Article/Intelligence
Investment Grade Debt Still Went Bankrupt: What Wall Street Missed About Hooters and TGI Fridays
- Whole business securitizations, or WBS, have been a popular borrowing tool for franchisors but can be “blunt instruments” in downside scenarios, to the detriment of both the franchised business itself and the ABS lender. Conflict between the two may be more acute when the parent company also owns and operates stores in addition to managing the franchise or brand, as layering in the securitization structure does not mitigate underlying business risk. The recent bankruptcies of Hooters and TGI Fridays highlight these risks and challenge the robustness of WBS as structurally enhanced, bankruptcy-remote financing vehicles.
- Based on the 25 WBS in our dataset, leverage is typically 4x to 6.6x, with a 5.33x mean, as measured as debt to securitized net cash flow, or SNCF, calculated as securitized collections less manager fees, servicing fees and securitization operating expenses, which tend to be negligible. This compares with an average leverage ratio of 6.75x, on a debt to EBITDA basis in our non-WBS dataset. We note that SNCF in WBS is typically greater than EBITDA, and therefore SNCF leverage may be understated compared with EBITDA equivalent leverage.
- We will be hosting a webinar to discuss whole business securitizations and other nontraditional securitizations tomorrow, Tuesday, June 10, at 11 a.m. ET, which can be registered for HERE.
The efficacy of whole business securitizations, or WBS, as both a financing vehicle for companies and a structurally enhanced and bankruptcy-remote credit investment has been called into question after the bankruptcy filings of TGI Fridays in November and Hooters in March. Historically used by restaurant and fitness franchisors to create investment-grade-rated debt, resulting in a commensurate low cost of borrowing and suitability to the franchise business model, WBS may not all be fit for purpose, particularly in downside scenarios that give rise to conflicts between investors and the originating parent company in its capacity as manager. These conflicts may be exacerbated when the parent company also owns and operates stores in addition to managing the franchise or brand.
Of the 25 WBS securitizations in our dataset, the average percentage of franchised restaurants (or locations for nonrestaurant businesses such as Lifetime Fitness) in each system at the time of first WBS issuance was 89%. The system mix naturally dictates the underlying collateral in support of the WBS. In systems with lower franchised percentage, operating profits from company-owned stores are typically contributed as collateral to further support the WBS. Of the WBS analyzed, Hooters had the lowest franchised percentage (although this may change post-bankruptcy) at roughly 54% when it issued its Series 2015 notes. For the 12-month period ending the second quarter of 2021, when it issued its Series 2021 notes, EBITDA at its company-operated restaurants accounted for just under half of the securitization’s collections, according to a KBRA report seen by Octus, formerly Reorg, while franchise royalties and fees accounted for only 17%, and royalties from company-operated stores made up the balance. By contrast, in Jimmy John’s Series 2022 WBS, franchise royalties made up 93% of securitization collections, company-owned store royalties 1% and franchise fees 6%. Franchise fees refer to initial upfront payment to the franchisor when opening a location.
Ultimately, a lower franchise mix is typically viewed as credit negative because of the increased exposure to margin pressure and therefore increased cash flow volatility.
Because, in most systems, franchise royalties are structured as a fixed percentage of sales – typically 4% to 6% for domestic U.S. franchises and roughly half that for international locations – WBS often have a systemwide sales trigger for rapid amortization events, whereby if systemwide sales fall below a certain threshold, all collections are diverted to repay principal on the notes before compensating the manager and flowing to equity (which is typically owned by the manager/parent). Below, we show systemwide sales and franchise percentage and detail the underlying collateral for 25 inaugural WBS transactions, ranging from Dunkin’ Brands in 2006 to Subway in 2024.
While it may be both legally practicable and economically advantageous to convey the entirety of a company’s rights to franchise royalties and related payments to a bankruptcy-remote entity for the purposes of issuing debt, it does not functionally alter the role of originating parent as manager of the system and brand. It does, however, provide constraints in terms of how the parent performs this role as manager in furtherance of the brand.
Typically, the parent company or franchisor assumes the role as manager under the securitization structure, whereby having sold 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. Below is the Hooters WBS structure prior to its bankruptcy filing:
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