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Journal of Retailing 87 (3, 2011) 393–405

Intellectual Property Securitization and Growth Capitalin Retail Franchising

Tahir M. Nisar ∗School of Management, University of Southampton, Highfield, Southampton SO17 1BJ, United Kingdom

bstract

A retail franchisor needs growth capital so that the brand continues to grow and franchisor–franchisee relations remain strong. However, accesso corporate liquidity to fund such franchise growth options is not unlimited. A method of raising finance particularly suited to retail franchisorss intellectual property (IP) securitization that allows companies to account for intangible assets such as intellectual property, royalty and brandsnd realize their full value. In recent years, a number of large restaurant franchisors have securitized their brands to raise funds, including Dunkinrands and Domino’s Pizza (Domino’s). We use property rights approach to show that IP securitization provides mechanisms that explicitly define

wnership of intangible assets within the securitization structure and thus enables a company to raise funds against these assets. Using a case studyxample of a retail franchise IP securitization transaction, we also provide evidence that these mechanisms are not overly restrictive and can besed more widely to help fund retail franchise growth and expansion.

2010 New York University. Published by Elsevier Inc. All rights reserved.

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eywords: Retail franchising; Intellectual property securitization; Brands; Fran

Introduction

Retail franchise growth is a critical parameter in a franchisor’setwork stability. A franchisor may support its ambitions forapid growth by improving its brand’s appeal as well as help-ng develop its franchised units. The low contractibility of thenancial assets in the early phases of a franchise’ organizational

ife cycle points toward this critical role of a franchisor in assist-ng its franchisees (Windsperger and Dant 2006). Franchises ofetail brands also need to provide an assurance that they are atable business. This is important as many entrepreneurs embarkn a franchising business because it offers the greatest potentialnancial rewards (Bradach 1998; Grünhagen and Dorsch 2003).nyone looking to start their own business and capitalize on thepportunity offered by a franchise brand will be concerned withhe long-term strength and viability of the franchise they are tak-ng on. It is for these reasons that franchisors pay close attentiono their own capital structure, in the manner they raise funds, in

ddition to their relationships with their franchisees.

The strength of a franchise business is also tested during aime when credit conditions are fragile. Due to large liquid-

∗ Tel.: +44 023 8059 3427; fax: +44 023 8059 3844.E-mail address: t.m.nisar@soton.ac.uk

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022-4359/$ – see front matter © 2010 New York University. Published by Elsevier Ioi:10.1016/j.jretai.2010.12.001

growth

ty requirements, a credit crunch may hit the retail sector hard,esulting in an increased scrutiny for franchise loans, delayedonstruction and even some store closures due to lost businessnd difficulty in getting credit to see them through. Lenders maylso increase their equity requirements for the new franchisees,everely jeopardizing the franchise growth efforts. Franchisorsay then be expected to help their franchisees seeking growth

apital. For example, Domino’s Pizza (Domino’s) offered upts own cash to its franchisees post-2007 credit crunch. It washort-term financial support, mainly in the form of small loansr payment deferrals for large operators who were looking tourchase additional locations.

Amid financial turmoil, franchisors can only step in to keeprowth on track and ensure the stability of the franchise network,f they can boast of a viable capital structure. They need to haveccess to sufficient operating funds to be able to extend supporto their franchisees and fill any gaps left by the reluctance ofraditional lenders to fund franchise growth. Windsperger andant (2006) describe this issue in the following terms, “The

ranchisor may be quite constrained by the information asym-etry between the prospective conventional lenders (e.g., banks,

enture capitalists) and himself concerning the profitability ofnvestment project envisioned by the franchise concept. Dueo their low salvage and/or liquidation value, the conventionalenders are likely to find it more difficult and risky to finance

nc. All rights reserved.

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94 T.M. Nisar / Journal of R

nvestment projects if the investments are in intangible assetss compared to tangible assets such as plant and equipment”p. 264; see also Caves and Murphy 1976; Combs and Ketchen999). Many retail franchise companies also lack high invest-ent grade ratings because of their weak credit, and thus cannot

aise funds on favorable terms. In recent years, a method ofaising finance has gained prominence that enables companieso take loans on their intangible assets and make the necessarynvestments. The $1.7 billion Dunkin Brands IP transaction andhe $1.8 billion KCD (Kenmore Craftsman DieHard, Sears’ spe-ial purpose vehicle) bonds, which came to the market in May006 showed how companies with weak credit can benefit fromuch a technology. Subsequently, Domino’s issued $1.85 bil-ion in asset-backed securities in 2007, funded by its franchiseperations. The deal was the largest IP securitization at that time.oth Dunkin Brands and Domino’s deals underscored the notion

hat a securitized debt structure is almost custom-built for largeranchised operations, in particular the restaurant industry.

Royalty and intellectual-property-based securitizations allowompanies to borrow against their brand strengths and futureevenue streams (S&P 2002; Schwarcz and Ford 2003). Retailompanies with weak credit can benefit from such an approachS&P 2002). Asset-backed securitizations have been around forome while now; borrowing against a company’s assets, such aseal estate holdings, equipment or computer lease receivables,ere in vogue since the mid 1980s. IP securitization, on the otherand, makes possible for a company to use intellectual propertyssets as primary collateral and realize their full value. In contrasto mortgage-backed securities and other types of securitizationeals, IP securitization aims to calibrate the risk and make itore transparent for investors. Early franchise transactions in

he 1990s were based on a restaurant’s future sales, real estatend equipment, the traditional set of assets used in a securiti-ation deal. The later IP-based securitizations, however, usedhe collateral against a brand’s trademark, systemwide royaltyevenues and intellectual property to obtain high ratings. Manyhousehold names’ in the fashion world packaged their royaltyights and trademarks into an off-balance sheet entity (Erol 1999;&P 2002). The securities issued against these assets were ratedy debt-rating agencies, enabling the fashion design businesseso borrow at much more favorable rates.

As intangible assets are the key driver of an IP securitizationransaction, it inevitably raises the question of the distributionf ownership rights over these assets in a securitized struc-ure. We draw upon property rights theory to examine theseuestions. The theory says that when contracts are incomplete,he best way to generate incentives for two parties to invest inon-contractible assets is to allocate residual rights of controlo the party that will be most profitably affected by doing soDemsetz 1966; Hart 1995; Hart and Moore 1990; Segal and

hinston forthcoming 2011). In the absence of such rights,ontracting parties are likely to make suboptimal relationship-pecific investments. Using a case study of an IP securitization

ransaction, we investigate how these residual rights of controlnderpin securitization structures and if these structures pro-ide sufficient incentives for investment in intangible assets. Ournvestigation shows that the property rights framework explains

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g 87 (3, 2011) 393–405

n good measure the practice of IP securitization, and that its a valid means of raising finance, especially when companieserive their significant value from intangible assets.

The article is divided into four sections. The first sectioniscusses general issues involved in retail franchise growth, inarticular the role of a franchisor as a capital provider. It is fol-owed by our introduction to the IP securitization method. Wehen provide a case study of Domino’s securitization, includ-ng an early assessment of its performance. The final sectiononcludes with suggestions for future work in this area.

