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Should you join the securitization craze?


Jeff Lawrence

Franchised brands released billions more in securitized bonds to the investor community this year as the practice known as securitization grows.

Securitization is a trendy topic all across the investment world—even Bob Dylan and Neil Diamond have become securitized assets under a new bond from a performing rights organization. Investors will soon be able to buy bonds and generate a return on future revenue generated by people playing their music. Why? Investors want to buy in because Bob and Neil are classic artists with a predictable high volume of listeners.

It’s the same reason brands such as Domino’s, Wendy’s, Jack in the Box and Dunkin’ are on the asset-backed securities, or ABS, market. They are cash flow machines with generally predictable results, a long operating history and valuable branding. That’s what makes a good security for the kinds of investors that tap into the market.

Investors are looking for predictability, and many are required to only invest in securitized assets. Firms such as insurance companies, big institutions and mutual funds all buy in for expected yields between 2 and 5 percent. That’s about half of the long-term average of the S&P 500, but without the volatility.

A new wave of franchise securitization has these investors especially eager to buy because deals from the likes of Jack in the Box, Wendy’s and Massage Envy represent a way to tap into the lucrative retail sector instead of typically boring stuff like car and home loans. In the past 12 months, franchised companies issued $7.8 billion in bonds under whole business securitization structures, according to financial research firm Finsight.

But before those investors can sign on for the next round of Wingstop securities, the companies have a lot of work to do.

Process first, payoff later

“Securitization is the process of taking something that’s typically not a security and transforming it into one,” said Leo Efstathiou, founder and CEO of Finsight. “It’s taking assets that are either real or financial and packing them up in a such a way that they can be traded with the efficiency of a typical security.”

Efstathiou started his finance career helping companies set up their securities, mostly ABS. Those loans are all backed up by collateral like a home or a car; if the loan isn’t getting paid and it’s not flowing to investors, the asset can be repossessed to collect some of what is owed.

In franchising, the perfect correlation is the royalty, the roughly 5 percent of sales that flow up to the company. It’s a generally predictable flow from many diverse operators to insulate from market-to-market difficulties. But because there isn’t always a clear and transferrable asset, franchised companies generally fall under whole business. As the name suggests, these companies aren’t peeling off parts of the business. After all, what is a rose without thorns and what is Domino’s without its logo?  

“Whole business is a little bit strange in that it’s very difficult. What is Domino’s without its IP? How do you strip out the Domino’s Pizza without having access to the Domino’s brand, the app, the ingredients, the recipes, the supply chain?” said Efstathiou. “You can strip out loans from Chrysler and leave them isolated. But how could you ever eat a Domino’s without ever interacting with Domino’s, you can’t do that. So whole business is not just the franchise fees, but all the IP that makes those franchises work.”

Whole business securitization is pretty rare; fewer than 20 companies have done it because it’s hard.

First, before even thinking about the process, a potentially securitized company needs massive scale, a high level of sales ($100 million-$150 million in revenue), a diverse operating footprint, good cash flow and a long operating history. But it also needs to put in some serious work beforehand and provide ongoing support for security holders.

For these select companies, there are easier and faster ways to get capital.

Domino’s charts the course for ‘zors

Jeff Lawrence, Domino’s CFO, was there in 2007 when the company made some waves by becoming one of the handful of companies to take it on, and the first U.S. food brand.

“We kind of pioneered it, we did it for a couple reasons. It was an attractive fixed rate, which was apples to apple better than a traditional bank. And it was flexible,” said Lawrence. “I was actually the corporate controller at the time and it was a heavy lift, but if you look at the amount of money we’ve saved with this structure, it’s completely been worth the effort.”

He said it’s largely a legal and finance exercise boxing up disparate parts of the business and getting all the valuable assets into the structure. But once that months-long process is done, he said, it’s “rinse and repeat.”

Since 2007 Domino’s has come back to the securitized market four times, in 2012, 2016, 2017 and 2018, making it the preeminent borrower in the space, and it has made securitization the dominant source of funds for the business. Clearly, something is working.

“Over the last decade, we’ve saved tens of millions of dollars,” said Lawrence. “With added flexibility to invest on behalf of our franchisees and invest in the long term health of the brand.”

How? Securities come with a lower cost of capital because asset-backed or whole-business securities are seen as less risky, so investors give more favorable rates on their money and are willing to allow higher debt levels. So every one of those five securities offerings from Domino’s saved many millions as it raised nearly $7.5 billion over the years.  

“Those people that can qualify, they have two questions: Is it worth the extra time to set it up the first time and is the juice worth the squeeze?” said Efstathiou. “It’s not worth the squeeze for everyone. But for Domino’s to shave off two points off $3 billion, that’s $10 million a year.”

As for drawbacks, there aren’t many. There’s a lot of work on the front end and plenty of reporting, but Lawrence said it’s pretty close to what they already report as a public company. Efstathiou said it could potentially make it harder to get additional debt, but bankers allegedly increased Domino’s 2017 offering by $100 million because investors were so eager to get in.

Everyone can win. The major investors get new options for their limited investment rules, securitized companies get better access to and cheaper debt, and shareholders do better. When a company goes from borrowing at 6 percent to 3 percent, for example, it’s the same business with the same revenue with lower cost of capital and thus better returns.

Expect to see the trend toward whole-business securitization continuing for the select few companies that qualify.

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