SECURITIZATION: AND THE BOND PLAYED ON

By James Brandman

Decision-making on new securitization opportunities could hinge on the latest music charts judging by the flurry of interest in using intellectual property (IP) and entertainment to finance bonds.  The glitz and glamour of the entertainment world come hand in hand with big numbers.  Observers note that the untapped IP market hold assets worth up to a trillion dollars.

Bonds securitized on IP rights are not new, having already gained entry to the private placement market in the United States, with big-name musicians leading the way.  But it is now only a matter of time before IP bonds switch across to the lucrative public market, according to a Moody's Investors Service report published in July.

Deals in other areas of IP --- movie libraries, book publishing, trademarks, patents, and sports contracts --- are expected to follow.  "I would see no reason why we should not go down that route in the future," says a spokesman for Dutch publishing giant Wolters Kluwer.  "Although the way we finance our operations is not a pure securitization of publishing rights, they are at the core of our business.  Publishing rights in combination with people and operations are cash flow-generating activities."

Groundbreaking and innovative in musical terms, David Bowie was, to no one's surprise, the artist who set the market precedent.  Entrepreneurial investment banker David Pullman became the first to securitize intellectual property backed by future revenues from royalties when he launched $55 million of "Bowie Bonds" in 1997.  The Pullman Group has entrenched itself as the prime instigator of the deals, dishing out bonds for Motown songwriters Brian and Edward Holland and Lamont Dozier, songwriting duo Ashford and Simpson, and most recently, the "godfather of soul," James Brown.  All the bonds received single-A ratings from Moody's and Duff & Phelps Credit Rating.

The potential of the IP securitization market is huge.  Intellectual property and entertainment assets worldwide are worth an estimated $1 trillion, according to Pullman.  But with little more than $100 million in deals done to date, the market is nearly nascent.  "For the markets to grow, you would have to get the companies that control large pieces of intellectual property to enter," says Jay Eisbruck, vice president and senior credit officer at Moody's in New York.  IP transactions also rely heavily on popular tastes, adding complexity and risk to any analysis.  Investors needs to be fully versed in their unique qualities.

Morgan Stanley Dean Witter was the first major investment bank to complete a deal with an element of IP securitization when it raised $1.4 billion for the premier motor-racing body, Formula One.  "When we were marketing the Formula One bond, we had to educate investors quite considerably on the value of IP rights and why they're a good security to lend on," says Steve Din, executive director of securitization at Morgan Stanley in London.

He's now looking to create deals securitized on the rights to brand names.  "Brands are no different from buildings," he says.  "Like buildings, they need maintaining and nurturing.  You have to invest your money to protect your brand and maintain its value."

Nor is Pullman standing still.  He's looking to raise anywhere between $25 million and $100 million by packaging the works of various songwriters and then selling them in one large transaction.  This would help achieve a higher rating and help tranche the bonds into various categories, with senior classes potentially rewarded with a rating as high as triple A.

The techniques developed on the model of the Bowie Bonds can be applied to a much broader set of assets and structures, Eisbruck believes.  For example, the characteristics of a movie library transaction might include pooling together a large group of films with wide, long-lasting appeal and looking at revenue generated by long-term licenses offered to a diversified group of television networks and major film studios.  Book publishing rights act like music royalties, with copyrights over books and music caught under the same laws.  As for trademarks and patents, securitizable revenues can be generated by licensing these rights to third parties.

Following Polygram's merger with Seagram (which owns Universal Records), there are five major record companies: Sony Records, EMI Group, Bertelsmann Group (BMG), Universal Records, and Warner Brothers Records.  Together, they control more than 80% of the US market, with similar penetration in Europe and Asia.  All have ratings of Aa3 (Sony) to Baa3 (Universal), with the exception of the unrated BMG.  "It will work for larger companies, and they will all eventually do securitizations on their assets because it makes sense for them to be off balance sheet.  That means higher earnings per share," says Pullman.  "There's also the nonrecourse factor.  They will have liquidity and cash to do other things with."

"For record companies, film studios, and distributors, which have a much larger funding requirement than individual artists, you could see it making a lot of economic sense to do an IP securitization," says Din.  "Once you're able to convince a [major institutional] client that you can bring a very tangible benefit through securitizing their intellectual property assets, then you've gone a long way toward generating the interest needed to help that market develop."  But such deals will not be limited solely to the record giants, says Pullman.  Over the next two years, as investors become more familiar with IP as an asset class, openings could emerge for smaller independent labels.  "For mid-, small-, and micro-cap companies, it's a great way to compete with the giants," says Pullman.  "The capital can be used for acquisition financing."  And record companies also stand to benefit from issues brought to market by their artists, he says.  "It helps them because the more people we finance, be it Bowie or James Brown, the less money they have to put out, "he says.  "Instead of them giving advances, we do.  We're replacing the role of the traditional publishing advance or bank loan and so helping create liquidity and diversity.  And the more we do, the greater the value of these catalogs."

Compared with typical bank loans, IP securitizations are expected to offer lower interest rates, though typically they would pay interest of one to two percentage points higher than a corporate bond.  They would have longer maturities (between 10 and 15 years) and an ability to reclaim the assets after the debt is fully repaid."  In a loan transaction the bank will normally take title to the assets and other assets they own," says Eisbruck.  "That doesn't happen in an asset-backed transaction --- you have to transfer title to the assets themselves."

The sticking points for a company, though, are the up-front expenses and legal fees, he says.  These can escalate over time when trying to establish complete ownership of the assets.  "For a number of tangible assets there is a very reliable means of verifying ownership of the asset," he says.  "But for IP rights, especially copyright, it's considerably more difficult."

But the Moody's report foresees steady growth in volume over the next two years, as issuers are likely to find securitization a more attractive prospect to other types of financing.  But predicting how IP bonds will take off in Europe is little more difficult, says Eisbruck.  And Pullman agrees: "There's a tremendous appetite for off-the-run, asset-backed issues in Europe.  It's just a little easier to do in the United States because the whole process is different, and there are many more investors."  What's more, investors are becoming more familiar with intangible assets because of E-commerce and Internet-related investments.  This gives IP assets a great deal of credibility, says Din, considering the size of the Internet investment market.

"Our belief in terms of investors and the rating agencies is that IP assets are stronger because they appreciate, as opposed to loans, which depreciate as they get paid off," says Pullman.  "It's a standalone entity, an intangible asset that you could run from a home computer --- that's what we like about it."

GLOBAL FINANCE, November 1999, p. 66-67