A leading analyst has said that with the present value of the equity in Punch Taverns at barely 2% of the enterprise value, he can see the possibility of this being wiped out in any restructuring that would look at the positions of all of the stakeholders, not just the equity owners. Geof Collyer at Deutsche Bank, said: “Over the past year or so, Punch has been injecting cash into A & B to stave off defaulting on the debt service cover ratios (DSCR). Some of this has been recovered by upstreaming cash for plc tax purposes, though Punch has paid very little actual cash tax since IPO in 2002. “On demerger, Punch was left with slightly less cash than had been expected, and most of this is required to support A & B, to prevent them being taken over by the bondholders. As the equity shareholders have almost no control over the cash flows of the business, investing in the equity prior to any restructuring is effectively going in blind.” Will all the plc cash be required to provide support for A & B? Collyer said he saw little value in the Punch equity beyond the value of the unrestricted cash left in the business. He said: “Punch’s cash injections have kept the DSCRs above default – though the point at which the bondholders take effective control of the business is a little higher than the 1.25x DSCR default covenant, when outside consultants are called in. In H1’12, the unsupported DSCRs were 1.07x in A and 1.03x in B. In FY’11, the level of support was £68m, which resulted in a net cash outflow post upstreaming of £8m. We estimate a similar situation this year, but estimate the outflow to get progressively worse. “We estimate that the levels of support will increasingly outweigh the amount of cash able to be upstreamed, causing a possible cash flow crisis that could lead the group having to consider qualifying the accounts from the point of view of still being a going concern – hence the need to restructure.” Do equity investors have a fallback position? Collyer said that Punch is in a more extreme situation than Enterprise Inns, in terms of dilution from disposals and levels of operational cash generation. He said: “Around 55% of Enterprise’s cash flows come from pubs that are not ring-fenced by the securitisations and their DSCR requirements. Though we do not expect it to be placed into a position where it would have to choose, Enterprise could cut the cord to its securitisation and walk away, leaving the shares in our worth around 90p each. Punch does not have that luxury – unless it decided to abandon its pub estate. “Furthermore, we estimate that operational cash flows at Punch generate less than one-third of its annual securitisation amortisation schedule requirements. Cash flows could be boosted by abandoning any development capex, but that is hardly going to help reposition the estate, and there are minimum levels required by the securitisation terms and conditions. “Punch has laid out its recovery plan but, amongst other areas, it needs to gain approval from bondholders for its disposal plan. This non-core estate has been written down to £633m, and the programme is scheduled to take place in an orderly market over 5 years (42% of pubs, 25% of EBITDA). We assume that Punch would seek to buy back its floating rate notes in the market with the cash proceeds, hopefully below par, and avoiding the ‘Spens’ cost that would be required to be paid if the fixed rate notes were retired earlier than the full term (usually around 120% of par). “The hitch here is that the fixed rate notes are higher up the pecking order than the floating rate notes and the senior note holders may well obstruct the use of proceeds to retire more junior tranches of debt in any restructuring agreement.” Collyer said he saw the extreme negotiating stance as follows. Wait until the current year ends, books are audited and all cash flows upstreamed to the plc. Then threaten to walk away from the pubs, handing back to equity shareholders the cash held at the plc and the shares in Matthew Clark Wholesaling (MCW) to investors. He said: “Assuming MCW was still worth the £35m implied on the original transaction (might be a big assumption), this could allow the group to give shareholders between 5-20p, depending on plc winding up costs. This ‘walk-away’ plan has some merit, as the bondholders would not want to have to suddenly be directly running 5,000 pubs. “Whatever is finally agreed regarding the new capital structure, the outlook for Punch’s cash flows must be set at a level that is sustainable for any future equity business. Given our current estimates of cash flows, the group would need to get the interest bill reduced by at least 25% just to become cashflow neutral post funding the amortisation schedule. “In most restructurings, any future equity ownership is usually taken up by the unsecured bondholders that have had their investments dramatically reduced. Here everyone is protected although degrees vary significantly between the debt tranches.” Where is Punch’s operational performance vs. the peer group? Although there will be some marginal timing differences, Collyer said that Punch is performing better than its former estate, now part of Spirit, but some way behind Enterprise Inns. He said: “In Q3, the group did not comment on 40% of its estate – the non-core part – which presumably had fallen somewhat further than in H1.” Valuation & Risk Collyer said: “Given its precarious position, we are using a SOTP valuation to derive our target price, as opposed to a trading multiple-based method. On 10x EBITA (same multiple that we use for Enterprise Inns), the enterprise value of the equity is more than cancelled out by the debt, so any equity value would come from the value of the unrestricted cash at the year-end plus any value for MCW. This equates to a value somewhere between 0p and 15p. “We err on the cautious side, and have downgraded our target price from 9p to 5p. The main upside risks to our Sell stance include (i) a significant pick-up in trading that generates enough cash to satisfy amortisation requirements in 2016’ (ii) a return to like-for-like profits growth in the tenanted estate; and (iii) an early resolution of the discussions with bond holders that does not radically reduce the existing equity base in any debt for equity swap that could result from any financial restructuring.”