What next for Stonegate’s remaining L&T business?

One of the big questions following the blockbuster acquisition of Ei Group by Stonegate was what exactly the new custodian would do with its vast new leased & tenanted estate.

With a clearly defined strategy as a managed, mostly wet-led pub company, and a growing variety of formats to play with, it was obvious Stonegate would look to convert pubs over to its managed specialism.

And there was strong appeal for more conversions to Ei’s Craft Union model, the wet-led community business run under a franchise-style agreement, where the operator receives a percentage of turnover.

But even with these opportunities, the Ei estate was some 4,000-strong, and there has been speculation ever since the deal in 2019 over just how much of this Stonegate would want to offload.

For various reasons, most notably Covid, this process of rationalisation and sorting through the estate might have taken longer than was originally expected.

Yet some three-and-a-half years later, the issue remains that a hefty chunk is too large and complex for Stonegate’s focussed model.

Even discounting those licensees that go free-of-tie or market-rent-only, there could be as many 1,500-2,000 pubs that don’t have an obvious home, according to an estimate by one industry insider.

Leased & tenanted, usually wet-led community pubs, generally operate under a more modest turnover than their managed counterparts, and Stonegate has to share this upside with its acquired tenants.

Others will have converted to restaurants for instance, which are of even less interest for the company – think independent curryhouses with a meagre beer trade, where Stonegate is reduced to a mere rent collector.

“The question you’ve got to ask is, are Stonegate the best people to run those?” the source asks.

“Or actually, is it one of the ways that they can pay down the debt that they’ve accumulated by buying that business [Ei]?”

Paying down its £2.6bn debt pile was the key rationale offered in the Bloomberg report which broke the story that Stonegate was looking to sell off around 1,000 of its pubs.

Stonegate declined to comment on the piece, with sources close to the company dismissing the report as speculation.

Bloomberg reported the TDR Capital-backed group, which acquired Ei for c.£1.3bn just before the pandemic hit, is looking to raise an estimated £800m from the sale.

Real estate investment bank Eastdil Secured is said to have been appointed to advise on the planned sale, which is likely to be kicked off in the spring.

With the cost of borrowing higher than it has been in years, and debt markets increasingly difficult to access, there are clear incentives for the company to reduce debt.

And where there is clear logic for Stonegate to have a simpler business, this in turn offers an attractive potential for existing tenanted pub operators and prospective new vehicles to buy and build.

So who might to be in the market for 1,000 pubs – and could the current market uncertainty present a spoiler for the plans?

One potential candidate would be Green King, which could see a chance to grow its Pub Partners business, with backing from owner CK Asset Holdings.

Another could be Punch, whose investor Fortress Investment Group has a stated ambition to build the pub company under the Clive Chesser-led management team.

Meanwhile Oaktree Capital might consider it an opportune moment for its Red Cat Pub Company vehicle, run by former Greene King CEO Rooney Anand, to diversify and bolt on a leased and tenanted division.

The process could also see new partnerships emerging, with experienced management teams coalescing around an investor seeking an entry into the market, to build a brand-new pub platform, in a similar vein to Admiral Taverns.

“There are management teams that will be running around the market today saying, ‘we can run these pubs for you, Mr Private equity’, people with expertise,” the source tells MCA.

A third buyer profile could be from a property background, who see the value in good operational real estate, like New River/Hawthorn – so long as they can collect rent and understand how to run a beer business, a “property play, effectively”.

“There’s likely to be quite a bit of interest. It’s just rather a large cheque of £800m that you’ve got to write out,” the source says.

Depending on interest, those tasked with selling the collection will likely want to sell it as as one, rather than slice and dice it for multiple buyers.

That means the buyer will have to take “the rough with the smooth… the good, the bad and the ugly”.

“It isn’t necessarily going to be the bottom end though,” the source suggests. “It has to be the sellable parts of the business.”

Another perspective is that the sell-off could be indicative of the intense pressure the leased and tenanted sector is under, a market typically populated by small, independent operators.

MCA understands major pub companies are increasingly concerned about lease holders and tenants handing their keys back due to the soaring cost of doing business.

While these pubcos have often supported their tenants through Covid, the current crop of pressures could prove to be the final breaking point.

The project certainly gives Stonegate’s new CEO David McDowall plenty to get his teeth into, the former BrewDog COO officially starting at the company last week.

MCA’s contributing editor Peter Martin says that in the current climate, being part of a business with scale is invaluable.

“Looking at the numbers, managed pubs are doing well top line,” he says. “They still have the same costs as independents, but obviously they have more financial headroom.

“The independents have got an issue. The challenge for the pubcos is, how much can you support them?

“In this brave new world, it’s all about strength in numbers. Size matters with the costs we’ve got.”

Martin doesn’t discount the prospect of more traditional pubs coming out of the market, particularly if a new buyer decides a change of use is the best use for the asset.

“It may be a longer-term investment play, someone outside the industry, because you’ve still got the real estate,” he says.

“The issue for the market is we’ve had a net 30,000 closures across licenced trades. We shouldn’t be surprised if we see more closures or change of use for some of those properties down the line.

“We go through these phases over time, and we may be going through another one because of the sheer cost of doing business. If you’re a small operator, it’s not looking great out there.”

Despite the gloomy prospect of more pub closures, Martin suggests other hospitality venues could cater to the enduring demand from consumers.

“People still want to go out,” he adds. “The questions is, where do they want to go, where are they going to be?

“We’re going through some big changes in the market. And this is perhaps one manifestation.”