Bears out for leased pubco model

Ted Tuppen once told a group of analysts that whether he worked seven days-a-week or two, it would not make much of a difference to the fortunes of his company, Enterprise Inns. The founder and chief executive was merely attempting to illustrate the robust and machine-like qualities of his leased business – then Britain’s biggest pub group – but it is safe to assume now that in the current climate, if he could work eight days-a-week, he would. For the leased model is under immense pressure. The list of current ills facing the pubcos is long, and unfortunately getting longer: the dire trading conditions and worries about licensee viability; a shrinking talent pool; the future of the tie; the ongoing financing requirements of some of the biggest groups, given their substantial levels of a debt; and the spectre of possible legislation. A leading analyst with Morgan Stanley recently suggested that as many 30% of the leased pubs owned by Britain’s dominant two pub companies may be “uneconomic”. Jamie Rollo and his leisure research team suggested that a substantial number of pubs were over-rented and that with financial assistance to licensees on the up and the number of pubs available for lease rising, there was significant cause for concern. A huge question mark now hangs over the tie – the mechanism that originally helped pub companies establish themselves as profit powerhouses, which enables companies like Enterprise and Punch to derive comfortably more than 50% of their revenues from beer and machines. With on-trade beer sales in freefall, various observers are starting to question the long-term future of a model that derives so much from a product currently declining at 10%. The premiums that most leased pubs have to charge end users for beer because of the cost of being supplied via the tie also presents a greater competitive obstacle than ever. Mitchells & Butlers estimates that the retail pricing gap between its pubs and its leased rivals can be as big as 70p on pints of beer and lager, which at time when consumers are as value conscious as they have ever been, must have licensees reaching for the bottle. It must be like an 18-handicap golfer taking on a scratch player without receiving any shots. The question for pubcos is: is the price they charge for beer making the current trading woes of licensees worse, driving pub goers into the off-trade and to managed pubs? Some pubcos have put in place discounts to reflect the current tough times, but how accommodating can the leased operators be before it really starts to hurt their own position? If beer and machines continue to decline at 9-10%, how long before pubcos have to fundamentally reappraise the tie and the way they structure agreements? Trouble is, they will never be able to replicate the kind of profit-per-pub yield by switching to a purer rent model. There are also fears regarding some of these companies debt situations. A recent, overly-bearish article in the Financial Times painted a bleak picture for Punch, mapping out what it would take for the group to go bust. The paper said revenues would “only” have to fall 30%. The talk was overdone but for someone as committed to shareholders as Punch chief executive Giles Thorley to scrap the dividend in order to conserve cash, things are clearly uncomfortable. There is also the threat of regulatory interference with the forthcoming investigation by the Business and Enterprise Committee, which begins in earnest next week. Despite the best protestations of pubco executives (cue tuts, bewildered expressions and murmurs of: ‘surely not another investigation?’) there is a real sense that this probe could bring about regulatory change. Some analysts believe that MPs will demand regulation to the remove the machines tie – machines was something that pub companies promised to look at during the last parliamentary probe in 2004 – and call for greater clarity on how rents are set. The dismissive bravado regarding this investigation does not do the pubcos any favours. It could overhaul the way they operate. There does appear of late to have been something of a renewed commitment to service, especially on the part of Punch. They now talk about licensees as customers. It is about time. This has been labelled as something of a Road to Damascus by some. Having to genuinely fight for customers is a relatively new position for pub companies. Part of the success of the model has been built on the long queue of people ever ready to pay their money and take their chance with a leased pub. There is evidence that this talent bank is shrinking – business loans are harder to come by and people’s ability to release equity from their homes to finance a lease is diminishing. Confidence is also waning – with “five pubs closing a day” headlines, who could blame those having second thoughts? It was always argued these companies were insulated from tougher times, with licensees feeling the pain long before any fallout at pubco HQ. Now that licensees are in pain, it remains to be seen how the big leased groups will be impacted. The market appears to be moving away from the tied-lease model and many are predicting a wholesale shake out.