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?

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.

“Management that is trying to secure highly rated debt should realize that they can’t necessarily do things the way they did before,” observes Moody’s senior vice president Michael O’Connor. “This type of securitization can change your business.”

Absolute Beginners

Many of the companies that investigate WCS are attempting securitization for the first time. The issuers are often unsophisticated in capital-markets transactions and unprepared to generate the type of operating information that the securitization market mandates. For instance, says Moody’s Weill, in addition to typical financial ratios, his ratings agency collects asset-related information such as franchise growth rate, number of sales per store, vendor delinquencies, and payment rate of purchasers.

The best candidates for WCS are companies that operate in markets with high barriers to entry and low competitive risks. Their brands should have already proved their value; cash flows from new products are too unpredictable.


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