NEW YORK — Bill Blass did it. So did Guess Inc. Now BCBG Max Azria is in the process of doing it.
The “it” refers to a 25-letter structured finance vehicle called asset-backed securitization (ABS). Fashion firms using this format finance loans backed by the income streams associated with their intellectual property, such as brand trademarks. However, the income stream can also come from other sources, such as the minimums guaranteed under licensing or retail franchising agreements, which then serve as collateral for the so-called ABS.
The technique arose from the real estate market where bonds backed by mortgages have been in use since the 1800s. In similar fashion, the loans provided to firms such as Blass and Guess were each bundled into bonds that were sold to private investors. Those with the requisite level of sophistication to invest in these asset-backed bonds tend to be institutional investors such as venture capital firms, as well as certain high net-worth individuals.
James Malackowski, president and chief executive officer of Duff & Phelps Capital Partners, speaking at a conference sponsored by the World Research Group here last month on “Advancing IP Structured Financing,” said intangible assets such as intellectual property “50 years ago were about one-third of the S&P market capitalization, and now represent almost 90 percent.”
He told attendees that more than $100 billion annually is collected in IP licensing income. In addition, more than $200 billion annually is written off from IP impairments, while more than $300 billion annually is lost in unpaid infringements. Yet, he noted, only 10 percent of all technologies are licensed to third parties, representing “tremendous opportunities” for licensing income streams underlying IP structured finance vehicles.
Robert D’Loren, president and chief executive officer of UCC Capital Corp., observed, “For the first time, a branded product company, such as a fashion firm, can adequately monetize its brand. In the past, this kind of company has only been able to raise significant capital based on its receivables or inventory, which offered it no liquidity.”
The lack of liquidity, he explained, left companies with few financing alternatives, among them so-called mezzanine lenders requiring a 22 to 30 percent rate of return, very expensive equity capital or a combination of the two. He added that the structured finance vehicle is one way in which public firms can even be taken private.His firm does deals involving a minimum of $20 million, with the average in the $30 million range. About $200 million in deals were done in 2002, and the firm expects to do about $500 million in deals by year-end. Asset-backed securitizations, which had zero annual issuance in 1992, have grown to $400 billion in annual issuance in 2002.
D’Loren is working on the BCBG note issue, expected to close later this month. His prior firm, CAK Universal Credit Corp., where he was president and chief operating officer, was the company that handled the Bill Blass bonds, the fashion industry’s first deal involving the asset-backed format.
The Blass bonds represented a huge payday for the late designer, where $25 million was monetized by the royalty stream generated by his label. The acquisition of his business was financed primarily by the sale of $25 million in asset-backed securities. Essentially CAK UCC lent money to the new business owners, Blass’ biggest licensee, Haresh Tharani, chairman of The Resource Club Ltd., and Blass’ chief financial officer, Michael Groveman. Rated “BBB+” by Fitch, the bonds are self-liquidating and due to be paid off in 2009.
Asset-backed bonds, according to D’Loren, are an appealing financing vehicle because they provide a company with a “cheaper way to raise cash, a longer-term investment and reliable liquidity.” He added that because the format is an investment-grade transaction, the company gets a fresh investor pool while at the same time providing bond buyers with high rates of return.
Lenders are protected in case borrowers ever find themselves in a distressed situation because the trademarks and licenses are permanently transferred to a new entity that is bankruptcy protected, according to D’Loren. With that structure in place, the assets underlying the basis for the securities would not be affected should the operations side of the business need to file a Chapter 11 petition. The new firm that holds the assets receives the financing proceeds arising from that ownership. Under the corporate structure that is set up, the new entity licenses the marks back to the operating company. The royalties then owed by the operating firm are used to repay debt.
Control is one major reason the financing and logistics structure works, in addition to the added benefit of decreasing the risks. By separating the assets from the operations, lenders can give themselves absolute control of the trademarks if they choose. In that scenario, if the operating firm runs into difficulties, the lenders can terminate the licensing agreement and find a new manufacturer. In effect, the structure provides for an implicit guarantee that the income stream and required production end of the process can continue even if the original operating firm cannot.There are few financial players in the asset-backed securities market in terms of deals that are done in the fashion industry. D’Loren has done several, including the one for Candies Inc., announced last August. J.P. Morgan Chase & Co. was the banker for the Guess deal.
Another transaction is expected to be announced within the week, this time involving a retailer, according to financial sources who declined to disclose the name of the banker involved in the deal. Market sources indicate that the retailer is The Athlete’s Foot. But officials at The Athlete’s Foot could not be reached for comment. D’Loren, who reportedly is involved in the deal and has been financial adviser to the firm in the past, declined to provide details about other pending transactions.
Sources said deals involving retailers would likely involve variations of the licensing theme regarding the types of assets placed in the new entity. While a retailer would have some brand equity in its nameplate, its retail stores would be the primary source of income. In cases where the stores are subject to franchise agreements, each contract becomes comparable to a licensing arrangement where the stores are different players in the supply chain. Moreover, in such a scenario the income stream is guaranteed because franchise agreements also have minimums that are guaranteed under the contract.
One other key piece to getting the deal done, assuming all other requirements such as obtaining an investment grade rating are met, is having a backup manager. The Jassin-O’Rourke Group is the leading player in the role of backup manager for many of these fashion-related asset-backed deals.
Andrew Jassin, co-founder and managing director of the Group, defined the role of backup manager as one “who can keep the business flowing in case there is a failure, whether it means finding new licensees or making other recommendations to ensure no disruption in the core business.”
Sometimes his role begins very early in the process.
“Often times we work as a consultant in the preliminary stage when parties are still trying to put together the deal. Our role is in researching the marketplace and determining the positioning of the brands against the competition. We’ll do our research and then issue a report that includes a discussion of the viability of the brand, its business outlook and retail positioning. We’ll also check out the licensees and see what the potential is for future licensing opportunities,” Jassin said.The report helps the financial team with their due diligence as part of the process in determining whether a property is a good candidate for an asset-backed security. Part of that calculation includes the current royalty income stream and potential future income opportunities weighed against the expected shelf life of the brand.
Jassin noted that his firm’s involvement in the preliminary stage is no guarantee it will be designated backup manager in the final transaction.
Still there’s no denying that the background knowledge gleaned from the early-stage research report provides an important basis in understanding the “business” of the brand, which then allows the backup manager to hit the ground running if called upon to do so.
While Jassin declined to disclose fees in connection with his firm’s backup role, a Wall Street source said a standby fee can be about in the $15,000 range a year, plus reasonable out-of-pocket expenses. The fee is paid by the issuer of the asset-backed securities, most often the new entity that now comes to own the intellectual property assets.
According to D’Loren, the current economic environment fosters tightened bank credit lines and a closed initial public offering arena for many branded-product firms. For those firms, structured finance vehicles may be an ideal alternative for raising money assuming certain criteria are met.
“We look for a company that is not tied to its supply chain, where the brand has at least a five-year history and has third-party licensing,” he said.
His firm uses what he calls a “ValueNet” formula for valuing a brand. “It allows us to bifurcate a company into its licensing operation and supply chain components. For valuing a company, you treat the supply chain as if it’s a licensee. Therefore, the brand is an asset independent of the supply chain and can remain a good brand even if the supply chain fails,” he said.
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