Punch Taverns: Managed Pubs And The Punch Spin-Off

23rd Jun '11 by valuhunteruk

5 comments 14435 reads

My last post on Punch Taverns (LON:PUB) took quite a generous view of the recent spin-off of its managed pub business. The essential idea was that the sum of the managed and leased business is worth more than the two businesses combined so value is being realized in the spin-off. However, there is still a lot of uncertainty here so I am going to go deeper into this situation.

One update that I feel it is important to mention briefly is that a committee has been formed amongst the noteholders of Punch A and B who have criticized the spin-off. This is not something to be taken lightly as it suggests PUB’s creditors are preparing for the somewhat inevitable credit event at the end of this year. The committee, quite rightly, have been hostile to management and the spin-off as it is costing £30m which is essentially money that could be returned to them. However, we will leave this until later.

In this post, I am going to concentrate on the managed side of the business. We will look at the valuation and operating metrics of all the managed pub companies in this sector (whether they be a subsidiary or the main operations). As well as looking at this from the point of view of the Punch spin-off we should also consider how these companies will perform individually. The industry is experiencing a massive capacity overhang and we would expect some companies to be better positioned than other to take advantage of this over the coming years. As this consolidation happens, we should see the industry return to profitability.

(The market cap figures appear to be off so some of the valuations may be inaccurate, most importantly EV/EBIT)

Comparables - The first step is to consider who the competitors are. The businesses in this sector operate in three main sectors: managed pubs, leased pubs and breweries. The companies listed above are those that have a managed business however, only Mitchells and Butlers PLC and JD Wetherspoons are just managed pubs alone. I have also included The Restaurant Group which operates a few restaurant brands which is somewhat comparable so what Spirit will do.

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liquiddevil

25th Jun '11

I work in the pub trade and operate several free of tie managed pubs & 1 tied Punch lease that is due to transfer to Spirit.

I read your article with interest but would like to comment on a few points:

Valuations - 'the likely outcome will be consolidation/bankruptcy//asset sale....4x EBITDA'
How do you get the multiplier of 4x EBITDA for these leases? In the current market you would be lucky to 2.5x (even allowing a premium for a group sale) and there are a large number of single units currently changing hands for less than 2x EBITDA. Therefore, I assume you are referring to the sale of the freeholds? I agree that the sites Punch/Spirit are most likely to offload are at the bottom end of the scale in terms of profitability and some of these will be worth more for alternative use, i.e conversion to flats etc. I note that further on 'considering the Punch spin-off we expect fair value to be 5-6x EBITDA' - in the alternative use case 5-6x may be too low. See www.fleurets.co.uk or www.christie.com for sites for sale.

Profitability - 'JDW has poor margins'
I agree! We all see the Wetherspoon deals and wonder how/why they sell so cheaply. In many cases Wetherspoons will have a headline grabbing offer and many other drinks are not as 'cheap', in the same way as Tesco/other supermarket. (In fact, I believe Wetherspoons operate more along the lines of a supermarket than a standard pub model.) Also, many Wetherspoon sites are concentrating on food which can generate high margins and increased customer spend, leading to the impressive levels of turnover you have indicated. JDW can put enormous pressure on suppliers to reduce cost of goods but there will always be a limit. Having acquired some ex-JDW sites in the past, the biggest issue we have noticed is labour - their management structure is so costly with General Manager, Shift Managers, cooks/chefs, bar staff etc. This can work when turnover for a particular site is in excess of £1million p.a. but becomes a drain on profits when it falls below that level.

Recent Trends
You are right to question the tied pub model. This has been criticised for many years and more recently the Beck report recommended various changes. In many cases, these tied sites are let to owner operators with little experience for (at least) 2 reasons:

1. They are a relatively cheap way to get a pub of your own - in some cases your may only have to pay a few thousand for F&F
2. They are poor quality (in terms of decor, location, prospects) so do not attract the more capable/experienced operators

In many ways these only suit owner operators as they will not need to employ a manager and will have accommodation provided.

There is over capacity in the pub sector and we are seeing consolidation, which should be seen as an opportunity for good quality operators. I don't necessarily agree that food will be the main focus in future. I note that some companies are focussing on this and doing very well. This has been a focus since the smoking ban and I have noted above that JDW are also going down this route but there will always be a place for good quality pubs, despite the government continuing to hammer us with taxes and cheap drink in supermarkets.

valuhunteruk

Thanks very much for the comment, its always helpful to hear the views of an expert doing business in the industry rather than my slightly ignorant guesses as to whats going on.

Valuation - Yes, I should have actually highlighted what I was doing with my multiples. Basically, it was for the whole Spirit business and the number was calculated by halving what JDW is selling for (I think the numbers may be wrong and I haven't had time to check). I had seen some transactions for the type of multiples you mention and hearing about alternative use is helpful. This is a really tough area to work out, especially working out what Spirit is going to get for the leased pub it takes over, as you don't know what the pubs are like.

Profitability - Again, thanks for the comments about JDW and the colour about how they run their pubs. It is interesting you highlight the high fixed costs of the food business, something I hadn't thought about or realized.

Recent Trends - I am actually just about finished putting together a post on the leased pub companies and obviously the tied model is main concern. I had started to comment on how one-sided the risk was in favour of the lessee and how low the sunk costs were. I had suspicisons along the lines of your second comment when I saw the breakdown of where PUB's leased pubs were: mainly in areas under 100,000 people and the north of england. I also agree with what you say about drink, I ran through some maths and I think its likely that a lot of the leased pubs are viable but run by via a different model.

Again thanks for your comment.

1st Aug '11

A bad day for Punch. I think today's performance shows the tied model really is no longer in intensive care but is actually dead now!

The performance today was due to the spin off of Spirit (which was all of the managed business and some leases). the ratio was one-to-one (so 1 share of Punch Taverns (LON:PUB) gets you 1 share of £SPRT ).

it will take a few days (distribution of the new shares should be done in mid-August) for stuff to settle down but £SPRT was offered between 50-55p and Punch Taverns (LON:PUB) was offered between 17-11p which is roughly up from where it was before (there was some heavy selling before the spinoff). it looks like there is going to be more heavy selling of Punch Taverns (LON:PUB). In my opinion, the valuation still looks kind of generous and I wouldn't be suprised to see it go under 10p. Will have to do some maths though. The selloff on Enterprise Inns (LON:ETI) has been very heavy too recently (down 55% since start of the year).The hearings in Parliament have also been quite interesting as well.

2nd Aug '11

I noted that this was post spin-off. I am even less confident in the performance of Punch. I accept that some maths is required: is the sum of the parts greater than the original value? It just seems that Punch now has the weakened estate.........:

Hands up all those who love the beer tie?
http://www.morningadvertiser.co.uk/news.ma/article/91297

Punch Taverns: Managed Pubs and the Punch Spin-Off

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Valuhunteruk

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