ResearchThe Weekly (5/31)

The Weekly (5/31)

May 31, 2024

When was the last time you had a Subway sandwich?

It was around college graduation for us, but it’s not because we don’t love a good turkey club, rather the insurgence of other fast casual options that fit the bill (h/t Jersey Mike’s).

Although it hasn’t been top of mind for us, Subway has been dominating the mindshare of some of Wall Street’s biggest institutions this week as they bid at Subway’s oversubscribed debt offering.

The transaction, although off the beaten trail, offers an interesting case study on some of the niche downstream impacts of the higher for longer interest rate environment.

Roark Capital, a private equity firm, announced plans to acquire the Subway franchise in August of 2023. To purchase the sandwich maker, Roark is leveraging what’s called a whole business securitization - the latest development in a changing interest rate environment.

A whole business securitization (WBS), a spinoff of the better-known leveraged buyout (LBO), requires a company to pledge most or all of a company’s assets as collateral (think: franchise royalties, supply-chain rebates, inventory, real estate, etc.). By doing so, the company is able to receive lower financing costs thanks to additional protection provided to lenders.

These types of deals are becoming more common place for private equity investors, especially in the franchise space.

How does it work exactly?

WBS structures can secure capital at lower rates as investors and ratings agencies are provided with detailed data sets covering various parts of the business. This data allows for a more granular analysis of the operating history of franchisees, enabling investors and ratings agencies to model downside risk to assess where royalty revenues can continue to sustain debt servicing costs if sales drop.

The Subway financing is the largest deal to date highlighting the momentum in the WBS market. But Subway isn’t alone: Dunkin’ set the original high-water mark of $2.5 billion in 2015, and these deals have quietly financed other multi-billion-dollar transactions from Zaxbys to the bakery chain Nothing Bundt Cake.

It's easy to say that the renewed interest in WBS deals is largely attributed to the rising rate environment.

Gone are the days of free money where capital could be easily borrowed for low-single digit percentage points. The same deals that once hovered close to 7% interest are now closer to 11-14%. If it’s a multi-billion dollar deal, leveraging a WBS could save the company (and the investor) tens of millions of dollars over the life of the loan.

What’s interesting, though, is that the whole business securitization trend is also leading to multiple expansion.

Investors can secure not only a cheaper cost of capital but also higher debt multiples than what is available through mainstream debt financings. This gives dealmakers an edge in auction processes, as they have more capital available and can outbid competitors.

The result? Potentially higher purchase prices and exit multiples. A counterintuitive outcome given that higher rates usually have an inversed impact.

For now, whole business securitization has largely been siloed in the franchise world but who’s to say these principles can’t be applied to other fields?

With the recent successes, dealmakers are now exploring whether a WBS structure can work for other large M&A transactions. Performing rights organizations, fitness franchises and coin-cashing machines operators all come to mind as suitable offshoots.

As interest rates remain elevated, businesses and investors will be forced to get creative if they’re looking to raise debt or finance growth. Maybe whole business securitizations offers the next frontier for folks to reduce expenses and continue expansion.

Have a great weekend,

– Your Titan team


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