Imagine you are a company boss, apprehensive about attention from private equity groups and activist shareholders.
Then someone tells you your loans and bonds could be replaced by cheaper debt, perhaps in a larger amount, while giving you more flexibility – for example, to pay dividends or buy back stock.
It may sound too good to be true, but for some businesses it is possible. The key is the use of complex structuring techniques to isolate particular assets and cash flows and borrow against them.
The resulting structure echoes traditional asset-backed securitisation, but involves lenders taking operating risks as well as more traditional financial risks. The technique, known as “corporate” or “whole business” securitisation, does not suit every company – one quid pro quo, for example, can be a reduction in managers’ operating discretion. But when appropriate, it can be transforming.
One recent example is Domino’s, the pizza group, which completed a $1.85bn securitisation of its business this year. “Our look at the maths shows this is a slam-dunk, so long as you plan to take the leverage to optimal levels,” says David Brandon, Domino’s chairman and chief executive.
Domino’s is unusual in several ways. It has a strong US franchised restaurant brand and a business model that lends itself to whole business securitisation.
Just as importantly, until relatively recently the now-listed company was under private equity ownership.
That gives Mr Brandon and his colleagues a mindset that makes them keen to borrow as much as the company can reasonably support in order to reward shareholders.
Securitisations have been used by other US restaurant chains, notably in the acquisition by private equity groups of Dunkin’ Donuts, owner Dunkin’ Brands in 2006.
More are on the way. In February, Applebee’s, the restaurant chain, hired Citigroup, Lehman Brothers and Bank of America to explore possibilities, including a securitisation. This month, another restaurant group, Ihop, agreed to buy Applebee’s. Ihop plans to raise about $2bn in cash for the deal from a securitisation of Applebee’s business and additional borrowing under its own securitisation arrangements.
The potential of the technique is not limited to restaurants or franchising groups. All the big groups in the US cellphone tower ownership business have shifted to a 100 per cent securitised financing structure, most recently American Tower.
“We’ve set these securitisations up effectively as captive finance companies,” says Rob Krugel, head of the esoteric asset-backed securities business at Lehman.
Ten years ago, David Bowie collected cash upfront for future music royalties using a securitisation structure.
While not strictly a whole business, the transaction had relevant characteristics, as do other music and film deals where revenues are uncertain. Music group EMI, itself in private equity’s sights, is believed to be considering securitising its music publishing assets.
“I would say originally it was really driven by private equity sponsors looking to make leveraged buy-outs more attractive,” says Ted Yarbrough, head of global securitised products at Citigroup. “Now, other companies are looking at it as part of their capital structure.”
Financial sponsors like securitisation structures because they provide businesses with “permanent” capital that is almost entirely unaffected by a change in ownership or even bankruptcy of the umbrella business – the listed Domino’s entity, for example.
Corporate securitisation is a particularly active area in the US, but there are opportunities elsewhere. The UK’s pub and motorway rest stop securitisations were probably the first of this type although they had a property-related element missing from some of the newer structures.
In general, however, the use of corporate securitisation in Europe has been on the wane, aided by strong loan markets.
Paul Lund, who heads Standard & Poor’s European corporate securitisation team, says: “Clearly, when there is significant plain vanilla bank liquidity available
in the market, corporate securitisation is going to be less attractive because it’s a complex process and more expensive.”
Figures from S&P show that just £5.4bn worth of deals were done in Europe last year, of which more than £3bn were so-called “tap” issues, where companies raised more money within existing structures.The vast majority were in the UK.
This year has seen a further slowdown, but the yearend total is likely to show strong growth – largely due to the expected £8bn securitisation by BAA, the UK airports operator, which was bought by Spanish construction group Ferrovial last summer.
Much of the corporate securitisation activity in Europe has been related to big, simple assets that often have their cash flows protected by regulation.
Businesses that fit this bill include infrastructure, such as ports and hospitals, and utilities, such as water companies.
There is still activity in healthcare and leisure industries.
Steve Cook, head of European whole business securitisation at UBS, says that activity has been picking up, as private equity buy-out groups and others involved in takeovers begin to consider combining corporate securitisations with junior loans.
He points to NetCare, which bought the UK hospitals company General Healthcare and financed the deal with senior investment-grade debt through a securitisation and more expensive mezzanine debt.
Elsewhere in the world, Mr Yarbrough of Citigroup notes the huge $12.5bn equivalent yen-denominated deal for Softbank in Japan last year.
The deal refinanced Softbank’s acquisition of the Japanese subsidiary of Vodafone, and was backed by the assets and income from the mobile phone business, renamed Softbank Mobile.