Franchise fee securitization on the menu

Bonds backed by restaurant sales, franchise fees, licenses and royalty payments – essentially, all of a fast food chain’s operating assets – are in hot demand. Since January, five deals totaling nearly $4.9 billion have priced or been launched; the latest, a $2.075 billion offering from Domino’s Pizza, came this week.
Known as “whole business securitizations,” these transactions are still relatively rare, so it’s unusual to see so many in such a short period. They’re typically used to refinance the debt of franchises acquired by private equity firms in leveraged buyouts. Moving operating assets to a bankruptcy remote affiliate separates them from the credit risk of the heavily indebted parent company; most bonds are rated triple-B, at the cusp of investment grade.
Some of this year’s issuers, like Domino’s, were taken private years ago and are refinancing whole business deals that have been paid down. But several, including Five Guys and Coinstar, are first-time issuers. All are taking advantage of a strong market for structured finance. Issuance of all kinds of U.S. asset-backeds reached $193 billion in the first five months of the year, up 40% over the same period of 2016, according to S&P Global.

The first whole business offering of the year came from TGI Friday’s, which raised $450 million in February a deal underwritten by Barclays. The Dallas-based quick-casual chain has one of the lowest store counts of recent issuers, at 903. It also has a high concentration of overseas stores, which account for 42% of sales, according to S&P Global Ratings. Same stores sales have been declining; to drum, but the company hopes to boost sales by remodeling stores, improving and simplifying its menu, and focusing on bar sales. To entice investors, it pledged to repay 2% of the principal of the senior notes per year. Proceeds will repay debt taken out when the company was acquired by Sentinel Capital Partners in 2014, and pay a dividend.

Domino’s Pizza, the restaurant and delivery chain owned by Bain Capital, is marketing $2.075 billion of notes backed by the fees and payments received from its network of more than 14,000 franchised stores across the globe. It's the company's first trip to the securitization market since 2015, and the largest transaction of this type since since DB Master Finance issued $2.6 billion in bonds in January 2015 backed by payments from Dunkin’ Donuts franchisees.

Miller Investment Management took an initial stake in Five Guys, the premium hamburger chain, three years ago, in 2014. In May, the company launched a $440 million transaction backed by royalties from 908 franchise locations and 452 company-operated restaurants, representing approximately 66.8% and 33.2% of total North American locations, respectively. Proceeds will be used to refinance its existing credit facility, pay certain transaction expenses and fund expansion, including the opening of 82 stores this year. A risk cited by both KBRA and Moody’s Investors Service is the high percentage (35%) of company-owned stores. Cash flows from company owned stores are less certain because operating costs can eat into them, whereas franchisees must pay a contractual percentage of royalties, regardless of their earnings, according to Moody’s.

The $800 million securitization completed by Focus Brands Funding in April involved franchise agreements with more than 5,000 locations for all six of its store brands, including its “fast casual” segment of Cinnabon, Auntie Anne’s and Carvel shops found in airports and malls. Proceeds from the triple-B rated notes will allow Focus to pay off a $625 million loan that rated only B2 by Moody’s Investors Service. The deal furthers Focus’ efforts to deleverage from a high of 7.0x at the end of 2013 to 5.8x last year, before taking out the $625 million loan. The debt was built up from the acquisition of the different brands (which also include McAlister’s Deli, Schlotzsky’s, and Moe’s) by its private equity sponsor Roark Capital Group. One of the chief risks for investors, according to S&P Global Ratings, is the “signficant” decline that the Focus snack brand locations have seen in shopping malls. “The ‘snack brands’ may be more volatile in a period of stress, as they generally are not a destination in and of themselves,” but rather an impulse buy for hungry shopping mall customers, the presale report stated.

Coinstar’s relationships aren’t with franchisees but with retail/product partners like Wal-Mart and grocery chains such as Kroger’s and Albertsons that benefit from the in-store vouchers the kiosks print out. Coinstar enjoys long-tenured relationships averaging 18.2 years with its top 10 retailers – but the company also has patents that will expire during the life of the transaction, according to Kroll Bond Rating Agency. A $900 million offering completed in May was used to repay of a $560 million first-lien bank loan due 2023, as well as a $134 million second-lien loan; it will also fund a dividend payment to Apollo Global Management, which acquired the coin-change kiosk operator’s parent company Outerwall last year.

Center Parcs Group, a company that operates short-break vacation sites across England, is another repeat issuer. In May it launched a £830 million (US$1.06 billion) offerings of bonds backed by its operational cash flow. Proceeds will be used to refinance existing debt and pay a dividend to a related firm. The cash flow is derived from Center Parc's five getaway settings of secluded village cabins and lodgings, which have had a five-year average occupancy rate of 97%, according to S&P Global. Center Parcs reported net EBITDA of £155.2 million on revenues of £312.6 million in the first three quarters of fiscal year 2017 – a margin of 49.6%. The company’s revenue-per-lodge figure was £179.6 million, a 4.9% jump from last year.