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How Domino's Persuaded Wall Street to Lend to It For Less; Whole-business securitization enables companies to issue bonds more cheaply

  Ben Eisen; New York, NY, 11 Oct. 2017  

Restaurant chains are turning to complex debt deals that lower their borrowing costs, but at the price of control over their most valuable assets.

This summer, Domino's Pizza Inc. sold $1.9 billion of bonds backed by essentially all of its revenue streams, including payments from franchisees, intellectual property and license and distribution agreements. The deal, which allowed it to borrow at well below the going rates on junk bonds, was the latest example of firms putting all their cash-generating assets into separate entities that are used to back the debt.

The practice, known as whole-business securitization, is enabling companies to issue bonds more cheaply by effectively giving lenders more-direct access to the most valuable pieces of their enterprises. The companies that have done these deals tend to have stable cash flows, but many would likely have trouble getting investment-grade ratings if they wanted to issue typical corporate bonds, market participants say.

In the case of Domino's, the pizza chain drew an investment grade BBB+ rating from S&P Global Inc. It is one of the earliest users of this structure, and had a junk level rating until 2007, when it paid off its old debt to do its first of four whole-business securitizations, which the company says has saved it tens of million of dollars in borrowing costs over the last decade. The most recent deal was so popular that bankers increased its size by $100 million, according to a person familiar with the matter.

"Within this whole business space, it's as hot as it's ever been," said Jeffrey Lawrence, the chief financial officer of Domino's. "There are more market participants, more people who have done their homework and are comfortable with it."

Through September of this year, a group of mostly restaurant chains have borrowed $6.7 billion through these transactions, more than during any other three-quarter stretch since at least 2008, when financial technology firm Finsight began tracking the data. Finsight says there have been at least 25 deals since the financial crisis, with eight so far this year. If the activity remains at its current pace, 2017 will be the biggest year in memory, market participants say.

In some ways, the structure requires the company and investor to iron out what would happen to the debt in a hypothetical bankruptcy before the securities are even issued. Typically with these deals, cash flows like franchise fees continue to be pledged for repayment, and investors can snatch the assets in the event of a default.

While the company generally benefits from lower borrowing costs, the rigidity of the debt structure can leave it with less ability to issue debt outside the securitization or sell assets if its cash flows start to decline.

"If the business goes sour, it's not like you have anything left in reserve," said John Kerschner, head of U.S. securitized products at Janus Henderson Investors, who has participated in some recent deals and passed on a few. "What you could see in a business really deteriorating rapidly, it would go down that much quicker."

A healthy outlook in corporate America and years of near-zero interest rates are heralding a renewed appetite for bond structures that link risky companies trying to lower their debt costs and yield-starved investors in search of income. In exchange for borrowing at cheaper rates, they're taking on a debt structure that can limit flexibility, potentially shortening their lifeline if the business takes a turn for the worse.

Since these issuers pledge all their assets to back the bonds, the structure isn't any riskier for investors than if the same company sold unsecured bonds that aren't linked to specific assets. But it echoes the precrisis era in which increasingly complex products became popular.

Whole-business deals are a small but growing piece of the market for so-called esoteric asset-backed securities, a loose category of debt made up of unusual assets such as music royalties, shipping containers, timeshare properties and even inventories of rough and polished diamonds. The pickup in whole-business issuance in the April-to-June period this year helped lift the broader category of esoteric ABS to its best quarter since the end of 2010.

"People have been pushing toward more and more esoteric deals," said Keith Allman, a senior analyst in the mortgage and structured finance group at asset manager Loomis Sayles & Co., which has participated in some of the recent whole-business offerings.

Whole business securitization developed in the U.K. with so-called pub financing in the 1990s. Lehman Brothers bankers began applying the concept to U.S. restaurant chains in the mid-2000s, typically using bond insurers to guarantee the debt. The structure began to catch on, and while the deals generally held up during the financial crisis, market participants say, the prices on the debt fell along with the broader ABS market.

Chains including Jimmy John's, Dunkin' Brands Group, Inc., and TGI Friday's Inc. have all completed deals this year. Coinstar, the Apollo Global Management LLC-owned operator of coin exchange machines, has also done a deal this year.

A few years ago, a falloff in cash flows pushed Local Insight Media, a publisher of Yellow Pages directories, into default on a securitization done in 2007. It is the only whole-business default in S&P Global's records.

The recent popularity has diversified an investor base once made up of mostly insurance companies. Now many big money managers are buying into these deals, bankers and issuers say. The yields are often better than what an investor could get on other types of high-grade corporate debt, which is in the neighborhood of 3%, according to Bloomberg Barclays. Still, prospective buyers must often invest more time analyzing the company, industry, and legal structure of the debt--all for yields that are lower than in the junk bond market.

Other investors have found unexpected benefits. Mr. Kerschner said four of the analysts at Janus Henderson were so taken by Jimmy John's after the company did its securitization in June that they began planning to open up their own sandwich shop franchise.