Retail franchise growth

Watsona et al. (2005) suggest that a particular feature ofetail organizations is asset intangibility, and therefore theyse franchising to be a valuable means by which to developheir businesses, both domestically and abroad. Their empir-cal findings provide ample proof of the positive impact ofranchising on the intellectual capital development and knowl-dge management for retail organizations. Franchisees typicallyre the engine of growth at many retail chains, in particularestaurants (Bradach 1998). Franchisees help develop retail mar-ets by breaking into new territories and opening new units.ranchisees may also be instrumental in purchasing the fran-hisors’ underperforming stores earmarked for improvement.owever, franchisees may need financial and transactional helphen looking to open new stores or purchase underperforming

tores (Grünhagen and Dorsch 2003; Kaufmann and Stanworth995). The re-purchase of underperforming units can be partf a franchisor’s strategy to turn around domestic results. Thisequires that the franchisors have sufficient resources availableo finance and support such transactions. This is also the view oforton (1995, 1988) who argues that franchising exists in order

o reduce “operating and financial transactions costs.” This isgainst the capital constraint or the resource dependence hypoth-sis that suggests franchising provides capital for the franchisort lower costs (Caves and Murphy 1976; Ozanne and Hunt 1971).

Norton’s view can be verified by casual evidence from theestaurant franchising industry. Restaurant franchisors imple-ent specific programs that broaden their franchise bases as aeans to grow business. In addition to implementing measures

hat grow same-store sales, they may also emphasize franchiseecruitment as a way to expand their franchise operations. Forxample, in recruiting new franchise demographics, franchisorss diverse as Pizza Hut, KFC, Domino’s and Little Caesarsizza have introduced special recruitment incentive programsor veterans, minorities and women. Domino’s offers veterans$20,000 discount off the franchise fee. These programs are

nderpinned by the need for offering greater financial securitynd lower risk to the prospective franchisees. The programs maylso translate into helping franchisees get financing, as well asore favorable lease and real estate terms. They thus provide an

dditional layer of support, over and above the backing a fran-

hisor can offer to its franchisees with a well-known brand andssistance and network cooperation (Bradach 1998; Lafontainend Shaw 1999). There is also an opportunity to demonstratehat the franchisor’s capital base is solid and can cope with any

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T.M. Nisar / Journal of R

olt in the financial market. Over the years, the industry hasmplemented a variety of specific franchisee-help programs; aew cases are enumerated below:

Burger King offers its operators who are looking to purchaseadditional retail locations short-term financial support andsolutions. The support may take the form of deferrals of roy-alties, small amounts of bridge financing or other costs, andany lending may include relatively small increments.Little Caesars Pizza provides 100%of the financing to com-plete the sale of corporate restaurants to a franchisee. Thefranchisee may be looking to expand but have trouble gar-nering the needed capital. The company may also suspendcollection of the planned increase in royalties for a specificperiod of time.Papa John’s charges existing franchisees a specific amountfor subsequent units. To make sure that healthy franchiseesare not deterred from expansion it waives the franchise feesfor a specific period of time on the purchase of any closedunit that was reopened by another franchisee.To encourage new franchised openings and acquisitions, PizzaInfi Inc. waives the sales royalties for a franchisee’s first yearof operation. The company collects only a 2% royalty in thesecond year when its royalty rate is 4%.Red Robin Gourmet Burgers Inc. reduces the contributionrate by both franchised and corporate stores to its nationaladvertising fund. Rather than contributing the normal rate,operators may now contribute a lesser amount. The royaltiesmay instead be directed to its national advertising.

ll such programs are intended to help franchisees secure neededrowth capital. Banks and other lenders may be reluctant toend to them and therefore more flexible arrangements may beecessary between franchisors and franchisees. This suggestshat, to increase the amount of financial support franchisors canffer franchisees, franchisors will constantly have to explorereative ways to keep funds flowing (Combs and Ketchen 2003;tassen and Mittelstaedt 1995). In this way, franchisors act asapital providers, and not merely the passive recipient of capi-al, as the capital constraint hypothesis may lead us to believe.his also provides support to the idea that franchisors set up

ranchising networks as quasi-internal capital markets, whereapital flows not only from the franchisees to the franchisorsut also from the franchisors to the franchisees (Combs andetchen 1999; Gertner, Scharfstein, and Stein 1994; Kochar997; Norton 1995; Stein 2003; Triantis 2004).

Intellectual property securitization

As our discussion in the preceding section shows, franchisorsonstantly need growth capital both to provide short-term financ-ng help to franchisees and to develop their long-term brandsnd the network resources. One way to achieve this goal is to

ecuritize the company’s intangible assets and raise the requiredunds. Assets securitized under an IP securitization transactionre highly rated because of the guaranteed structure (Schwarcznd Ford 2003). Such transactions may also help reduce infor-

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ation asymmetries between different financial market agentsThomas 2001; see also Iacobucci and Winter (2005) for annalysis of securitization when there are no information asym-etries). A notable early example of IP securitization was that

f “Bowie Bonds” in the late 1990s that enabled the rock staravid Bowie to borrow against the value of his future music

oyalty revenues. The transaction paved the way for some ofhe franchise industry’s largest firms to undertake debt recap-talizations based on the securitization of intellectual propertynd brands.

IP securitization is by far the most efficient way to financehese types of assets (Erol 1999). Securitized companies canffer notes with triple-A-ratings, meaning that they are highlynlikely to default (S&P 2002). Such rating cannot be achievedf companies offer bonds through standard bank or bond struc-ures. The cost of securitization may then be less than otherunding strategies such as a simple corporate debt contract. Anxample of Hertz’s securitization illustrates this point. Hertz’securitization transaction was completed as part of a buyout in005. The cost of corporate debt used in the Hertz’s acquisitionas much greater than its cost of financing via IP securitiza-

ion. The weighted average cost of IP securitization financingas just under LIBOR (London Interbank Offered Rate) plus2 basis points (bps; the basis point is commonly used for cal-ulating changes in interest rates, equity indexes, etc.), while theuyout’s financing ranged from LIBOR plus 200 bps for a $1.6illion five-year ABL Facility (Ba2/BB+) (a typical ABL facil-ty includes a three-year revolving credit that is used to supportorking capital needs), $2.25 billion of seven-year term loan

Ba2/BB+) at LIBOR plus 225 bps and $2.025 billion of (B1/B)ine-year senior unsecured notes at 8.875%. The financing alsoncluded $600 million of 11-year senior subordinated notes at0.5%. This information shows that Hertz pays much highernterest on its corporate debt than what it pays on its securitiza-ion bonds. The additional capital provided by an IP securitizedoan also enables the company to enjoy a considerable amountf financial and operational flexibility. The strategy significantlyewards its shareholders going forward. For example, Hertz usedts loan facility to repay the debt taken on by its private-equityponsors.

