Whole-business securitization (WBS), a structured finance product where a company issues secured debt against substantially all of its cash-yielding assets, is now on the radar of dealmakers seeking ways to manage M&A financing costs or increase overall leverage.
Historically, for corporate borrowers with specific types of cash-generating assets, WBS structures have been used to lower the financing costs of debt raised for general corporate purposes or increase overall leverage. Today, private equity (PE) firms and other M&A dealmakers are getting in on the action for a new purpose.
In August 2023, news broke that PE firm Roark Capital Group was planning to secure US$4.9 billion in a WBS deal to fund its US$9.6 billion takeover of sandwich chain Subway. According to Bloomberg, a group of seven banks agreed to provide a temporary loan to Roark for the Subway acquisition, which would then convert into one of the largest WBS deals on record.
The Subway financing is the largest deal to date evidencing this new ground in the WBS market, with dealmakers now exploring whether a WBS structure can work for other large M&A transactions.
This new ground represents a steep change for WBS financings, which started out as securitizations of trademarks and franchise-related agreements. WBS financing has proven particularly popular with fast food chains, with Wendy’s, Dunkin’ Donuts and Domino’s among the issuers to have used WBS finance in recent years.
As WBS has evolved, companies in other industries with licensing agreements or royalties, such as performing rights organizations, fitness franchises and coin-cashing machines operators, have also been able to put WBS structures in place.
Franchisees or license holders, which operate independently from the corporate owners of the brands and trademarks, pay royalties to the corporation based on aggregate sales under a franchise agreement. WBS deals place all these trademarks, franchise agreements (or other royalty or license fee generating agreements) and related assets into bankruptcy remote special purpose vehicles (SPVs) that own the cash flows and intellectual property (IP) rights of the corporate issuer. Debt can then be raised by these SPVs, with the cashflows from the assets in the SPV used to pay the principal and interest on the debt.
Lower cost of capital
Companies with suitable assets that can be structured as WBS have been able to borrow at cheaper rates than those available in the loan and bond markets.
WBS structures can secure capital at lower rates as investors and ratings agencies are provided with detailed data sets covering the royalty and IP rights held by the SPVs. This facilitates a more granular analysis of the operating history of franchisees, enabling investors and ratings agencies to model downside risk to assess where royalty revenues can continue to sustain debt servicing costs if sales drop.
Another selling point of the structure for investors is that risk is diversified across geographies and their local economies, with revenues coming in from thousands of franchisees or licensees in multiple locations. All these elements are analyzed through a ratings agency process that covers the entire business model, and when a WBS is issued an investment grade rating there is an additional layer of comfort for investors.
By creating a structure around the ownership of cash-yielding assets and implementing a priority order for how cash is distributed, issuers build a level of safety for investors that allows for borrowing at a reduced rate compared to a non-securitized structure.
As interest rates have climbed, more companies that could lower borrowing costs by isolating assets into an SPV have started to consider WBS more seriously. In the past, when rates were low, the work involved in putting these structures in place may have caused companies to hold back. However, as the need to refinance is coming up again for certain companies as their bonds mature and debt costs rise, more businesses are exploring WBS options.
Adapting WBS for M&A
As seen in the case of Subway, PE and M&A dealmakers are among the emerging cohort of issuers considering WBS financing for M&A transactions.
Given that the SPVs formed as part of WBS structures are designed to provide that investors will be paid their principal and interest before other expenditures, issuers can secure not only a cheaper cost of capital but also higher debt multiples than what is available through mainstream debt financings. This gives dealmakers an edge in auction processes, as they have more capital available and can outbid competitors.
Applying WBS in a M&A situation, however, is not without its challenges. WBS structuring is very data driven and requires large amounts of detailed information and cooperation from target companies.
Navigating the process also requires significant support from banking and legal advisers that bring a combination of M&A, securitization and leveraged finance experience to the table to help borrowers understand their options and to put the most advantageous financing package in place.
The market is still piecing together how best to make WBS work in relation to M&A. However, given the number of high-profile transactions that have used WBS having been announced, the use of WBS for M&A is expected to become more and more common.