long for the structure to catch on in the U.S.? It's all about what happens should a company that has used the structure file for bankruptcy. In a traditional securitization, the true sale status of the assets is usually watertight -- they are pledged to the special purpose securitization vehicle and are bankruptcy-remote. That's not so clearly the case with whole business securitization precisely because most or all of a company's assets are tied up in the structure. "If a WBS deal securitizes the core assets of a company, a bankruptcy judge might feel his or her ability to restructure the company was significantly compromised by the securitization and use their equitable powers to interfere with it," says Stephen Macy, senior credit officer at Moody's Investor Service. "I think this is, in general, more of a possibility with WBS deals than traditional securitizations." Company executives could lobby to have the WBS structure overturned. That nearly happened when LTV filed for bankruptcy in 2000. The steel company's executives asked the court to allow it to use the cash from its securitized assets to stay in business and keep as many of its 30,000 employees as possible on the payroll, claiming the assets had not been sold to the special purpose vehicle -- even though ABS had been the only financing path open to LTV at the time given the company's longstanding problems. The bankruptcy judge nearly agreed with executives. In the end, LTV received debtor-inpossession financing that took out the secured bondholders. LTV's deals were not whole business securitizations, and this has so far remained a one-off case of true sale being called into question in bankruptcy court. But the number of employees at risk of losing their livelihoods gave the judge an incentive to consider keeping the securitized assets of the company with the employees, Macy says. Given their structure, whole business securitizations could be more prone to evoke similar sentiments than regular asset-backed deals. Because of these kinds of issues, many regard WBS as a

kind of hybrid of secured and unsecured debt financing. " When we wrote our first report on this back in 1999, we basically said WBS is a peculiar example of senior secured funding," says Alexander Batchvarov, head of international structured credit research at Merrill Lynch in London. Investors in UK deals have fewer concerns because bankruptcy laws there are more creditor friendly: if the special purpose vehicle the assets are sold into holds liens on both the fixed assets, such as the land and the building, as well as the floating assets, such as receivables, then the administrator of the SPV has full control over the assets. Bankers, lawyers and the rating agencies back in the U.S. have come up with some ideas that have helped to kick-start the market. Rating agencies are imposing structural features in

"Most people would have said before we did that deal that you could never do a whole asset securitization of that size on a company like Dunkin'."

Sandra Horbach, managing director at the Carlyle Group

the deal that protect against the possibility of bankruptcy. One example is to significantly limit the ability of a company to take on additional debt once it has sold a WBS deal. Another is performance triggers. WBS deals often have interest-only periods, or partial amortization, in which excess cash flow goes back to the sponsor. If overall cash flow begins to deteriorate, the deal can go into what's called full turbo, where all cash, after paying expenses and interest, is used to amortize the bonds or fund a reserve account. "WBS deals tend to have much more elaborate triggers than traditional securitizations," says Macy. "Among other things, this minimizes exposure to a successful attack on the structure." Ratings agency analysts say they've been talking to a number of companies about how to use these features to structure deals. They estimate a handful of deals similar in size to the Dunkin' and Domino's deals could come to market this year. Just how large a market for WBS develops will ultimately be determined by issuers' willingness to accept the restrictive covenants required to make these deals work, and investors' appetite for the inherent risks in this structure, Standard & Poor's wrote in a report issued in February. Says Eric Hedman, a director at S&P: "This market will probably never be as big as the term auto securitization market, but the interest in this kind of securitization, as an alternative to bank and bond debt, is much more pronounced today than in recent years." Caren Chesler is a freelance journalist. Her work has appeared in The New York Times, Bloomberg Business News, Investors' Business Daily, Investment Dealers Digest and Financial Advisor Magazine.

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