Under a securitization transaction, a company sells its operat-ng assets to a new legal entity – a special purpose vehicle (SPV),hich can be a limited liability company or a trust. SPVs are

bankruptcy-remote” entities (being bankruptcy-remote implieshat the bankruptcy of the borrower does not affect the secu-itized assets) and they are set up to assume ownership of aompany’s assets and cash flows. In many restaurant industryases, SPVs are affiliated franchisees. This new structure is cre-ted with the purpose of insulating the buyers of asset-basedecurities against the credit risks of the seller/originator. Intel-ectual property assets are pooled and then transferred to thePV which pays for the assets by issuing securities to buyer

nvestors. They are called asset-backed securities because all

ayments to the lenders are funded by cash generated from thessets held in an SPV (Schwarcz 1993). Asset-backed securitieserive their credit-worthiness from their own assets, and, hence,hey achieve high credit quality. The issuances of debt at interest

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96 T.M. Nisar / Journal of R

ates corresponding to the high credit ratings of the SPV issuerean that the originator faces reduced level of financing costs

n comparison with alternative forms of financing.After considering the scope of the creditors’ ability to enforce

ecurity, a securitization transaction is concerned with designingovenants to further enhance the stability of the arrangements.his involves creating a transaction structure that specificallyeals with the implications of raising a significant proportionf investment-grade debt. There are a number of elements tohis analysis; as a first step, potential cash drains are identifiedn the SPV’s revenues that are beyond the scope of its opera-ions. These may arise from the business operator’s obligationso its creditors and the regulatory jurisdiction in which it oper-tes. For example, tax liabilities could affect the cash used forebt service. To mitigate the impact of such cash drains andther weaknesses, covenants and credit enhancements may bedded to the securitization structure (Schwarcz and Ford 2003).s is often the case, the management of the securitized assets

emains with the originating company, so there will be an issuef the incentives in the securitized structure to ensure opti-al re-investments. This is achieved by negotiating operational

ovenants that restrict the operations of the securitized assets tochieve certain performance goals.

Property rights approach and IP securitization

The property rights approach is used in its basic form as aheory of the firm, specifically how ownership structures suchs vertical integration are chosen in order to provide incentivesor noncontractable relationship-specific investments (Hart andolmstrom 2010; Hart and Moore 1990; Segal and Whinston

orthcoming 2011). A contract is complete when all present anduture contingencies are fully anticipated and acted upon. Opti-al actions are specified, terms negotiated and all commitments

ulfilled and verified. If there are any breaches, a contract alsorovide for remedies. Since the seminal work of Coase (1937),great deal of intellectual effort has gone into identifying thoseonditions in which transaction costs are high, and contracts areot truly complete (Coase 1937; Hart 1995). Williamson (1985)evelops a typology of transaction costs in terms of how anyxchange relationship may involve specific assets; the frequencyith which transactions take place; and how opportunism may

esult in hold-up behavior on the part of the contracting parties.uch transaction costs may render an exchange unprofitable.

The alternative may be to write an incomplete contract, withome residual rights remaining outside the remit of the contractHart 1995, p. 65; Hadfield 1990, p. 946), causing the rightso the asset that cannot be specified in the contract to accrueo the residual claimant (Fama and Jensen 1983). When annforeseen contingency occurs, residual claimants decide howhe asset should be used. For example, contracts are likely to bencomplete when parties make relationship specific investments,nd thus parties who bear the residual risk of these investments

hould make all important decisions. This is the reason that theommon (or ordinary) shareholders generally bear the resid-al risk in most enterprises, and have the power to make keyorporate management decisions. The assignment of property

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ights in this way drives resource allocation efficiency (Coase960, p. 16; Demsetz 1966, p. 67). For instance, intangible assetsre not contactable and hence the degree of intangibility of thesset is a key characteristic relevant for the determination of thewnership structure (Brynjolfsson 1994; Hart and Moore 1990;aness 1996). The distribution of property rights over these

ssets provides the necessary investment incentives.This is perhaps one of the reasons that franchisors have a mute

hance of raising capital from the traditional capital markets,s ambiguity remains over the true value of these assets. Con-entional lenders cannot adequately evaluate the investmentsisk associated with a franchisor’s concept because there typi-ally are significant information asymmetries in the franchisor’susiness model incorporating intangible assets (Choate 1997;illiamson 1988). The greater the difficulty contracting on these

ssets, the greater is the reluctance of the conventional lenderso lend. As the property rights theory implies contractual incom-leteness can limit the investment incentives of an agent if theesidual rights of control are not clearly defined. An IP securiti-ation overcomes these obstacles by creating mechanisms suchs an SPV that define and establish appropriate ownership struc-ures incorporating intangible assets (S&P 2002). Because ofhe isolation of the assets from the business risk of the borrower,nvestors are better able to evaluate their inherent resilience (Erol999). When a franchisor seeks IP-based funding, it will beequired to transfer the ownership of its assets to the issuer SPV.here will also be a need to strike a balance between the desir-ble levels of future investments in intangible assets and theeneration of cash flows to service the existing debts. Absenthese mechanisms, a franchisor is unlikely to be in a position toaise funds that meet its goal of achieving required liquidity.

In a securitization transaction, an SPV delinks the originator’susiness risk from the risk of the securitized assets and transfershe control of the assets from the originator to the securityhold-rs. Legal boundaries are drawn around these assets such thathe obligations (e.g., tax liabilities) of the non-securitized assetso not affect the securitized assets. Therefore, any business riskf the originator will have no impact on the operator of theecuritized assets. Such a transaction is characterized as “truesset sale” between the originating company and bondholders.he change in ownership is also reflected in how control over

he use of the securitized assets lies with the securityholdersia the issuer SPV. Being a residual owner, an SPV also con-rols those aspects of the operations not fully covered in the

anagement/servicer contract. This means that the SPV canully incentivise the servicer/originator to make value enhanc-ng investments in the exchange between the originator andondholders.

Based on the predictions of the property rights approach, itan be argued that a re-assignment of the ownership rights is theey to the effectiveness of IP securitization. This is reflectedn a number of specific features of a securitization. First, atrue sale” between a buyer and a seller is necessary to pro-

ide new mechanisms of control and incentive (Iacobucci andinter 2005; Schwarcz 1993, p. 29). Second, bondholders exer-

ise extensive controls through structured enhancements such asperating covenants, cap-ex (capital expenditure) requirements,

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waps and liquidity facilities and reserves (Chava and Roberts008; S&P 2002). In some cases, these enhancements restrictanagement actions but in others they provide opportunities for

e-investment in business. Such controls reflect bondholders’oncerns for maintaining the securitized assets to the establishedtandards of business, but they also enable them to benefit fromurther growth. In an IP securitization in franchising, this mayranslate into brand development, the growth of the franchiseusiness model or other such benefits. Third, an IP securitizationllows securityholders to adopt an intensive interactive approachith the operators of the securitized assets for monitoring and

ontrol. It may take the form of bondholders appointing mem-ers of board of directors, designating special advisers or expertsnd holding regular meetings to exchange information with theperators of the securitized business (S&P 2006). IP securitiza-ion thus creates structures that ensure optimal specializations inperations as well as providing incentives to align the interestsf the firm’s various sets of stakeholders.

