When Ian Dyson began his new job as chief executive of Punch Taverns in September, it might have seemed his main task was to devise an operational turnround strategy for one of the biggest companies in the struggling pub sector.
But he has also had to become something of a financial engineer.
Most of Punch’s estate – 97 per cent – is held in three independent vehicles financed by bonds backed by the pubs themselves.
So when Mr Dyson took the helm, he became the head of something akin to a private equity firm managing three debt-laden companies.
Now, two months after saying he was engaged in a strategic review, speculation is swirling over how activist an “investor” in these entities Mr Dyson wants his company to be.
The speculation includes rumours of interest by real private equity groups and talk of a radical restructuring.
Some analysts have argued that Punch should default on much of its £3.14bn net debt, essentially handing over the keys of more than 5,000 pubs to bondholders. Others are more conservative, but most agree change is needed.
Mr Dyson’s predecessors organised the company into three entities – Punch A, Punch B and Spirit.
Each has turned in such poor performances in recent years that, under their debt covenants, they are “cash trapped”, meaning any excess cash after debt payments must stay within the securitisations rather than be returned to shareholders.
Group seized opportunities to expand
Punch Taverns bulked itself up in the wake of the deregulation of the British pub industry in the late 1980s, writes Adam Jones.
It benefited from the break-up of the integrated brewing and pub businesses that used to dominate the trade, such as Allied Breweries, Grand Metropolitan, Courage and Bass.
The 1989 Beer Orders legislation put in place by the Conservatives forced those big companies to sell many of their pubs in order to stimulate competition in the sector.
Punch was one of the aggressive newcomers that snapped up large portfolios of those venues and then used their scale to negotiate big discounts with the once-mighty brewers.
At the same time, it used a controversial industry quirk – the so-called beer tie – that enabled it to act as sole beer supplier to the semi-autonomous publicans renting its pubs.
These two levers gave Punch some years of stock market success after its stop-start 2002 initial public offering, which priced the shares at 230p just days after an initial flotation attempt had failed.
In an environment in which debt was cheap and freely available, the shares approached £14 at their peak.
However, the enormous securitised borrowings that Punch took on in the course of its expansion eventually put its business model under tremendous strain, when economic conditions soured and a smoking ban also discouraged some drinkers.
That was in spite of the fact that one of the original selling points of Punch had been the supposed resilience of its small, community-based pubs through both good and bad times, compared with the more cyclical nature of bigger, more fashionable town centre bars.
Punch Taverns shares closed at just over 66p in London on Friday, giving the company a market capitalisation of £425m.
No wonder equity investors are eager for change. But even bondholders believe that change is necessary. “The cause of the problem is the performance,” says one, pointing to an 11 per cent decline in sales this year.
The market is tough, with pubs having to work harder to draw in customers who are increasingly happy to drink at home. But Punch is still losing out to rivals: “You can’t just hide behind the market,” the bondholder says.
“The value in Punch Plc shares reflects the value of its investment in Spirit and the notes it bought in A and B,” says one restructuring specialist.
In the view of Paul Hickman, an analyst at Peel Hunt, Mr Dyson has several options. These include renegotiating the structures of the securitisations, which could mean resetting covenants, deferring debt repayments or swapping junior debt for equity in a securitisation; or simply ending support for Punch A and Punch B, eventually leading to a default.
That final route would leave bondholders with the choice of selling the pubs at a loss or running them, possibly bringing in a competitor such as Enterprise Inns .
A default would not necessarily have significant repercussions for Punch shareholders. The securitisations are independent entities, and a default by Punch B, for example, would not affect the finances of Spirit, although it would have an operational impact: Spirit’s pubs would lose the buying power that comes from being part of a 6,770 pub estate.
In the case of a default, equity holders would also lose out on the value created by any recovery by the pubs in question. And Mr Dyson, who comes from Marks and Spencer, would have to be willing to irk the bond markets in his first chief executive job.
The Financial Times