A Starring Role For IP?

With corporate acquisitions in 2009 about as plentiful as water in the Mojave Desert, intellectual property could prove to be not only the next fountain of deal flow for private-equity sponsors, but also a potential tool for helping their portfolio companies.

A plethora of firms like Apax Partners, GTCR Golder Rauner, Intellectual Ventures, Kohlberg Kravis Roberts and Spectrum Equity Investors have found a source of opportunity in IP, an area with the potential to unleash new financing activity in one corner of the banking world that until recently has been moribund: securitization.

Copyrights on animated television characters, drug patents, film libraries and music catalogs are drawing interest from financial buyers at a time when the securitization market is on the mend. Whether it's capital-strapped companies seeking to raise capital by shedding intellectual property, songwriters looking for extra income or over-leveraged corporations aiming to refinance debt, IP is situated to play a larger role in the new Wall Street, where traditional and attractive corporate buyout candidates are few and far between.

KKR executed the most recent deal in the space when it acquired Crosstown Songs America's 8,000-plus song catalog valued at $80 million through a joint venture with German media company Bertelsmann AG. The catalog includes a host of songs penned for artists like Britney Spears and Tina Turner, among others. The deal follows that of Hilco Consumer Capital, which announced its joint venture with the family of the late Bob Marley in February. The Toronto private-equity group plans to expand the late reggae singer's brand portfolio into a wide array of products including accessories, footwear and luggage.

The predictable income streams derived from song royalties, paid year after year, along with licensing fees collected from the use of trademarked brands, underpin private-equity interest in IP. Beyond the scope of capitalizing on regular streams of income, IP also offers another incentive for financial buyers. It has the potential to be securitized or packaged into bonds that are backed by royalty payments as collateral. The bonds can then be used to refinance existing debt of portfolio companies -- an attractive option for overleveraged private-equity-owned companies -- or conversely as acquisition financing.

"The IP assets that private-equity sponsors are buying today may be leveraged if they generate consistent, predictable cash flow," says Cory Wishengrad, a managing director in the asset securitization group at Barclays Capital.

Wishengrad, a former Lehman Brothers banker, knows something about structured finance and private equity, having worked on Dunkin' Brands' highly successful $1.7 billion securitization arranged by Lehman in 2006. The financing, comprised of $1.5 billion of senior fixed-rate notes, $100 million of subordinated fixed-rate notes and a $100 million senior revolver, was triple-A rated and Ambac Assurance Corp.-insured. Equally important from an acquirer's standpoint, the notes were used to replace bridge financing that private-equity firms Bain Capital, Carlyle Group and Thomas H. Lee Partners had used to purchase Dunkin' for $2.4 billion in the same year.

"The reason why the Dunkin' Brands securitization was so successful was because it provided the private equity sponsors with better financing than they could get in the traditional credit markets, while at the same time offering investors an opportunity to earn incremental spread relative to similarly-rated securities," says Wishengrad.

Jordan Yarett, a partner at Paul Weiss who advised Lehman on the Dunkin' ABS deal, says when it comes to ABS issuances, "the covenants are very limited and attractive and the investor can benefit from more leverage."

Iconix Brand Group, a New York-based company, was particularly successful in using securitization to fund a number of apparel brand acquisitions over the last several years, including the $45.9 million purchase of Rampage and $80 million purchase of underwear apparel brand Joe Boxer through structured securities arranged by UCC Capital Corp., now part of NexCen Brands Inc.

The use of structured finance products as a means to fund an acquisition or refinance existing debt is dependent on a healthy ABS market. To suggest that securitized deals like Dunkin's are poised to take the asset-backed securities market by storm this year would be misleading. For the moment, plain-vanilla issuances driven by big-name automotive issuers like Ford Motor Co. and TALF are drawing investors back to the market. There are indications, though, that the market is opening further as more ABS deals are being launched and helping to resuscitate a market that has been on the ropes since the credit crunch took hold, say portfolio managers like James Harrington of New York-based fixed-income firm Ryan Labs Asset Management. "People are focused on the higher-quality names."

Securing a triple-A rating on an IP-backed transaction without a monoline wrap is a tough proposition at best, which greatly limits the scope of investors that might be inclined to invest in an IP credit. Even so, with the market on the rebound and spreads contracting, the stars are aligning for a potentially favorable reception in coming months for alternative-related issuances, Wishengrad says. "I expect that dynamic will be helpful in creating an environment that is suitable for intellectual property securitization going forward."