Methodology

In this study, we examine organization changes that occurhen a company securitizes its assets. Because IP securitiza-

ion takes the whole business of a company to securitize, anxamination of the company’ organization and governance prac-ice will be necessary to fully understand the consequences ofsecuritization transaction. Following Denis (1994) and Baker

nd Wruck (1989), who adopt a case study research approachn their investigations of LBOs (leveraged buyouts), we focusn one particular case of IP securitization, i.e. Domino Pizza’sDomino’s) IP securitization. Domino’s is the largest deal of itsind and has set important trends in the use of IP securitization.s it is a listed company, we also have access to performanceata, unlike other securitization deals that mostly occur in therivate sector. Our study examines the Domino’s various com-onents of IP securitization and considers its early impact onperating performance. We use three sources of information toonduct this analysis: SEC10-K filings provide information onompany risk factors and corporate governance; EBSCO andexisNexis datasets contain information on official announce-ents and other related business information; and Orbis, aureau van Dijk dataset, supplies company financial informa-

ion. The daily stock return data are obtained from the Centeror Research in Security Prices for our event study analysis.

ndustry overview

The US pizza market is a mature, highly competitive androwing market. It is estimated that franchised pizza chainsccount for around 60% of the market, and there are around50 well known pizza franchises in operation (PMQ 2009).esides, there are a large number of local and regional pizza fran-hises. After reaching record sale figures of $34 billion in 2007,

eflecting the tremendous growth in the business in the pre-2007redit crunch period, the industry experienced sluggish growthhroughout 2008 and 2009, a trend that has continued well into010. The minimum wage also increased from $6.55 to $7.25

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er hour since July 24, 2009, affecting some franchise outletsore than the others. However, the wage bill increases have to

n extent been offset by falling commodity prices.The growth drivers for the convenience retail sector are

ncreased trust in online purchasing, the introduction of new-commerce platforms, and the popularity of at-home leisurectivities. As consumers seek changes in their increasingly busyifestyles, it is likely that e-commerce will have the largest impactn future sales of home delivered foods. The value of the homeelivery food market is estimated to grow 30% in the comingears (PMQ 2009).

retail franchise network

Domino’s is one of the world’s leading pizza delivery com-anies that operates through a network of more than 8200ompany-owned and franchise stores, located in all 50 statesf the US and across 55 countries. Domino’s domestic storesegment is comprised of 4584 franchise stores, or nearly 90%f the total market. The domestic franchises are operated byntrepreneurs who own and operate an average of three to fourtores. The company employs about 12,500 people.

Domino’s leading position in pizza delivery market is mainlyue to its large, global, and diversified franchise networkDomino’s 2010). Domino’s is a strong and consistent cash flowenerator, benefiting from its powerful brand. Its franchisingtrategy is underpinned by a focused and efficient operationsodel, given that it provides delivery and carry-out services

nly (no dining area). This is against the common market strat-gy of providing multiple components of the pizza category,articularly dine-in. This also means that there is no need forxpensive real estate, and stores can be relatively small and areelatively inexpensive to build and operate. It costs on aver-ge $150K–250K to open a franchisee, making it a low costusiness. Domino’s uses a master franchise model in whichaster franchisee can sub-franchise and/or directly run stores.omino’s puts emphasis on technology-driven customer ser-ice and innovation, both in its own stores and in franchisedtores (Domino’s 2010). For example, all stores are equippedith Domino’s Pulsetm (in-store order entry system) and onlinerdering is used in all corporate stores. Through the inclusionf Pizza Tracker, the company also enhanced its online orderingapability.

There are other characteristics that make Domino’s fran-hise system unique: internal candidates are given the priority,lthough there is always strong competition for obtaining a fran-hisee; and it is a franchisee’s only business – as per the franchiseerm, active, outside business interests are not allowed. The aims to align the franchisee’s interests with that of the company’s,nd to provide incentives for franchisees to work closely with theompany to reduce costs (Domino’s 2010). Domino’s averageelationship with its top 50 domestic franchisees is 19.5 years.t achieves over 99% collection rate on the franchise royalty and

ver 99% franchise contract renewal rate. There are no signifi-ant concentrations, as an average franchisee owns 3–4 stores.t also has a large and growing international presence, which isvidenced from the 48% growth in its franchised network mar-

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Table 1Securitized loan triggers.

Trigger Estimated EBITDA drop % of waterfall trappeda

First $65–75M 25%Second $75–85M 50%Third $95–105M 100%

a Waterfall is after interest and minimal general and administrative (G&A)service fee. Waterfall arrangements are designed to determine the priority of pay-ment such as between senior bondholders and subordinate bondholders. Thesea(

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enabled it to raise significant amounts of investment grade debt.The cost of its debt was much lower than the other financingopportunities available at the time. This implies that notehold-

Table 2Securitized debt.

Debt amount Interest rate

$1.6B senior ABS debt 5.961% cash interest rate$0.1B subordinated debt 7.629% cash interest rate

98 T.M. Nisar / Journal of R

et from year-end 2003 through 2008. These factors, along withn experienced management team, improve its ability to handleeverage. The principal sources of revenues from domestic storeperations are royalty payments based on retail sales by its fran-hisees and company-owned store sales. Similarly, the principalources of revenues from its international network of 3469 fran-hise stores are royalty payments generated by retail sales fromranchise stores and sales of food and supplies to franchisees inertain markets.

In terms of its capital structure, Domino’s sets the followingpecific objectives: providing liquid market for acquisi-ion/divestiture of stores, as appropriate; increased investmentn growing business; providing source of earnings to company;aying significant dividends; repurchasing shares; and delever-ging. There is some evidence that the company has achievedome of these objectives. For example, it paid out $14.45/sharen quarterly and special dividends since its IPO (Initial Publicffering), or over $900 million; it authorized for a $200 millionpen Market Repurchase Program and disbursed approximately9% of the authorized amount; and it repurchased $68.3 millionf principal on outstanding fixed rate senior notes for a totalurchase price of $34.6 million.

omino’s IP securitization

Domino’s undertook a major recapitalization in April 2007o convert traditional bank bond financing to asset-backed secu-ities funding. The recapitalization boosted its shares to a newigh, bidding up the stock 12.8% to $32.38. This was the firstime it had undertaken a securitization, following on the heels ofwo other recapitalizations. Domino’s securitization is a restau-ant franchise royalty deal. As Domino’s business has a strongash flow characteristic, it makes it a suitable candidate for asset-ased securitization. It issued five-year, interest-only securitiesnd two optional one-year extension periods. The deal providesomino’s with the lowest cost of financing; in comparison to the

ompany’s current bank/bond financing structure, it has a lowernterest rate and fewer restrictive covenants. In many ways, theeal resembles previous quick-serve restaurant franchise secu-itizations.

