Article/Intelligence
Hooters’ Whole Business Securitization May Test Bankruptcy Remoteness, Credit Enhancements of Structure; Comparison With TGIF Illustrates Different Funding Mechanism Due to Mix of Company-Owned vs. Licensed Restaurants
- A potential bankruptcy filing of Hooters of America, manager of the whole business securitization, may impact the structure differently from what was the case with TGI Fridays’ securitization because of a significantly different mix of cash flows supporting the securitization structure.
- Hooters has a relatively low franchise mix in its system, and its whole business securitization includes contribution of profits from company-owned stores, exposing creditors to additional cost pressures.
- Company-owned store EBITDA makes up roughly half of the securitization collections from which management fees are paid to Hooters’ parent as manager. While more cash flow is being contributed to the securitization, the management fee associated with company-owned stores is typically higher. The management fee paid to Hooters’ parent appears to be on the high end relative to other securitizations, and this reduces the net cash flow to service securitization.
- TGI Fridays by comparison has few company-owned stores, and it retained these outside of its securitization. Only royalties from these stores were contributed to the securitization, and the deferral of these, in addition to the overpayment of the management fee, contributed in part to the removal of TGI Fridays as manager.
Hooters of America, or HOA, may be a further test case for the robustness of the WBS structure, ahead of potential filing. Unlike TGIF’s securitization, which was secured by franchise royalties and company-operated store royalties, HOA’s securitization cash flow collections, in addition to royalties from franchised and company owned locations, also appear to include company-operated store EBITDA, according to a KBRA ratings reports seen by Octus. The HOA securitization creditors are thus inherently more exposed to variability in operating costs and economic cost considerations made by the HOA parent to affect margins.
It is also not clear whether the HOA parent company, as shown below, has any debt or operations outside that of performing its duties as manager under the securitization and operating the company stores whose royalties and profits have been contributed to the structure. Thus, the securitization assets, while legally separate from the parent’s estate to the extent that the true-sale is not unwound in bankruptcy, may in effect constitute the entirety of the underlying business cash flow.
Whole Business Securitizations
The whole business securitization, or WBS, construct has been used by restaurant franchises to securitize royalty streams from franchised and company-owned stores, and in some cases, operating profits from company-owned locations as well. The parent company, or franchisor, assumes the role as manager under the securitization structure, whereby, having conveyed most or all revenue-generating assets to a special-purpose entity, it receives a management fee to conduct training, as well as marketing of the brand, supply-chain management and ensuring overall quality control so that the franchisees can operate the system under the brand.
In the case of TGI Fridays, the parent was removed as manager on Sept. 3, 2024, in part because of overpayment of a management fee to itself.
TGIF had also been improperly withholding sublicensing fees and had been deferring the payment of 4% royalty on company-owned store sales, according to S&P.
The TGIF transaction was already in rapid amortization since the second quarter of 2020, after the breach of the $1.5 billion systemwide sales-related trigger, and backup manager FTI Consulting Inc. assumed the role of successor manager, according to a KBRA comment at the time of the removal. According to the first day declarations, TGIF and the securitization entities entered into a transition services agreement pursuant to which the “Debtors will continue to provide certain corporate and support services for the benefit of the domestic and international franchisees.”
Upon TGIF filing for chapter 11, KBRA noted that the filing affects only the 39 company-operated stores of the system’s more than 500 locations, most of which were franchised. The company’s press release specifies that the TGI Fridays brand and related intellectual property “are owned by TGI Fridays Franchisor, LLC as a result of a securitization agreement with a separate investor group. These entities are not included in the Chapter 11 process.”
Comparatively, Hooters has a much higher company-operated store mix in its overall system, with only 47% of its system franchised at the time of the closing of the Series 2021 transaction. KBRA highlighted in its initial ratings report that the Hooters system has the lowest franchise percentage and one of the highest contributions to securitized collection from company-operated store profits among restaurant whole business securitizations, which in its view could be credit negative.
KBRA notes in its WBS methodology that the quality of cash flow pledged to the transaction is also considered and often includes top-line cash flows such as royalty or rental payments and operating profits from company-operated locations. According to the methodology, top-line cash flow is generally regarded as higher quality because it is associated with lower volatility and is not typically impacted by margin compression. Additionally, it notes that for a franchise business, a higher level of franchised locations relative to company-operated locations may be viewed more favorably because of the larger proportion of top-line revenue, in addition to the potential reduction in operational complexity associated with running franchise operations versus company-operated locations.
HOA WBS
A comparison of the HOA 2021 Series notes and TGIF 2017 Series notes is shown below:
The HOA Series 2021-1 A-2 and B notes were downgraded by KBRA to BB- and B respectively on Sept. 18, 2024, and while the transaction debt service coverage ratio, or DSCR, has fallen to 1.66x, triggering a 50% cash sweep event, as noted in yellow above, HOA has not been deemed in breach of its responsibilities as manager. This would require an interest-only DSCR of less than 1.2x, among other manager termination events
As reported by KBRA in its most recent downgrade note seen by Octus, the system’s total store count was 318 in the second quarter of 2024, compared with 372 a year prior and 377 at issuance. Meanwhile, systemwide sales totaled $876.9 million during the the last-12-month period ending in the second quarter of 2024, compared with $941.4 million for the prior-year 12-month period, albeit up from $785 million for the 12 months ended May 16, 2021. The securitization has a built-in rapid amortization trigger if systemwide sales are less than $425 million. The report notes that while the securitization is current on its payments, over the past several quarters, the casual dining industry has seen traffic and same-store sales declines, partly due to the impact of the current inflationary environment on menu prices.
At the time of issuance in 2021, the structure was levered 4.7x through the A-2 notes and 5.4x through the B notes, on the basis of normalized securitized net cash flow, or SNCF, of $58.4 million. Normalized collections at the time were $80.9 million, of which roughly half was company-operated adjusted EBITDA, as shown below.
Assuming negligible servicing fee and securitization expenses, the implied management fee (collections less securitized net cash flow) at closing was $22.5 million, or 27.8% of retained collections.
According to an S&P analysis of WBS management fees as a percentage of retained collections, management fees averaged approximately 16% for the trailing 12 months ending in the first quarter of 2023..
While KBRA does not disclose the HOA management fee formula in its ratings report, there is typically a fixed based component and a variable component which is either based on unit count or a percentage of retained collections. When based on unit count, the per-unit fee for company-owned units is typically twice that of franchised units (since operating expenses are borne by the franchisee) and could explain why the estimated HOA management fee at 27.8% is on the high end.
