Not all that long ago, when a company needed some financing, it went to a bank and got a loan. Or maybe it talked with private-equity firms or other investors and sold some equity. But this is 2024, which means that generations of bankers have had plenty of opportunity to make the whole thing more complex.
In the restaurant space, one popular bit of financial engineering is known as a whole business securitization. And it is popular among a certain subset of the industry, specifically large franchised chains.
A bunch of restaurant brands, from Applebee’s to Zaxby’s, have used a whole business securitization, or WBS, as a way to borrow money. This year, Roark Capital employed the largest WBS on record to fund its purchase of Subway. And then it went back for more.
The mechanism is far more complicated than traditional forms of debt, and it is not for everybody. But it enables these companies to borrow at lower rates, which can save them millions of dollars over the years.
That is music to the ears of CFOs and corporate boards looking to improve profitability any way they can. It has funded massive acquisitions, helped companies save millions and allowed at least one company to multiply its size several-fold in just over a year.
“It’s a very stable structure if you’ve got the scale,” said Andy Wiederhorn, the founder and chairman of Fat Brands, which engineered nearly $1 billion in acquisitions in 2020 and 2021, largely using WBS.
There is a downside to this, however, both for the borrower and the people investing in such deals. One company finding that out now is TGI Fridays, which just lost control of most of its assets after a trustee over its WBS declared a rare “manager termination event.”
How it works
A WBS allows companies to borrow funds at lower rates by essentially eliminating much of the risk to the lender, in this case buyers of bonds.
Companies use their cash-generating assets to back bonds. In the case of franchise restaurant chains, that typically means revenue from royalties paid by franchisees or licensees—a typically stable source of generally profitable cash.
The WBS is structured in a way to provide some protection for the bondholders, which enables the bonds to be sold at “investment grade” ratings, which lowers the interest rate and therefore the borrowing costs to the company.
Borrowers create secondary companies, and then pledge their revenue-generating assets used to back those bonds to that company.
These secondary companies typically have names that look like they were crafted by a chief financial officer, probably because they were, such as “Subway Funding LLC” or “Bojangles Issuer LLC.”
That secondary company will issue bonds that are sold to investors. It sends the funds raised from that sale back to the parent company.
The secondary company then collects royalty revenue from franchisees—or whatever other revenue-generating assets are used to back the bonds. It first pays the bondholders what they’re owed for the debt. And then it sends whatever is left back to the parent company, which will use it to pay other bills.
The original company effectively becomes a holding company that simply manages the secondary company, which owns most of the assets.
The way in which the system is structured provides some security for the investors buying the bonds, because it ensures they get repaid first. It prioritizes their payment before other vendors get paid.
Thus, even in situations when the brand struggles badly, the debt can get repaid. Local Insight Media, a company that published Yellow Pages—phone directories for those of you too young to know what those are—filed for bankruptcy in 2010 and emerged a year later. But the bondholders were repaid in the case, which often doesn’t happen with lenders in bankruptcy situations.
All of this results in cheaper debt. Standard & Poor’s in a December 2022 podcast noted that 99% of the WBS ratings are “investment grade,” which comes with a lower interest rate. By contrast, the “vast majority” of corporate ratings are “speculative grade,” effectively a lower credit rating.
At a glance
Securitizations take hold
The structure has been used for decades by a variety of companies but it gained popularity among franchise restaurants in the mid-2000s.
Domino’s Pizza notably used a securitization in 2007, which has saved the company tens of millions of dollars in financing costs in the years since and has quietly played a role in the brand’s comeback.
Domino’s shortly thereafter launched a new pizza recipe and then embarked on more than a decade of growth that would make it the world’s largest pizza chain.
The structure works for larger companies that have a lot of revenue-generating assets, such as intellectual property or franchise royalties. Those royalties provide a stable source of revenue that’s more recession resistant than, say, operating an actual restaurant.
