The Whole Truth

Whole company securitization is helping non-investment-grade companies raise capital and recognize intangible assets on their balance sheets, but can it overcome its checkered past?

Whole 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.

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