Whole business securitizations have been all the rage in the restaurant business lately, and for good reason: They’re generally cheaper than other options.
For the most part, this wasn’t an issue for the entire time this financing mechanism was used. Until, that is, last year, when TGI Fridays lost control of its assets in a “manager termination event,” and then filed for bankruptcy. And then Hooters filed for bankruptcy last month. None of that had ever happened in the restaurant industry, and it hadn’t happened in any industry in 15 years.
Those two bankruptcies highlight a key issue in that particular market: They promote unnecessary risk, particularly for the companies that use them.
I covered this topic on my podcast this week, and also wrote an explainer piece here. In short, a WBS is a form of structured finance that uses a company’s cash-generating assets to pay off bonds. Companies create secondary companies and then pledge those assets to those companies and continue to run those assets under a management contract.
That company collects the revenue, pays the bondholders and sends what’s left back to the original company.
The structure provides some downside protection for the bondholders, which came into play last year when Fridays lost its management agreement after the company overpaid itself a management fee to pay off vendors for its company-run stores that were not part of that securitization.
A bunch of companies have used securitizations over the years, and they were especially popular last year as interest rates drove up the cost of borrowing. There were a dozen offerings in the restaurant industry. “It’s really quite simple,” Ed Cerullo, a credit analyst with Octus, told me on the podcast. “It’s the cheapest form of capital.”
Because of the guarantees attached to the debt, the investments are considered safer and come with a lower interest rate. Standard & Poor’s noted that 99% of WBS structures are given “investment grade” ratings.
But it was also easy to see the risk associated with the debt when the companies created these structures. It’s one thing for Domino’s to use a whole business securitization. It’s another thing for a full-service chain to do this at a time when demand for such chains is on the downswing.
This was especially true in 2021, when Hooters of America created its securitization. That was after the pandemic, when demand for full-service restaurants was particularly in question. Fridays’ WBS was in 2017, and in fairness to the company nobody knew the pandemic would hit in 2020. But it was still a declining chain at the time.
Indeed, many companies wouldn’t be able to get the debt at all. For its entire history, Fatburger owner Fat Brands bought struggling and declining chains at extremely low prices for its entire history. At one point it had to borrow money from Sardar Biglari at credit card-like interest rates. Fat Brands that same year used a complex series of instruments to fund a $10 million purchase of the declining Elevation Burger.
And then in 2020 and 2021 Fat Brands used a series of WBS deals to orchestrate the acquisition of $1 billion worth of restaurant chains.
WBS structures enable companies to take on a lot of debt, which helps explain why private-equity firms like them so much—the firms were behind both the Hooters and the TGI Fridays deals. The structure itself lowers the cost. But as Cerullo noted on the podcast, it also carries restrictions that can prevent companies from investing behind marketing or other efforts when times get difficult.
In short, WBS is yet another instrument that can be used to overleverage companies at the expense of their long-term health.
Restaurant companies need debt and always will. And there will always be some, particularly those led by private-equity firms, that will take on too much debt, especially when it’s available for cheap. And that’s exactly what whole business securitizations enable.