The investment banker says the decision if a buyout is funded via securitization rather than leveraged debt, though, will be driven by whether financial buyers can secure better terms in the asset-backed securities market with more structural protections and higher credit ratings relative to corporate debt.

One downside to using a securitization as acquisition financing is the amount of time it can take to arrange. Whereas senior bank debt and high-yield bonds can be arranged in short order, structured products may take a year to pull together and often require batteries of attorneys. In short, it can be an expensive and lengthy process, according to M&A dealmakers.

"Securitization of assets takes a lot of time and energy, and can be an expensive process. As an acquisition financing tool it's not very efficient, but as a long-term financing tool it can be [if it achieves a lower cost of capital]," says John Fargis, a managing director of US media investment banking at Jefferies & Co.

Because of its intangible nature, IP is considered to be "esoteric" in ABS market lingo, as compared with standard ABS issuances involving automobile issuers, for example. The uniqueness of trademarks, music rights and other IP, which have the ability to monetize over a long period of time, doesn't mean investors should back away from it, says Jason Kravitt, a partner at Mayer Brown. "IP is a terrific asset to securitize because it has so much value tied up in it which doesn't monetize automatically."

Indeed. Some financial sponsors saw the opportunity to tap into the area a few years ago, and have sought to increase the IP property of companies owning music rights.

Spectrum, for instance, invested in Los Angeles-based Bug Music in 2006 through a partnership it set up with former Paramount Enterprises president Tom McGrath called Crossroads Media. The private-equity firm has funded Bug's purchases of 25 music catalogs, boosting its copyrights to 250,000 from 120,000 when it invested in the business three years ago.

At the same time some music conglomerates have considered using securitizations as a means to refinance corporate debt. Terra Firma-backed EMI Group Ltd., for example, was considering using its music publishing catalog to launch a securitization a couple of years ago, before it turned to corporate debt financing this month, says a market source.

In the music world, David Pullman, founder and chief executive of Los Angeles-based Pullman Group LLC, pulled off perhaps the most famous entertainment IP securitization of all time 11 years ago. He arranged a private placement of $55 million of 10-year asset-backed bonds with insurer Prudential Insurance Co. on behalf of rock star David Bowie that became known as the "Bowie Bonds," setting the stage for a raft of future copyright-collateralized ABS deals. The securities, which yielded 7.9% and drew single-A ratings, were based on the future royalty payments from 25 David Bowie albums recorded before 1990.

"It was an ideal asset-backed security with diversification for their portfolio with a long average life of approximately 10 years to match the assets and liabilities of a life insurer and well-diversified, international steady-income streams," says Pullman, who trademarked his IP bonds as Pullman Bonds.

He subsequently arranged a $30 million Motown Bonds issuance in 1998 for the songwriters behind hits like Diana Ross & the Supremes' "Stop in the Name of Love," and a securitization two years later for the estate of Marvin Gaye, among others.

Then, an investment banker named Rob Horowitz at the Royal Bank of Scotland kicked things up a notch in 2001 by structuring a deal on behalf of London music business Chrysalis Group plc. Although he wasn't the first to carry out such a deal, the banker put together one of the larger transactions at the time with a $100 million securitization that encompassed thousands of artists and involved an international music publisher.

More recently, the prospect to capitalize on the vast Beatles music catalog held by the late mega-star Michael Jackson, who owned 50% of Sony/ATV Music Publishing, that holds the songs, has had Wall Street a-chatter.

Peter Walsh, a managing director at Huron Consulting Group and former founder of structured finance company Six Degrees Capital Management, says esoteric ABS issuances weren't just limited to the entertainment industry. He notes that in the early half of the decade pharmaceutical companies like Royalty Pharma, a New York biopharmaceutical company, also carried out securitizations. Royalty launched a $225 million securitization in 2003, and a spate of similar deals followed.

Structured finance transactions aren't, of course, without their share of risks for issuers or advisers. In July, for example, Lamont Dozier, who penned Motown classics like "Stop in the Name of Love," filed suit against law firm Willkie Farr & Gallagher LLP and Deutsche Bank Trust Company America, alleging a conflict of interest over a 1998 deal to securitize royalty payments. Securitization also offers a realization opportunity, Pullman says. "The private-equity firms want to buy [music rights] entertainment and IP portfolios, bundle them up and finance out through a Pullman Bond or sale to another publishing company."

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