Operators facing ever-more demanding investors and mounting challenges have tended to focus on premiumisation and the strength of their brand, estate and people. However, CBRE’s Simon M Johnson warns this may no longer be enough. He suggests bolt-on acquisitions are likely to become more crucial to success with the result that fledgling brands with an edge will become more valuable.
The most recent results season from the quoted pub and restaurant companies and updates from some of the larger private operators had a number of near universal themes including cost headwinds; falling consumer confidence; lower retail and
leisure park footfalls; increased discounting activity; and the decline of food sales compared to drinks.
With that background, the largest operators in the eating and drinking-out sectors had to present a compelling investment case to hard-pressed shareholders and a wary debt market. With few exceptions, they chose to focus on the distinctiveness of their brand offering; potential for premiumisation; quality of their estates; the skills and enthusiasm of their people; and the strength and flexibility of their balance sheet.
Establishment is now ‘tired’
However, we are not convinced that all will thrive in 2018 – particularly given the high-profile disappointments that we have already seen among some of the former rising stars of the casual-dining space and the continued caution from the value-food pub sub-sector.
Therefore, it should not be too surprising to suggest that established formats have become ‘tired’ and that refreshing their model in terms of capex, menu changes, staff training and technology may no longer be enough. These operators may need to look seriously at bolt-ons of fledgling concepts that have a different appeal to a more cautious consumer and pump up the current prospect of flat earnings.
However, the competition for operators with an edge (and particularly those with freeholds) will be intense and from a wider group of buyers than ever before. Existing players will need to prove their worth against a new breed of investors.
Adding bite to portfolios
There is already evidence for both trends over the past 12 months or so with Marston’s acquiring the Pointing Dog Group to add to its Premium segment; Stonegate buying Bar Holdings, bringing transport hub expertise to its considerable skills; and the addition of a vibrant UK craft beer business in London Fields to the international suite of Carlsberg brands.
We also note press speculation around the possible addition of Gail’s to Patisserie Valerie and reports of at least two potential bidders (current operators) that looked to add the brewpub, wet-led, high customer service traits of City Pub Co to their existing operations only to be overtaken by the IPO process.
However, this strategy doesn’t always work, as the sale of the Firezza gourmet pizza delivery business by PizzaExpress in November 2017 (having been acquired in February 2016) demonstrates.
Looking forward, we expect to see many more niche operators, often with unusual or clever ways of operating being approached by the major chains. There is at least one well-respected, mid-sized pub operator with an innovative approach to operating its sites that is thought to be considering its options actively, and we would expect some of the major chains to take a close look. And, there are many more that will watch any process with interest.
On the second trend, there continues to be significant private equity interest in the sectors where the concept, management or a growth story dominate and from real estate investors where there is a considerable freehold element.
The sale of Loungers last year is a case in point. Many large operators have tried – and in our view not succeeded – in replicating this licensed all-day concept and yet it was not a trade buyer that succeeded but Lion Capital, viewing this as a stand-alone business that can get to 250 units plus.
Joint ventures to gather pace
Furthermore, the completion in 2017 of the Punch deal with Patron/May Capital and Heineken, the purchase by Aprirose of the Milton portfolio of 73 M&B-managed pubs and the joint venture, which included Proprium, that bought Admiral Taverns, firmly planted real estate investors in the operational pub realm.
We firmly expect to see this continue in 2018 as property investors get even more comfortable with the risks and rewards of the operational side of freehold pubs and expand their portfolios at prices that traditional owner-operators either cannot see or can’t finance.
We also expect to see a significant increase in the use of ground rents and income strips to bridge that gap, not only in the way that Marston’s is financing its new-build programme (which incidentally has been cut back as the stock market can’t seem to price the value-add in the way that Marston’s does) but also as a way of acquiring, restructuring, refinancing or paying founders a significant dividend.
We have seen those structures not only informing value but driving pricing in large competitive processes in the operational real estate sectors. All the major Holiday Park transactions in 2017 were marketed with a significant element of ground rent financing built in and we expect this to continue as the weight of capital looking for long-term secure income continues to grow.
Therefore, the question we shall be asking many owner-operators in 2018 is “demand for great concepts is at a high point, pricing on your real estate is at a premium and interest rates are at a low point – what are you going to do?”. We believe that, for many, crystallising value will be the route they choose.
■ Simon M Johnson is a senior director at CBRE Specialist Markets