A major part of Domino’s securitization is its setting up ofn SPV, Domino’s Pizza Master Issuer (DPMI) LLC, to transferhe control of the securitized assets to the noteholders. DPMIssued notes that were backed by the company’s revenue gen-rating assets, including domestic royalties, most internationalncome, product distribution agreements, including supply chainBITDA (earnings before interest, taxes, depreciation and amor-

ization), and license agreements for its intellectual property. Thether main features of the transaction include:

fixed rate with no amortization for 5 years;two possible 1-year extensions;senior debt is wrapped with insurance;

debt service coverage ratio (DSCR) = collections/senior inter-est expense (this is the only financial covenant);normalized cap-ex (capital expenditure) in the $20–30 millionrange annually;

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rrangements are necessary as an SPV may have more than one class of creditorse.g., senior bondholders and subordinate bondholders).

collections cannot be calculated using publicly disclosedinformation, but it tracks closest to EBITDA; andEBITDA performance would need to drop by $65–75M annu-ally before first trigger is reached.

able 1 provides information on the triggers in the Domino’ecuritization transaction.

apital structure

Domino’s securitized debt comprised fixed-rate senior andubordinated notes and variable funding senior notes. It offeredwo tranches in the l44a market, including notes offered throughn A-2 class sized $1.6 billion. These notes were insured byBIA and Ambac in a 75/25 split. Moody’s Investors Service

nd Standard & Poor’s assigned triple-A ratings to the A-2 notes,hile the $100 million M-1 class was rated ‘BB’ by Standard &oor’s. The transaction also included an A-1 class, which was notffered. All these classes have an interest-only payment periodf five years, with two one-year extension periods, as mentionedbove. If the company does not exercise either of its two one-yearxtension options following the five-year interest-only period,ts securitized debt will be subject to principal amortization. Theecuritization does not prohibit the company to incur additionalebt. The company expects that the senior notes will accruenterest at a fixed rate of 5.261% per year and the subordinatedotes will accrue interest at a fixed rate of 7.629%. There maye an increased interest rate if it is not repaid or refinanced.nformation on Domino’s various components of the securitizedebt is given in Table 2.

It is evident that Domino’s securitization of its assets has

1.7B total funded debt 6.059% cash interest rate150M revolver facilitya

a The revolver facility allows the borrower to borrow, repay, and reborrow aseeded over the life of the loan facility.

T.M. Nisar / Journal of Retailing 87 (3, 2011) 393–405 399

Table 3Debt and operating performance.

1999 2000 2001 2002 2003 2004 2005 2006 2007

Total debt to EBITDAa 5.5× 4.7× 4.0× 3.2× 4.7× 3.6× 3.1× 3.0× 7.2×EBITDA to interest expenseb 1.8× 2.7× 4.5× 2.2×

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rs priced Domino’s intangible assets more efficiently, reducingts cost of debt. However, to achieve this outcome it was neces-ary to carry out a true asset sale by the Domino’s issuer SPVi.e. DPMI), transferring the residual control rights to the pur-hasers of the securities. Because the assets they own are remoterom Domino’s other activities there will be no material effectn the operations of these assets if Domino’s becomes insol-ent. The securitized assets are operated in accordance with theontrol and monitoring structures (i.e. structural enhancementsuch as operational covenants, incentives and specializations) asnvisaged in the transaction.

Table 3 gives details on Domino’s total debt to EBITDA andBITDA to interest expense multiples from year 2000 to 2007.his shows that the company has kept a solid pace of operatingerformance over the years and has proven ability to servicets debt. Given this information, the leverage achieved by theompany in 2007 as part of its securitization transaction seemseasonable.

Using its securitized debt, Domino’s was able to invest in theomino’s Pizza brand and its stores, repurchase shares of its

ommon stock and pay significant dividends. It also utilized theroceeds from the issuance to refinance debt. The switch of pre-ious financing into an asset-backed loan of up to $1.85 billioneant the following changes in its capital structure. The com-

any took on a bridge loan to provide for borrowings of $1.35illion, and used the money to buy back 22% of its outstandingommon stock at $27–30 per share. The bridge loan was repaidith funds from the securitization. In addition, it repaid about274 million of senior subordinated notes. The company alsoought back and repaid older, existing debts in an effort to easehe terms of its borrowing agreements.

perational covenants

Covenants generally have restrictive terms and the failure toomply with any of the terms may put a company in default,hich would have an adverse effect on its business. A company

emains subject to the restrictive terms of the securitized debt,ntil and unless it repays all outstanding borrowings. Banks andther bond markets normally use financial covenants to protectheir investments. One of the key features of IP securitizations that it contains operational constraints that may limit a com-any’s ability to incur additional indebtedness, pay dividends, oro make investments. A company’s failure to comply with theseovenants may also result in the acceleration of repayment of

ll of its indebtedness. Domino’s SPV issued and guaranteedenior and subordinated fixed rate notes and variable fundingenior revolving notes containing a number of covenants. Theerms of its securitized debt financing are the following:

tceo

Segment Income.ning of the year.

Financial covenants: The most significant financial covenants a debt service coverage calculation (i.e. debt service cover-ge ratio = collections/senior interest expense). There is also aequirement to maintain a specified financial ratio at the end ofach fiscal quarter.

Operational covenants: Securitization substantially increasescompany’s indebtedness, and combined with the fact that a

arge portion of its cash flows from operations must be usedo service debt there can be concerns for the company’s abilityo pay down its debt and how it operates its business. It is forhis reason that IP securitization includes a significant numberf operational covenants, including restrictions such as limitedbility to repurchase shares of common stock or dividend pay.omino’s operating covenants limit the ability of the company

o, among other things:

altering the business it conducts;selling assets;making loans and investments;engaging in mergers, acquisitions and other business combi-nations;incurring, assuming or permitting to exist additional indebt-edness or guarantees;incurring liens;declaring dividends or redeeming or repurchasing capitalstock; andentering into transactions with affiliates.

urthermore, there are a number of scenarios when the holders ofmajority of the outstanding fixed rate notes or the insurers have

he right to assume control of substantially all of the Domino’securitized assets, including: the company becomes the subjectf insolvency or similar proceedings and thus all unpaid amountsnder the fixed and variable rate notes could become immedi-tely due and payable; the company’s debt amount is acceleratedecause of a default under the securitized debt and the companys unable to pay such amounts; and the insurance companies thatrovide financial guaranties of the company’s fixed and variableunding note payments themselves default.

overnance at Domino’s

An IP securitization structures a closer alignment of interestsetween different stakeholders into the transaction. An elemen-

ary proposal is to constitute board of directors at the securitizedompany that deter or prevent any decision against the inter-sts of bondholders (S&P 2002). For example, “in the contextf corporate securitization, the case for independent directors is

