VideoWhole company securitization (WCS), sometimes called whole business securitization or operating company securitization, is a more complex version of traditional securitization. A parent company isolates revenue-producing assets — often the trademarks or patents that are the "crown jewels" of its intellectual property — by selling them to a limited-purpose, bankruptcy-remote shell company. The shell issues bonds backed by the assets and uses the proceeds to provide a secured loan to the parent.
One important distinction from a traditional securitization is that a WCS deal entails few, if any, contractual obligations to deliver funds. The assets must be actively managed, usually by the parent under agreement with the shell, to generate continued cash flow and to preserve their value.
Like the traditional model, however, whole company securitization requires that the assets can be protected from the parent's creditors. To be sure, the Days Inn case of the late 1980s — when the parent company entered Chapter 11, and the bankruptcy remoteness of its shell entity was put to the test — has haunted the WCS market ever since. (See "Ghost in the Machine," at the end of this article.)
WCS is a hybrid structure, notes Ira Schacter, a securitization attorney with Cadwalader, Wickersham & Taft. Because it mixes traditional lending with a securitization that isolates a cash flow stream, the issuer — that is, the shell company — will ask rating agencies to analyze how steady EBITDA is likely to be, and it will treat the flow as if it were a receivable subject to business risk. The magic of WCS, maintains Schacter, "is allowing companies to borrow against amortized debt on a going-forward basis."
Robert D'Loren, president and chief executive officer of boutique investment bank UCC Capital Corp., likens WCS to cash-flow lending, "but in a highly structured manner, as opposed to just lending against EBITDA." So why choose WCS over a cash-flow loan?
Reasons to Be Cheerful
"More bang for the buck," suggests Donald Camacho, chief financial officer of The Athlete's Foot Group. "A company with a low credit rating may never be able to secure a cash-flow loan," or at least not for a reasonable rate. Camacho also reckons that non-investment-grade companies would wind up in the junk bond market, where management would pay higher interest rates for reduced proceeds.
Only about 25 WCS deals have been completed in the United States since the Days Inn deal, and the proceeds have been small — usually between $25 million and $100 million. However, the pace is quickening: UCC's D'Loren estimates that 14 deals were completed during the last 12 months. Officials at Moody's Investor Services claim that several WCS deals are the credit rating agency's pipeline, although they won't divulge the number.
The newness of the class, and the complexity of the deals, makes WCS a hard sell. "Each case is different," says Ellen Welsher, a managing director at Standard & Poor's. Companies have a hard time finding precedents, she point out, because only a handful of deals have been rated and historical databases don't yet exist.
Then there's the touchy matter of who controls those intellectual property crown jewels. In most WCS deals, the shell company is run by former employees of the parent who have been "transferred" — although they never actually change desks or phone numbers. Often they then retain their colleagues at the parent company — who may be just down the hall — to manage the assets.
Since the shell has issued bonds backed by those assets, and since the revenue stream that services the debt depends on how well the assets are managed, a WCS deal incurs operating risk. To mitigate that risk, most WCS deals entitle the shell company to act on behalf of bondholders and substitute pre-approved backup managers. That can make for some hard feelings if the parent and shell companies share a water cooler.
Exposing proprietary data to the backup manager is an operational sticking point in itself, since "the ideal backup manager is often a competitor," notes Nicholas Weill, a senior vice president of Moody's. "You don't want to share your Rolodex and strategy with them."
Longer lead times are another deterrent. WCS deals don't sail through a ratings agency in a week, as a securitization of mortgages or auto loans might do; Weill contends that between three months and two years might be needed to identify operating risks in the business sector, make arrangements with a backup manager, and perform balance-sheet analysis, among other things. Legal technology and underwriting skills also have to play catch-up with this newer asset class, adds Dick Rudder, an attorney with Baker & McKenzie.
Finally, ushering the transaction through management "is not a 20-minute process," declares Camacho, who completed a franchise-fee securitization for the Athlete's Foot Group in August. At his previous job, sneaker maker Converse Inc. pulled the plug on a WCS deal at the last minute, according to Camacho. As he tells it, management balked at operating changes mandated by the bank and rating agency to lessen operating risk; they wouldn't outsource production to an overseas manufacturer or transfer the Converse trademark to a shell company.
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