Pizza Hut Puts Its Franchise Royalties Up as Collateral

Every Pizza Hut franchisee in the U.S. and Canada sends royalties to a brand that is now asking bond investors to lend against those payments.

LongRange Capital, the private equity firm that closed its purchase of Pizza Hut outside mainland China on Sept. 1, is marketing roughly $1 billion of notes secured by the chain's franchise agreements and related fees, Bloomberg reported Nov. 10. The bonds are expected to sell next week.

The structure is a whole-business securitization. Instead of borrowing against buildings or equipment, a franchisor pledges its contractual income: royalties, advertising fees, vendor rebates and trademarks. It is Pizza Hut's first, according to Kroll Bond Rating Agency's preliminary rating notice, which says Pizza Hut of America will contribute substantially all of its North American revenue-generating assets to a new issuing entity.

The collateral is large and almost entirely franchised. KBRA counts about 6,678 restaurants across the U.S., Canada, certain U.S. territories and military bases, which produced about $5.4 billion in systemwide sales over the 12 months through the second quarter. More than 99% are run by franchisees.

The money has a specific job. LongRange paid about $1.5 billion for the business, funded in part with an $810 million term loan, and the bond proceeds are meant to repay and refinance that loan, 9fin reported. The largest tranche is at least $600 million, with initial price talk in the high 200s to 300 basis points over benchmarks, and all tranches are expected to carry BBB ratings from S&P and KBRA. KBRA said proceeds can also fund general corporate purposes, including strategic investments in the U.S. and Canadian businesses.

On paper, nothing in a franchisee's agreement changes. What changes is the audience. Once royalties back public debt, systemwide sales, closures and fee concessions all show up in numbers that bondholders and rating agencies watch, and the brand has a strong reason to protect the fee stream it borrowed against.

The category is not making that easy. Rival Papa Johns reported North American comparable sales down 8.3% in its third quarter, Nation's Restaurant News noted in covering the bankruptcy of the franchisee behind Papa Johns' 6,000th store.

When the deal closed, interim CEO Eduardo Luz said the standalone company was "fully focused on Pizza Hut's guests, our franchisees, and the teams who bring the brand to life every day." Next week's pricing will show what investors think that focus is worth.