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einforced where the issuer SPE is owned by a non-SPE oper-ting parent, especially where the directors of the parent arelso the directors of the issuer SPE (S&P 2002).” This was evi-ent in the case of Steam Packet transaction, where the securityrustee was empowered to appoint a new board of directors tohe securitized subsidiary in the event of the subsidiary’s breachf a covenant. Management incentives are another importantechanism to create an alignment of interest between different

takeholders. “One way is for the transaction structure to incor-orate management incentives to maintain the credit quality ofhe company (S&P 2002).” Glas securitization transaction pro-ided incentives in such a way that the compensation of senioranagers was dependent on them maintaining the rating levels

S&P 2002).Domino’s securitization incorporates major aspects of board

ndependence and management incentives. In total, there areeven members of the corporate board, including 5 indepen-ent board members. The average tenure of a board members 9.71 years, while average director age is 55.42. At present,oard members have 13 outside directorships. Domino’s boardomposition is very similar to the other listed companies (Uzun,zewczyk, and Varma 2004), the only major difference being

he executive directors having a particularly extensive privatequity background. Domino’s current CEO was appointed byhe private equity owners before its IPO in 2005. The CEO startsith a base salary of $750,000 a year, and may earn as much as

nother $1.5 million in the form of a bonus if the company meetshe targets set out in the Senior Executive Annual Incentive PlanAIP). The company also gave its CEO stock options to purchase50,000 shares and a performance share award (which vests overhree years) of 75,000 shares of stock. Domino’s other seniorxecutives also participate in AIP. The targets set out in AIPpproximate closely to the performance goals of the Domino’securitization such as cost efficiency enhancement and earningsmprovements.

Analysis

Whether a firm’s capital structure affects its product marketompetition has been investigated by both theoretical and empir-cal research. Rotemberg and Scharfstein (1990) investigate a

odel in which shareholder-value maximization leads to eitherore or less aggressive product-market strategies depending on

he degree to which shareholders are informed about futurerm profitability. Chevalier (1995) finds evidence consistentith the conjecture that product-market competition becomes

softer” when leverage increases. In this section, we first inves-igate the stock-return responses of retail franchisors to thennouncement that a rival franchisor (i.e. Domino’s) is undertak-ng a securitization. An event study of abnormal returns aroundhe announcement date of a major capital market transactions a well-established approach in the merger and acquisitioniterature (Eckbo 1983; Stillman 1983). Chevalier (1995) con-

ucts her study of LBOs in the supermarkets using a similarpproach. The second part of this section contains an analy-is of Domino’s operating performance over the securitizationeriod.

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g 87 (3, 2011) 393–405

We begin our analysis by constructing a sample of two sets ofrms: firms in the industry that are directly competing with theecuritizing firms; and firms in the industry that are not directlyompeting with the securitizing firms. Firms in the industry areikely to exhibit a positive stock return response to the securiti-ation announcement if it is believed that other franchisors willollow suit. This of course depends on the improvements in thenancial outlook of the firm undertaking a securitization, butuch a response does not take into account whether the firmsn the industry directly compete with the securitizing firm. Forxample, if there is the expectation that the securitization trans-ction would make the competition softer, then it is likely thatranchisors operating in the same local market as the securi-izing firm will experience a positive stock-return response tohe securitization announcement. On the other hand, franchisorshat do not compete directly with the securitizing firm will benlikely to exhibit such a response. Competitor firms are likelyo exhibit a negative share price response if the securitization iselieved to make competition tougher. No such effect is likelyo be observed in the case of noncompetitors.

We study the daily stock returns of Domino’s, Dunkin Brandsnd 8 other franchiser firms (four competitors and four non-ompetitors). The event windows we choose are as followssimilar windows have been investigated by other studies includ-ng Denis and Denis (1993) and Chevalier (1995)): from one dayefore the event day through one day following the event day−1,1]; from ten days prior to the event date through one dayfter the event day [−10,1]; and from thirty days before the eventay through one day following the event day [−30,1]. We definehe event day as the day when a securitization announcement is

ade. We check company press reports to obtain informationbout securitization announcements and announcement dates.ur choice of the different event windows extends until oneay after a securitization announcement and therefore theres a reason to believe that they reflect the market’s expecta-ion of the change in the value of the competitor firm due tohe securitization event. Following Chevalier (1995), we esti-ate the event response parameters using seemingly unrelated

egressions (SUR). In our analysis, the models for estimatinghe responses of competing firms and non-competing firms tosecuritization event may be related not because they interact,ut because their error terms are related.

Table 4 provides the results. Columns 1–6 show the SURstimation of return responses for the sample firms. We firstonsider the hypothesis that competition becomes tougher fol-owing securitization. This hypothesis is supported in our data inolumn 1 and Column 3 as the return responses of the compet-

ng firms are negative significant for the securitization events.ith regard to the return responses for the noncompeting firms,

he average event coefficients are not significant. However, dataresented in Column 5 suggest that securitization softens com-etition. As this event window is significantly longer than thether windows we use in our study, it points to the possibility

hat such a window may not fully reflect the market’s expecta-ion of the change in the value of the competitor firm due to theecuritization. For example, there might be a belief that otherranchisors would also undertake a securitization. Our other

T.M. Nisar / Journal of Retailin

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vent study results provide evidence consistent with the conjec-ure that competitor franchisors experience negative abnormaleturns around the time of securitization announcement. Asrgued above, it is driven by the expectation that securitizationill lead to tougher product-market competition. These results

re relevant to the Domino’s securitization because it aggres-ively engaged in product innovations and brand developmenttrategies, as we discuss in the next section.

IP securitization relies on EBITDA (earnings before interest,axes, depreciation and amortization) and not on gross revenueso service debt on the securitized bonds. This is because theponsor must incur operating expenses to generate cash flowshat are used in a securitization transaction. The use of grossevenues for operating expenses at the top of the cash water-all is a critical element of securitization deals, a feature thatistinguishes it from the securitization of self liquidating finan-ial assets that are not dependent upon an operating companyo generate cash flow. It also highlights the role of the sponsorn running the securitized company’s assets. Our analysis, pre-ented in Table 5, thus focuses on Domino’s EBITDA and itsssets and sales performance. It consists of examining ratios ofifferent performance variables for each year studied (see noteso Table 5 for year definitions).

Panel A of Table 5 shows that Domino’s saw only a marginalncrease in operating performance immediately following theonclusion of its securitization agreement. It is important to notehat from the year prior to the securitization there was a big fall inoth the ratios of EBITDA to total assets and EBITDA to totalales. The ratios then increase slightly from Year 1 to Year 2

ollowing the securitization: the ratio of EBITDA to total assetsncreases from 47.49% to 48.08% and the ratio of EBITDA tootal sales increases from 15.36% to 15.64%. Although improve-

able 5perating returns following Domino’s securitization.