Restaurant chains have been playing the securitization game like a piano in recent years, and fast-food chains in particular account for the bulk of such transactions. At least two-dozen major restaurant chains have a WBS in place. There have been more than a dozen such WBS bond sales this year alone. Most of them have been restaurants.
The most notable of these recently was Subway, which took out nearly $5.7 billion worth of debt in three separate bond sales, securitized with royalties paid by its franchisees.
The first such bond sale Subway did, worth $3.35 billion, was the largest on record. And the debt helped the private-equity firm Roark fund much of its purchase price for the Miami-based chain.
That deal may not have happened without it, at least at the $9.6 billion price for which Roark paid to buy the company.
Rising interest rates have increased the cost of debt. And Subway’s general challenges in recent years, notably closing restaurants, would make traditional lending that much more difficult. By using asset-backed securities, Roark could meet Subway’s asking price.
The financing also fueled Fat Brands’ insane growth in 2021. The owner of Fatburger had mostly bought struggling or smaller companies that could be had for relatively lower prices. It then spent $25 million for Johnny Rockets, $443 million for Global Franchise Group, $300 million for Twin Peaks and $130 million for Fazoli’s.
Wiederhorn said his background in real estate finance, where securitization is commonplace, gave him an understanding of the practice in the franchising business. He tried to start Fat Brands with securitized debt, but it took some time to get investors to warm up to the idea.
“Once we established ourselves as an issuer, we were able to go back to bondholder groups,” he said.
The lower cost of debt is the obvious advantage, particularly now that debt costs are generally higher. WBS also comes without many of the restrictive covenants, or various requirements, with traditional loans. The bonds are also for longer terms, often 30 years, than traditional debt—though most companies refinance their bonds every four to five years.
Complexities and disadvantages
WBS is certainly not for everybody. The mechanisms are complicated. They limit companies’ financial flexibility. They also encourage more debt on the part of franchisors that could one day create significant headaches. And many of these deals are designed to protect the investors.
Larger brands tend to be the most frequent user of WBS because they have pay for larger finance departments that can manage their various complexities.
That includes dealing with ratings agencies. The bonds typically have to get rated by agencies, such as Kroll or Standard & Poor’s, which examine the structure of the securitization and apply ratings to them. But those ratings are ongoing, which requires companies to update their budget and cash flow models on a regular basis.
“It takes a team,” Wiederhorn said. “You’re not just on autopilot.”
Companies also limit their financial flexibility in such arrangements, given that most if not all the cash-generating assets are isolated and put under strict requirements.
This can also create significant headaches when brands have problems. This is happening as we speak with both TGI Fridays and Hooters, a pair of casual-dining brands that have WBS debt arrangements.
Both companies have had their debt downgraded recently over poor performance. But Fridays’ issue has been more serious. The company apparently overpaid itself a management fee, using it to pay overdue bills from vendors. That, plus other issues, led Citibank, the trustee overseeing the WBS, to terminate Fridays as manager.
In so doing, it placed control of the assets under the securitization, which was most of them, including royalties paid by company stores, into the hands of a backup manager, in this case FTI Consulting.
Most WBS deals are structured with such backups in place. Trustees overseeing the securitization can in certain cases place control of the assets under a different manager, which ensures the bonds get repaid if problems arise.
The new manager can even sell those assets if necessary.
The Fridays' issue is exceedingly rare. A manager termination hasn't happened with a restaurant franchise before. And even those who are intimately familiar with the funding strategy are at a loss to understand what will happen from here. "We're in uncharted territory," one said. Most likely, the backup manager will keep the employees on, manage the business and get the debt paid.
The termination was not over unpaid debt, after all, but a management issue. Fridays had been paying down its debt and had plans to pay it all off by selling company stores to franchisees and the entire company to the U.K.-based operator Hostmore. After the termination, that sale fell through. Hostmore itself is in the U.K.-version of bankruptcy because its own restaurants won't generate enough of a sales price to pay off the debt. And TGI Fridays is in limbo.
Yet it seems unlikely that the situation will sour restaurants on securitizations. Such failures are rare, after all. And companies love to save money on debt.