Leading analyst Goef Collyer at Deutsche Bank has said that if Whitbread is really serious in keeping restaurants, it needs to provide additional data to enable proper comparisons, and management needs to assess whether there is a realistic chance of achieving margin parity with the peer group. He said: “We would stress at the outset here that we do not see any imminent pressure on management to exit its restaurants business. [From our research] we can see that the pure OpCos (Gondola, Tragus) pay out around 9% - 11% of sales in operating lease rent. We also know that Greene King ascribes a ‘9% of sales’ rent proxy to profits when assessing investment applications internally. And M&B’s internal rent ascribed for internal performance measurement purposes across leasehold and freehold sites charges £190m a year, equivalent to an additional 10% of sales, over and above the 2.5% of sales that it is actually paying. “So if Whitbread’s Restaurants were separately quoted or reported, it would look like operating margins would be lower than the peer group. Therefore, management has to determine, in its strategy review, whether the upside for shareholders is better driven by selling off Restaurants, paying down a chunk of the pension deficit and handing back cash to shareholders or seeking to improve margins. “Since integrating Restaurants and Hotels, Whitbread’s management commentary regarding the restaurants’ performance has consistently focused around cover growth running faster than either lfl or total sales growth, and cost inflation, especially food and labour, all of which suggest that the margin – if it were to be broken out today – it is unlikely to be better than the 2009 version, and probably lower by around 50-100 bps. Who might be interested in buying the restaurants? Collyer wrote in April 2010 that Mitchells & Butlers remains very interested in the possibility of acquiring the Whitbread restaurant sites and that he would be surprised if they were the only company also coveting the portfolio. He said: “Although we do not see M&B as a potential buyer at present, due to apparently differing views amongst the shareholders on growth strategies and the fact that he group does not have a CEO, it would have been the number one contender to purchase, having publicly stated its goal was to try and buy around 700 sites from the public market back in February 2010, when the then CEO published the results of the latest strategic review. And also because M&B has already been successful with the last two major asset deals with Whitbread for almost £600m in total. “We did discuss Greene King’s possible interest in our recent note on the company. If the business were to come up for sale, we are sure that other bidders would emerge, including private equity. Ian Payne, exec chairman at Stonegate, has experience of acquiring pubs from Whitbread, and maybe if a deal with Spirit were not to come off, Whitbread could look interesting, though we would presume that the seller would want cash.” “We have said that we think Spirit could be interested – it would give its CEO Mike Tye a chance to have been MD of four of its divisions (see previous section), though we would struggle to see how it could finance a deal of this scale – unless it had had the opportunity to strengthen its balance sheet first.” What is it worth? Collyer said: “We do not know what the profits are, though we would be surprised, as we have stated, if they have strayed too far from the £50m of EBITA last publicly reported. Of course, the trend nowadays is to report House EBITDA. This is so the buyers can say how cheaply they have bought the assets for, whilst the sellers always cite strategic realignment or something to justify selling below what some people feel was appropriate. “In this case, a buyer may have to put overhead back into the business, as it would have to disaggregate the restaurants from the hotels, so the proforma profit number could end up being lower post a deal. We do not see any existing pub groups being able to absorb an estate of Whitbread’s size into their current operating infrastructure “Looking at the myriad of deals from 1998 to 2012 we think that the spread of retail deal EBITA multiples around 10x-12x would feel about right. This would give it, assuming profits are flat since integration with Hotels and not down, a valuation range between £500-£600m.” What would Whitbread do with the money? Collyer believes that one of the first priorities for Whitbread would be to reduce the pension deficit, which would free up future cash flows and assets that have been set aside as temporary collateral for the Pension Fund Trustees. He said: “This is an area that keeps coming back to haunt the group, although the situation now is significantly better than when the deficit was around a quarter of the equity value some years back. Any dent in the pension liability would accrue directly to the equity in our view. “A second priority would be to probably hand capital back to investors. The group after all does not need the cash to fund its rollout, which is already accounted for in the cash flow forecasts.” Collyer said that selling off the Restaurants would be initially dilutive, so cash back and a consolidation of the equity would make sense – and it is the route that the group has used several times before when the previous CEO was reshaping the business. He said: “We estimate that the EBITDA of the Restaurants would be around 15% of the group EBITDA on a pre-overhead basis. We think that the minimum injection into the pension fund would be around £100m of the proceeds. We have looked at two versions of what to do with the proceeds and the impact on our EPS forecasts and target price. “If the Restaurants business was sold, we see the combined impact on our forecast EV/EBITDA multiple as negligible, with minimal impact on our target price as well. So why would the group undertake such a dramatic structural change to make around15% less EBITDA? We see such a change of group shape removing one of the biggest speed bumps in the road when trying to persuade new investors to buy in; i.e. no pubs. We see this as especially being the case with US investors; this group owns around 40% of Intercontinental Hotels Group compared to less than 10% of Whitbread, and many of these are UK-based. “We estimate that such a move could add a point or two to the overall growth rate, but most of all it would focus investors’ minds on a business which has two fast growing businesses both of which have significant long term potential - Costa Coffee and a pure hotel business, Premier Inn. The potential for a re-rating would more than make up the slack.”