Year −1 Year 1 Year 2 Year 3

anel A: Operating performanceBITDA/assets industry-adjusted

atioa64.70 47.49 48.08 46.9872.34 58.22 61.56 73.09

BITDA/sales 17.11 15.36 15.64 15.18ndustry adjusted ratioa 36.83 26.58 29.11 31.65anel B: Profitability ratioseturn on capital employed 95.75 62.47 62.94 105.18eturn on total assets 42.20 11.74 17.87 29.87BITDA margin 17.11 15.36 15.65 15.19BIT margin 14.90 13.26 13.69 13.50ash flow/turnover 9.60 4.70 5.75 7.37anel C: Operational ratioset assets turnover 6.39 4.92 4.54 5.99tock turnover 63.03 58.68 58.55 54.23anel D: Per employee ratiosrofit per employee 12 4 8 13perating revenue per employee 108 117 136 138otal assets per employee 29 38 44 44

otes: Year −1 is the fiscal year ending prior to securitization transaction com-letion. Year 1 is the fiscal year of securitization transaction completion.a Industry-adjusted ratio for a given period equals the difference between the

atio for Domino’s and the median ratio for a sample of companies in the samendustry that period.

402 T.M. Nisar / Journal of Retailin

Table 6International store growth.

Years No. of stores Percentage growth

2005 2987 8%2006 3223 7%2007 3469 7%2008 3726 7%2

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ents in Domino’s operating performance in Year 2 and Year 3re not significant but at least the slide in the performance haseen halted. The results in Panel A also suggest that Domino’sas significantly better operating performance than its industryounterparts. Panels B, C and D provide profitability ratios, oper-tional ratios and per employee ratios, respectively. Except netsset turnover and stock turnover ratios, all other ratios increaserom Year 1 to Year 2 following the securitization. The upwardrend of improved results continues in some instances in Year.

The results presented in Table 5 are corroborated byomino’s stock price performance – it was up to 56% in009 which compares to basically flat results for the S&P 500ndex and a return of just 5.5% for competitor Papa John’sOckhamresearch 2010). In terms of sales performance, Yum!rands same store sales in the US for all brands were down%, the Papa John’s same store sales were down 0.25%, whileomino’s same store sales were up 4.6% in 2009. Besides, as of

anuary 3, 2010, the company had $42.4 million of unrestrictedash and cash equivalents, and $91.1 million of restricted cashnd cash equivalents and hence it did not use its current revolveracility for working capital needs. That freed its cash flows toursue other development goals. Unfortunately, information onhe company’s domestic store growth is not available. However,e do have information on the company’s international sec-

or – international represents 35% of total Domino’s adjustedperating income. As Table 6 shows the percentage growth innternational stores has remained steady over the years since005. It grew 7–8% annually. Overall, these results suggest thatperational covenants have not overly affected the ability ofhe company to continue with its strategy of franchise networkrowth and expansion.

An important operational covenant of Domino’s securitiza-ion relates to its investment in maintaining and developing itsssets. It specifies a normalized cap-ex (capital expenditure) inhe $20–30 million range annually. Minimum cap-ex require-

ents are designed to ensure the competitive position of theusiness remains at least as good as at closing. However, cap-x spend also deals with measures for the specific developmentf the securitized entity’s assets. In the case of Domino’s, thisan be seen in the investments made over the program period.xcept Year 3, Domino’s had cap-ex at the upper end of the20–30 range. We discuss some of these investment outlays inhe next two sections. In Quarter 4 of 2008, one of the Domino’s

ankers declared bankruptcy. Banker’s troubles however did notffect its current senior or subordinated debt or debt costs in anyay. This is attributed to the fact that its main source of liquidity

bpm

g 87 (3, 2011) 393–405

s its free cash flow (FCF), and it does not need the revolver forperating needs, as noted above.

usiness and brand development

Domino’s uses its earnings to meet a number of corporatebjectives, including re-investment in business. During the secu-itization period, Domino’s developed numerous new productsnd achieved process improvements that increased both qualitynd efficiency. It made significant changes to its pizza products inonfronting poor taste test results head on and introduced severalew products. Such investments were a big break from its past,s its lacklustre products had led to non-existent top line growthince peaking in fiscal 2005 at $1.5 billion (Ockhamresearch010).

Brand development is another key plank of Domino’s secu-itization. During its first three years, Domino’s domestic storesnvested approximately $1 billion on national, local and co-perative advertising. Marketing spend on spot TV, radio andrint media increased from an average of 0.5% of sales in 2006o an average of 2% of sales in 2008. Previously, every year,omestic stores contributed 4% or 5% of their retail sales to fundational marketing and advertising campaigns, with additionalequired contributions to market-level programs. This policyhanged in 2009 when there was a unanimous agreement that theranchisees will make a contribution of 5.5% of their retail saleso fund national marketing and advertising campaigns. Withhis, the required market-level contributions were eliminated.t is estimated that the new rate will save most franchisee 0.5%.omino’s also allocates increased funds for more alternativeedia. The goal is to communicate a common brand message

t the national, local market and store levels, thereby creatingnd reinforcing a powerful, consistent marketing message toonsumers. The funds are also used to support market research,ublic relations, field communications, talent payments, com-ercial production and other activities undertaken to promote

he Domino’s Pizza brand.Under the securitization program, product and brand invest-

ents have been accompanied by extensive restructuringeasures to improve operational efficiency. In supply chain,anaging commodities is Domino’s main focus, including

treamlining operations in the areas of veggie processing plantnd thin crust plant. Although vertical supply chain managementas been a hallmark of the company since its inception in 1960,t still found room for improvements in this area. It devised newontract strategies that included better supply contracts, lockedn prices via forwards and end-to-end price and logistics savings.he results were improved supply chain margins and profit shar-

ng rebates. Other cost efficiencies included driving fewer miles,sing less fuel and more efficient use of warehouses. Domino’sas also implemented specific programs to develop further itsranchise network, including a strategy to focus on underper-orming franchisees. It implemented a program under which it

ottom 12%, and subsequently worked with them to create alan to either improve their performance or sell their stores toore capable franchisees who wanted to grow. It was not long

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T.M. Nisar / Journal of R

efore half of the targeted franchisees re-committed to theirusinesses. As they started the process of necessary improve-ents, the results were more than encouraging. The rest of the

ranchisees began the process of selling their stores.

ranchisee support

Domino’s franchising model is underpinned by a strategy oforking closely with franchisees to improve store economics. Itenerally translates into a specific set of performance objectives,upported by investment in both physical and human capital.he performance objectives include ensuring high performance

ranchisee training, higher standards for new franchisees, and aocus on growing the best franchisees. A specific human capi-al development initiative is “Franchisee in Training Program,”mplemented over the securitization period. This is an 18 monthsrogram where candidates start off as assistant managers andork their way up to become store managers. As store managers

hey get the most vital experience of independently running thenits. After completion of this phase, they can apply for a fran-hise. Given the higher salary level they work on, they can saveor their own store. Domino’s also offers them $25,000 towardperating capital for their first store and discounts on fees andoyalties.

