Inside track by Peter Hansen, founder of Sapient Corporate Finance.
Between 1991, when Bridgepoint and LGV backed Enterprise Inns, and 2002, a year that saw the innovative Cinven and LGV acquisition of Unique Pub Company, private equity has played an important role in the development of the tenanted pub sector. A decade on from the last major private equity deal, Cerberus Capital Management has acquired Admiral Taverns to end a prolonged period of absence of private equity from the tenanted mergers and acquisitions landscape. Why has it taken so long for private equity to re-emerge as a significant force in this part of the market?
From 2002 until 2007 trade buyers, driven by cost synergies and the availability of debt finance, paid prices that private equity could not match. Since 2007, debt finance has been both scarce and expensive. It is, therefore, little surprise that the only three transactions in the pub sector over £100m in the last five years (M&B’s sale of 333 managed pubs to TDR Capital, RBS’s sale of 918 tenanted pubs to Heineken and now Cerberus’ acquisition of Admiral, all three of which Sapient advised on) were all cash-funded by buyers with deep pockets. Buyers who can pay cash and finance later have a considerable advantage in the bidding process and ultimately obtain better debt terms.
All tenanted estates have a “tail” of underperforming pubs that are unsustainable in the medium to longer term. Most disposal pubs are on short-term agreements so that the pub company can sell them with vacant possession. As a result, disposal pubs generate little cash prior to sale. It is unsurprising that most private equity firms are reluctant to purchase tenanted pub estates with a sizeable disposal tail that generates little cash.
Finally, in the last five years many pubs were over-rented as beer volumes fell due to the combined effects of the recession and the smoking ban. The pub companies have responded by supporting their tenants with increased beer discounts and rent concessions. There is concern, however, that pub profits are still not at sustainable levels for many pub companies.
How did Cerberus address this concern? Cerberus constructed a detailed tenant profitability model with the assistance of Sapient Corporate Finance and two leading firms of surveyors, Colliers and Fleurets. The surveyors visited each of the 1,100 pubs and interviewed over 300 tenants. The information gathered was analysed by Sapient and Cerberus, and it reassured Cerberus that Admiral’s pubs were profitable for both Admiral and for the tenant. The analysis was detailed and thorough – as thorough as any we have seen prior to an acquisition.
It is the sustainability of a pub and its profits – both for the tenant and the landlord – that is more important than the absolute level of profits. Admiral management recognised this, having sold over 2,000 pubs in the last five years, and when it finishes with a core estate of 700 to 800 pubs, it will have one of the most attractive and stable portfolios in the tenanted pub sector.
We believe that all tenanted pub acquisitions in future can and should include a detailed model of tenant profitability. After all, if the tenant doesn’t make enough money, then earnings are not sustainable for the pub company.
Cerberus was able to buy Admiral for three important reasons. First, Cerberus enjoys a strong reputation with Lloyds, having completed several transactions with the bank. Second, Cerberus paid cash, taking the financing risk and achieving a clean exit for Lloyds. There are very few private equity firms with the financial ability and the commitment to pay £200m for a tenanted pub business.
Finally, Cerberus was willing to acquire all of Admiral, including the disposal estate, recognising that the Admiral core estate is very attractive with stable earnings and strong prospects and the management team has proven ability in maximising returns from non-core pubs. Its extensive background in real estate also meant it was very comfortable when it came to understanding the disposal estate.
The Admiral management team succeeded in stabilising Admiral after the restructuring in 2009 and paid back £200m of Lloyds debt. Admiral also acquired and rehabilitated the Piccadilly estate in 2010 - Piccadilly was an ill-fated 2007 acquisition by aAim from Marston’s and financed by Lloyds. In fact, the management team created considerable equity value in the business at the point of exit from Piccadilly and from the original Admiral estate.
Cerberus has acquired the best tenanted platform and one of the best management teams for community tenanted pubs in the UK. Admiral can now move forward to develop its estate and look for acquisitions that will add value.
We estimate that there are over 3,000 tenanted pubs that are available for sale. The Admiral management team has proven success in acquiring portfolios of pubs and separating the wheat from the chaff, achieving top prices for those pubs that need to be sold on individually whilst strengthening core community pubs through investment and support.
Too often wet-led community pubs have been written off as having no future. However, as we have seen with TDR’s investment in the Stonegate estate, LGV’s investment in Amber Taverns and now with the Cerberus / Admiral transaction, canny investors are spotting the value in wet-led pubs, which have been undervalued by the market. We think this is a trend that is set to continue.
