Overall Group's current strategy is not sustainable. Structural change is required to drive value. Current structure and financial position were “barriers to realising value”. Split up the company and spin off its better-performing managed pubs division into a separate listed company in a bid to dramatically restructure its heavy debt. The group expects to separate the managed and leased businesses into two independent public companies before the end of the summer. It will shrink its tenanted operations to around 3,000 pubs from 5,967 currently through disposals and closures. Has examined the level and value of synergies between its managed and leased businesses and has concluded that they are limited. It said there were limited incremental operating costs associated with a separation of the two businesses. Matthew Clark to be retained. Regarding speculation about the company electing to 'walk away' from the Punch A and Punch B securitisations, it did not believe that this “would be in the best interests of our stakeholders”. It said that the ‘walk away’ option would remove the opportunity to create equity value in the leased business and would negatively impact the management, operation and valuation of the entire group. Managed There is much more to do and significant further sales, profit and value upside in the business. Average weekly sales per pub and operating margin before rent are well behind our competitors. The company believes there are no structural reasons preventing it from closing that gap. Opportunity to build key brands. The company will increasingly add expansion of these brands to its focus on operational delivery. Dyson outlined plans for the approximate expected size of each Spirit brand. Chef & Brewer would be the biggest brand on 140 sites, with Dyson revealing that the concept is returning "well in excess" of the 25% ROI figure. This would be followed by Fayre & Square (130), Barras (130), Taylor Walker (110), Flaming Grill (90), Original Pub Company (80) and Roast Inn (50). Opportunity provided by between 100-150 of the c.550 leased pubs within the Spirit debenture, the majority of which were previously managed, to convert them to one of its brands over the next few years. Group believes it is well positioned, has positive operating momentum and the potential to expand, all of which it said represents a significant opportunity to drive sustained growth in shareholder value. Leased Shifting the emphasis of its Leased business from quantity to quality. Leased business to be separated into two divisions – core and turnaround. Acceleration of ongoing strategy, downsizing to 3,000 pubs over the next five years Maximise value of core and non core estate. Core estate will consist of c.3,000 pubs with average ebitda of c.75%, with net income per pub of c.£80,000. This sector saw a net income decline of c.5% last year. Core estate expected to deliver annual long-term ebitda growth of 2-3%. Core division to embrace Pathway to Partnership programme. Look to attract the right partners through new lease offers, including new turnover based agreements currently being piloted, expand the Punch Buying Club, develop the skills of BRMs and invest to grow food revenues. Turnaround division – maximise short-term returns with a clear focus on costs and cash flow. The company expects to dispose of these pubs at a rate of around 500 per annum, fewer than the number that it achieved in 2009 and 2010, This will be phased to ensure it “balances speed of disposal against value”. Turnaround division will consist of c.2,200 pubs with average ebitda of c.25%, with net income per pub of c.£42,000. This sector saw a net income decline of c.18% last year. At the same time it will continue to drive the operating performance of these pubs and they will continue to be part of Pathway to Partnership and have access to the same support infrastructure as the core division. Strong core of high quality pubs, which will generate sustainable growth and value over time. Capital structure In addition to the cash resources held at PLC, there are also around 200 unsecuritised short leasehold properties and the group's 50% interest in Matthew Clark. The short leasehold properties currently give rise to an annual cash outflow of between £15 million and £20 million. The company said it was exploring potential opportunities to mitigate this liability and has placed much greater focus on driving operating performance and investment in these pubs, which it believes will reduce the cash outflow over time. Spirit includes the majority of the managed business as well as around 550 leased pubs. Actions taken to dispose of assets, repurchase debt and improve profitability have led to a reduction in the debt within this securitisation. It said that as a consequence of this, it believes the Spirit debenture will support the growth, investment and development of the managed estate while also facilitating cash returns to shareholders over time. Punch A and B Debt repurchases and asset disposals have also reduced the absolute debt levels in Punch A and Punch B but leverage, as measured by net debt to ebitda, has deteriorated due to the decline in profitability. As a result, while Punch A and Punch B continue to remain profitable and generate net cash flow (before debt repayments and disposals), they remain in a highly leveraged position and will require ebitda support to maintain headroom in the DSCR covenant. This situation, together with some restrictions included in the debt documentation, inhibits the ability of the leased business to execute its plan to downsize the estate and to deliver value for stakeholders. The company said following the demerger, it was likely to engage in some dialogue with bondholders with a view to optimising the capital structure. It could not give timing, scope or content of such dialogue. In the meantime, it said it would continue to provide the required financial support to the securitisations to enable the leased business to build on the progress it has made. Synergies Dyson said that historically there had been synergies between the managed and leased divisions, for example, beer supply. However, these have reduced as the market has changed. He said it would be "relatively straight forward" to transfer head office functions such as finance and human resources because staff in general work for either division. The market The company expects a 3.1% per annum decline in drinking out in pubs over the next five years. It expects a 3.5% increase in eating out in pubs during the same period. The group said it expects the share of food sales across its pubs to rise from 39% this year to 43% in 2014. The share of locals’ sales will fall from 26% to 25% over the same period, while locals will see their shares fall from 35% to 33%. Food sales accounted for 39% of sales mix in its managed estate and 21% in its leased estate. Geographically 46% of the group’s managed estate was based in London and the south, above the total market figure of 33%. The majority of its leased estate was based outside London and the south, with 33% based in the north, above the total market figure of 28%. The group said that it currently had around 1,500 leased sites in London and the south, double its current managed estate. 28% of the group’s tenants occupied a pub for over five years compared to 37% at Enterprise. 31% of the pubs in its leased estate were valued between £500,000 to £750,000 compared to above 45% at Enterprise. It said in conclusion that the pubs held in Punch A and B were of an overall lower quality of those in Enterprise. Analyst reaction Paul Hickman at Peel Hunt said: “The proposed demerger is less favourable to equity shareholders than we would have assumed, and as a result we expect to reduce our valuation of Spirit to c70p. Although shareholders still get the potential benefit of equity in the tenanted division of Punch, we struggle to attribute any value to this.” Simon French at Panmure Gordon: “We believe that today’s announcement is a first step in taking a measured approach to unlocking shareholder value, and we reiterate our Buy recommendation and 105p price target. “On our forecasts the group is trading on a CY 2011E P/E of 5.3x and an EV/EBITDA of 8.9x. We believe the Spirit debenture has equity value of £362m (56p per share), which, along with the cash and bonds of £274m (43p per share) at PLC level at the end of Q1 and c£39m (6p per share) value in the Matthew Clark JV, underpin our 105p price target. Costs associated with the demerger of £30m (5p per share) are offset, in our view, by the option value now available from a turnaround of the leased business.” Douglas Jack, analyst at Numis, said: “The Spirit bond estate will be de-merged crystallising the equity value of Spirit (83p/share) and creating a platform to potentially grow equity value in Punch (the A & B bond estates with 26p/share of effective net cash) over the long-term. We would Buy the shares for Spirit’s growth, gaining a free option in Punch in the process. “Punch has sufficient cash to support the bonds for three years, providing time to execute operational initiatives, disposals and negotiate with bondholders. Spirit has sufficient cash to boost investment, generate growth, leading to the bond existing cash trap and dividend payments resuming in 2012E. Our 110p target price reflects Spirit’s value (83p) and only the effective cash (26p) in Punch.” Punch’s shares rose this morning by 4.83% to 77.10p

Topics