Leading analyst Douglas Jack has upgraded Mitchells & Butlers (M&B) from Add to Buy following news of its likely takeover of the majority of the Orchid estate, which he described as an “excellent transaction” for the group.

The company yesterday confirmed that it was in advanced talks regarding the potential acquisition of what is bee lived to be the best c170 Orchid sites.

Jack, of Numis, said: “The likely acquisition of Orchid Pub Company should be an excellent transaction for M&B, in our opinion. It could be the last non-hostile takeover of a food-led estate in the sector for the foreseeable future.

“Offering material synergies, a minimal cost of financing and attractive returns from brand conversions, the deal should be strongly earnings enhancing in our view. We are upgrading our recommendation to Buy (from Add).”

Jack said he expected the final price of the £266m deal to be £256m after adjusting for working capital.

“We believe over 90% of these pubs are freehold and that more than 60% of the estate is food-led, with food accounting for over 50% of sales in the food-led estate and over 20% of sales in the wet-led pubs.

“Orchid reported EBITDA of £29.3m on turnover of £178.8m in the year to December 2012. We believe this is a sensible indicator of current EBITDA (after factoring in LFL sales growth and minimal profitability in the other 50 sites), although it is before central costs, which were £8.6m in 2012, of which we estimate c.£6m could be avoidable.”

He said there were further synergies and benefits of the deal to M&B.

“In addition to the £27m of implied post-centrals EBITDA, we believe: Orchid’s buying terms are currently poor vs industry leading at M&B; and that Orchid’s labour ratio is between 27-30% of total sales vs c.24% at M&B. After applying M&B’s buying terms and labour scheduling systems, we estimate post-synergy EBITDA could be c.£34m, with EBIT at c.£24m.

“In addition, Orchid has been achieving over 40% cash returns on its rebranding programme, on which it had planned to invest £30m over the next three years. We would expect M&B to continue this programme, also leveraging its own brands, bringing potentially another £12m of EBITDA.

“Given that M&B would be paying an estimated post-synergy EBITDA multiple of c.7.8x (c.13% cash return) vs a £5-10m cost of financing (it currently earns little interest income on its £250m of PLC cash), the deal should be at least 6% earnings accretive, by our estimates, prior to uplifts from rebranding part of the Orchid estate. Our only concern is that the resultant capex commitment to the Orchid estate could be used as an excuse to postpone a resumption in the dividend.”