Another recent franchisee support initiative is its inter-al minority franchisee recruitment program, “Delivering theream”, delivered in partnership with GE Capital Solutions,ranchise Finance. Through this program, financial support isiven to elite minority team members to build new stores. Nooans are given, although support is provided in securing loans.ather, it is incentive driven, as Domino’s offers waiving or dis-ounting on royalty fees. For instance, the financial assistanceay take the form of paying a franchise fee of just $5K, one of

he lowest fees in the industry. The program is motivated by theesire to strengthen the links between Domino’s franchisees andhe communities in which they serve. These communities boastf many pizza makers and delivery experts but lack the necessarynance to employ their skills as independent business owners.omino’s dream program is designed to help these prospective

ntrepreneurs to overcome the crippling financial barriers theyace.

ecuritization risks

Despite the frozen credit market in 2007–2008 that madehe transition process much more difficult, a number of fac-ors contributed to the Domino’s unbridled performance. As theompany enjoys a strong, well diversified franchise system, thisnables it to produce strong earnings. However, as Domino’secomes a highly leveraged concern, it also creates a number ofisks. There are other factors that may harm Domino’s abilityo make principal and interest payments on time and refinancets indebtedness. The company is, to a certain extent, subject

o general economic, legal and regulatory constraints that areeyond its control. Furthermore, if Domino’s does not realizeurrently anticipated cost savings and operating improvementsn schedule, or if future borrowings are not available to it under

abtm

g 87 (3, 2011) 393–405 403

ts variable funding notes in amounts sufficient to fund its otheriquidity needs there may be a risk that these factors also impairts ability to operate efficiently. In a worst-case scenario, if it isnable to refinance any of its indebtedness, its whole franchiseusiness may be put in jeopardy.

However, the above risks are minimized as long as Domino’snjoys strong brand equity in the market. Customer perception ofrands is a key competitive advantage factor in the retail indus-ry. Domino’s strong brand image in this market is its main asset,hich it developed over many years by pioneering the conceptf pizza delivery business. The company has invested heavilyo support its brand by an advertising strategy for a five-yeareriod that cost an estimated $1.4 billion in domestic advertising.ogether with its franchisees, it has taken other steps such as on-

ine customer service that promote repeat purchase. Domino’sranchising network also has a number of other distinctive fea-ures that makes it particularly effective in its market. Domesticranchisees, for example, which purchase all of their food fromhe company’s distribution system shares 50% of the pre-taxrofits, generated by the domino’s regional dough manufactur-ng and distribution centers. There are two specific advantagesf this arrangement: not only it provides the company with aontinuing source of revenues and earnings but also it strength-ns ties with franchisees by increasing their profitability. Moreignificantly, incentives for franchisees to work closely with theompany to reduce costs are enhanced. Taken together, theseactors appear to have significantly reduced the Domino’s riskf high leverage and contributed to its sustained performancever the securitization period.

Conclusion

Domino’s is a “full-company securitization” secured with theompany’s intellectual property assets. As Domino’s does notompete on physical assets, it could not raise growth capitalrom traditional sources of finance. Domino’s securitization ofts brands also offered it more flexibility than bank loan debt. AnP securitization allows a company to use its intellectual capitalo diversify its sources of funding. New funds can be used forifferent purposes including financing growth and expansion.n addition to fulfilling these goals and performing its role as aapital provider to its franchisees, Domino’s used the funds tonance a stock repurchase plan and pay out a special dividend

o its shareholders.According to property rights theory, the assignment of own-

rship rights is critical for investment in intangible assets andheir management (Hart 1995; Segal and Whinston forthcoming011). Previously, it has not been easy for companies to takeoans on their intangible assets precisely because of the difficultyn establishing appropriate rights of control over these assets.s Lev and Zarowin (1999) argue nonrecognition of intangi-les causes a significant decline in the relevance and usefulnessf company information systems, raising concerns that ‘arcane’

ccounting rules devised for a bricks-and-mortar economy maye ill-suited to an economy in which many companies deriveheir competitive advantage from investments in intangibles. For

any retail franchisors, intangible assets are their key source of

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04 T.M. Nisar / Journal of R

ncome but they could not be used in traditional lending marketsor reasons of information asymmetry and lack of appropriateccounting rules. In the case of Domino’s IP securitization, asur case study shows, these problems were tackled by employingwo specific strategies. First, an SPV was established that trans-erred the ownership of the Domino’s assets to bondholders. Aey aspect of this transfer was that the securitized assets were de-inked from the business risk of Domino’s. As a result, investorsere able to price these assets more efficiently. Secondly, a setf operational covenants was introduced in the securitizationtructure that ensured that the securitized assets were operatedo the benefit of the business.

Throughout the transaction’s early period, the economic andarket outlook did not look promising: negative domestic same

tore sales in the years prior to securitization painted a picturef a company struggling to cope with the aftermath of creditrunch. However, progress in others areas offset some of theegative trends it faced. Notably, Domino’s was able to imple-ent its operational covenants in ways that provided stability

nd necessary investment for growth. For instance, in terms ofnvestment in new product development, 80% of Domino’s cur-ent menu are new products. There were early improvements ints operational performance, along with net positive internationaltore growth. Financing decisions can have real product marketffects as are evidenced in Domino’s case where its securitiza-ion led to a change in product-market competition. Domino’sranchise system is also based on a strong and proven businessodel with a strong brand that allows it to compete on the basis

f product quality and service, usually important components ofretail franchise network.

Our results are also in line with recent literature on theole of quasi-internal capital markets in franchise organiza-ions (Combs and Ketchen 1999; Gertner et al. 1994; Kochar997; Norton 1995; Stein 2003; Triantis 2004). Using internalapital markets, franchisors can provide vital financial supporto their franchisees. Franchising is not a low cost source ofapital for franchisors’ development needs, as the capital con-traint hypothesis implies (Caves and Murphy 1976; Oxenfeltnd Kelly 1968–1969; Ozanne and Hunt 1971). Rather, fran-hisors actively raise funds for re-investments in business, as wend in the case of Domino’s. It may take the form of extendingnancial help to new franchisees, providing them with busi-ess training opportunities, or reducing the cost of running theirperations through measures such as a reduction in advertisingontributions or other similar method.

There is still a likelihood that Domino’s does not generateufficient cash flows from operations in the remaining yearsf its securitized debt to make scheduled principal and interestayments. Yet, the company has successfully dealt with similarype issues previously. Domino’s is also confident in its abil-ty to extend current securitization facility to 2014, and it planso keep this facility as long as it makes sense. It is also worthemembering that IP securitization employs a company’s trade-

ark and the promise of future royalty streams, which can be a

eliable source of income. Other than the risk of default, there arether limitations of this approach. As a securitization transactionequires a legal restructuring of a company so that assets can be

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uaranteed, only large, well-established companies have thus farenefited from this method of raising finance. Unlike a simpleank deal or bond offering, a great deal of management work islso needed to create bankruptcy-remote structures (e.g., SPVs).owever, more familiarity with the securitization approach and

ecent addition of expertise in the financial institutions hold theromise of small retail firms also raising funds in this particularay. This is an area that can be further explored. A securitiza-

ion transaction restricts management actions in many differentays. It will also be useful to know how management can addalue in ways that go beyond the experience of Domino’s whileemaining within the restrictive securitization structures.

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