Bonds - Securing a future with IP assets
31 March 1998
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Musicians are not the only group to utilise IP securitisation as a means of guaranteed future income, writes Matthew Higdon. Matthew Higdon is a solicitor at Taylor Joynson Garrett. Intellectual property (IP) securitisation is a high-profile issue on the international stage at present, with Rod Stewart rumoured to be following David Bowie onto the bond market in the near future.
These entertainers have stolen the limelight, but major corporates are also waiting to plug into the technology of securitising future income from IP.
Securitisation is a means of raising capital for the originating company by transferring existing and future receivables to a special purpose company which then issues bonds to repay the originator.
In appropriate instances it can produce significant and competitive funding for companies, whilst diversifying funding sources and effectively reducing risk for the originator.
Another major incentive to corporates is the off-balance-sheet, or quasi off-balance-sheet nature of securitisation funding. For banks and corporates alike, it is a very effective balance sheet management tool.
Until recently, securitisation had been applied to a narrow set of assets, predominantly mortgages, car loans, commercial loans and credit cards. But the asset class is now widening to include different mediums.
This reflects not only investor appetite for higher yield bonds, but also a growing realisation that securisation can be used to unlock balance sheet value in assets such as IP rights, for which more conventional types of debt financing may not be readily available or suitable.
There is a further development in the use of securitisation to provide acquisition finance, whereby fixed rate funding can be secured with repayment spread over 25 to 30 years.
The idea of using IP related assets to raise substantial amounts of cash is not a new one. Disney, Nestle, Calvin Klein and News Corporation have together raised somewhere in the region of US$1bn with bonds backed by copyright, trade mark and film related licences.
SmithKline Beecham is reported to be considering a bond to fund product development to the tune of £1bn. Investors will have their principal and interest serviced by the sale proceeds of certain ring-fenced pharmaceutical products when they come on-stream.
IP assets have characteristics that other assets do not. In many instances, IP rights have a longer shelf life and can produce revenue for a longer timescale than assets such as loans and mortgages. Potentially this means they could be securitised on an ongoing basis.
Furthermore, an originator can merely transfer the present and future receivables, whilst retaining legal ownership of the intellectual property (sometimes the client's most valuable asset), making this arrangement infinitely more attractive than an outright sale of IP rights.
As a mechanism for acquiring portfolios of IP rights, securitisation is potentially unrivalled. For instance, because libraries of musical works are priced as a multiple of the net publishers' income due from the catalogue, securitisation could effectively eliminate the front end acquisition costs during the life of the bond, leaving a residual value in the portfolio which could last as long as one hundred years.
The value of IP, unlike many other assets, can appreciate as well as depreciate. Any appreciation will be added to the residual value of the portfolio, introducing a potential upside for the final owner.
The final owner will probably have acted as servicer to the special purpose vehicle (SPV), so it appears to be in everyone's interest that the servicer uses its best endeavours to exploit the portfolio during the term of the bond.
Although there are accounting issues, these are not insurmountable and there are structures that could cater for this arrangement even under English reporting standards which are not as favourable as they are in the US.
Perhaps the most obvious difference between IP related revenues and the more traditional receivables previously securitised is that IP revenues can behave in a slightly more delinquent fashion, reflecting the changing levels of use or sale of a product.
As with all securitisations, an accurate prediction of cash flows to the SPV, timed to meet the commitments of the SPV to the noteholders needs to be modelled. With this type of revenue, historical data will provide some degree of prediction for the future. Nonetheless, it is clearly important to err on the side of caution in this context and take a relatively safe line so as not to leave the SPV short. A liquidity provider and other mechanisms can be called upon to fill in the gaps where a mis-matching of funding could potentially occur. This presents a challenge for banks. Arguably it is simply a matter of time before financial modelling techniques evolve to meet this demand.
In Europe, the commercial desire for the development of this product results from the emergence of successful companies with little that is tangible to offer as security, but with a wish to raise debt finance.
Securitisation is commonly perceived as a technique available and used only in transactions with complex structures. Allied to the use of this technique by major corporations to raise and manage cash flow, the banks are looking at this area far more seriously than they did hitherto when it was regarded as a slightly quirky frivolity. Funding techniques clearly have to evolve to keep pace with this movement.
The new lesson has to be that if there is a sufficiently discernible predictability in the cash flow of a product then a securitisation may be possible.