Deals of the year: postmortem

Introduction   The SunGard legacy   Dunkin' Donuts' securitization   A decade of Pfizer deals

Operating company securitizations are a legacy of Drexel Burnham Lambert Inc. It underwrote the first so-called whole-company securitization for franchiser Days Inn of America in 1989, one of the last securities it completed before the firm imploded.

Ambac Assurance Corp. made it possible for Dunkin' by granting a triple-A rating to its debt. But things quickly headed south for monoline insurers including Ambac, and Dunkin' was at risk of a severe liquidity crunch. Days Inn went bankrupt two years after the financing. Dunkin', with a bigger and stronger franchise, emerged unscathed, though there were cliffhanger moments.

Dunkin' was a watershed event premised on markets awash in credit. Securitized deals have been few and far between recently, but with the credit markets' recovery, industry practitioners are revisiting Dunkin's example, this time without Ambac.

"As there is a return to greater M&A activity, I think more companies will consider securitizations because it's an efficient way to raise debt," says Curtis Probst, a managing director at Goldman, Sachs & Co.

Closely held Dunkin', which franchises 16,047 Dunkin' Donuts outlets and Baskin-Robbins stores, doesn't disclose its financials. But according to Moody's Investors Service, Dunkin' boasts annual revenue of about $540 million and systemwide sales of about $7.5 billion, as of November.

Dunkin' placed all of its revenue-generating assets, including franchise royalties, rental incomes, licensing fees and ice cream sales, into a subsidiary whose $1.7 billion debt was then insured by Ambac. The maneuver saved it between $30 million and $40 million in interest payments annually.

Earlier, car rental company Hertz Corp. had done a similar structure, but Hertz securitized only 30% of the $15 billion LBO by private equity investors. In July 2007, pancake chain IHOP Corp. bought larger rival Applebee's International Inc. for $2.1 billion, securitizing franchise revenue and all assets to finance the transaction.

As the financial crisis unfolded, however, the structured finance businesses of monoline insurers' collapsed. Ambac feared a takeover by the Wisconsin Office of the Commissioner of Insurance that could have forced Dunkin' into rapid amortization last year. Had that transpired, all its cash would have been directed to debt payments and supporting existing franchisees, setting aside operating improvements and new-business development.

"At times it was a real nail biter," says Winthrop Minot, a partner at Ropes & Gray LLP who was involved in the complex transaction. "If the securitization had gone into rapid amortization, substantially all of the parent's cash flow would have been lost."

If worse came to worst, the sponsors believed they could refinance the company by providing an equity kicker, says one private equity investor who requested anonymity.

The sponsors tried to reach out to the Wisconsin regulator, which later decided to segregate Ambac's structured debt, sparing Dunkin'.

Ambac filed for bankruptcy in November. By then the credit markets were back in full swing. That same month Dunkin' completed a debt-funded dividend recapitalization that restructured the balance sheet with traditional bank and bond debt.

The new package gives the company more "call flexibility," but it removed the uncertainty relating to the securitized debt. It also gave the sponsors a $500 million payout, roughly 60% of their $800 million equity.

Ambac's woes aside, Dunkin' itself remained healthy. During the crisis, system-wide sales rose to $7.7 billion in 2010, up from $7.1 billion in '09 and $6.5 billion in '07. It opened 676 new stores in 2007, 986 in '08, 545 in '09 and 800 last year.

Its 7.3 times debt-to-Ebitda multiple remains high, and retained cash flow-to-debt was less than 5%, Moody's said. But Dunkin' generated about $120 million in cash from operations in the 12 months ended Sept. 30, sufficient to cover capital expenditures and mandatory debt amortization.

Even in the absence of bond insurers like Ambac, securitizations are far from dead, bankers and lawyers argue. A few are in the works, they say, including LBOs. When assets generate steady cash flow, companies can earn a higher rating by separating out those assets.

But whether large LBO securitizations like Dunkin's will garner support from investors is another question.