Peter Hansen, founder of Sapient Corporate Finance, the leading pub sector acquisitions and mergers advisory, explains why it’s currently an opportune time for private equity investors to buy tenanted pubs.
There have been three periods in investment for the tenanted pub sector since 1997. It’s easy to focus on peaks because they stand out so much and to focus on the fact that there has been hardly any deal activity in tenanted pubs over the last three years. But private equity investors got in very early, investing in Enterprise Inns in 1991, Punch Taverns in 1998, Pubmaster in 1996 (and 2000) and Avebury Taverns in 1997 (and 2004). After the 2002 Unique Pub Company deal, private equity stopped investing in tenanted pubs. Trade buyers then emerged after 2002, able to bid higher prices, achieve greater synergies, and it was tougher for private equity to compete. Finally, property investors entered the sector.
What a lot of people forget is that private equity generally has a very good investment track record in tenanted pubs. The money got lost by property investors, but the money got made on the private equity side. So there were a lot of private equity firms who remember what the industry was like 15 years ago. They’re thinking back to that and asking: “Is this the right time to get back in the market”? If Robbie Tchenguiz had stopped with his investment in Pubmaster, his legacy in the sector would have been a lot more favourable. He made a lot of money out of the sector but then proceeded into a series of ill-fated structured managed pub deals.
The other thing that is interesting is to look at what’s happened to sector multiples. Private equity paid between seven and eight times ebitda for pubs. Then the trade buyers became more prominent and drove multiples up to over eight times ebitda. Then we had the property boom where investors drove ebitda multiples up to eleven times and even twelve times at their peak. They have since come down. In 2009 we were selling pubs for Punch that averaged over £100,000 house ebitda - so very big pubs - at eight times. But in general, we are getting down to the longer-term average of seven to eight times multiples, which are prices that were paid back in the late 1990s and early 2000s.
In an attempt to quantify this we have created a simple private equity model to explain why private equity has always liked the pub sector and made quite a bit of money. Imagine a 300-pub tenanted estate - good pubs with average of £75,000 house ebitda, which makes them slightly larger than the Punch and Enterprise average. We have modeled in some modest operating improvement, and very modest leverage levels with 50-60% debt. As it happens, we have put in a little bit of multiple expansion, because we believe that multiples will increase over the next five years.
The returns are driven by what private equity was interested in originally - the ability of pubs to throw off cash to repay debt. This estate at outlet level generates around £23m of ebitda - and with some investment and some organic growth could generate £25m ebitda. What does that do for equity returns? As long as the business continues to generate cash, if you invest £76m of equity you end up with exit proceeds of £177m, which is a return of 2.3 times. Most of the return comes from the cash generated by the pubs, which is why investors value pubs. That’s the sort of return that private equity investors consider acceptable and attractive - and is one of the reasons why private equity was interested in the industry in the first place. That’s why we think private equity is going to be interested in investing going forward.
The other reason they’re interested is because of the kind of transactions that are going to be coming along in the pipeline - there are going to be some very attractive estates coming on the market; very profitable tenanted pubs generating £70,000 to £90,000 house ebitda per annum. A lot of people are thinking this is going to be just like the property boom. It’s not at all. It’s going to be characterised by a very different market of higher quality assets and more conservative levels of gearing. The quality of the assets (coming on to the market) has improved enormously. The industry has been through a very significant period of grooming estates, of churning portfolios, reducing the size of some. So the quality of assets that exist today and being run by the tenanted pub companies has never been higher - it’s the highest for the last ten years at least. What it is going to require, though, is improved, focused management. As the pub companies reduce the size of their estates, there will be opportunities for management teams to acquire 500 to 1000 tenanted pubs and operate them more efficiently and with greater control.
We believe there is potential for margin expansion because we don’t think that multiples right now are by any means at a cyclical peak. If anything, we think there may be some room for expansion going forward. Gearing is going to be constrained but in general our view is now is a far better time to be investing in the sector. We are starting to see performance stabilise. Over the next couple of years better management should be able to counteract the damage caused by the economic downturn and the smoking ban.
This an abridged version of Peter Hansen’s presentation at last week’s M&C Report Tenanted Pub Company Summit.
