M&B: a marriage of convenience?

As there has been a little time to digest the possible ramifications and scenarios, perhaps some further thoughts on the proposed £11bn Mitchells & Butlers-Punch merger are due.

Opinions within the industry vary - fairly emphatically - from a beautiful, strategically compelling deal to a “two drunks in a bar” collaboration, which seems not a little harsh.

What is certain is that there will not be a swift resolution to this situation.

There has been lots of talk of an alternative bid. Private equity houses said to be busying themselves running the M&B numbers include Blackstone and CVC - groups that know a thing or two about leverage buyouts in this space from their joint ownership of Spirit Group. But for all the talk, more of which resurfaced this weekend, there has been little walk.

If private equity does not manage to muster a credible alternative to give M&B shareholders something to think about, perhaps the entire business community should start to feel a little depressed, given that this is one of the most asset-rich, cash-generative businesses there is. If buyout groups cannot come together for this deal, then the implications are obvious. And we all fear that they cannot.

As for Punch, not everyone is a fan of its merger proposal. When the shares were pushing £14.00, CEO Giles Thorley could walk on water, but with Punch down at 641p, and with the Spirit Group part of the business not performing that well, tougher questions are being asked.

Strategically the deal is compelling. On a 5-year view, it’s a no brainer. But financially, commercially, the journey could be painful. Punch’s share-price fall was predictable, given the deal’s dilutative impact in the short term.

One hedge fund in particular, QVT Financial, is vocally opposed. One could argue that in buying in at this price - QVT owns almost 9% - and opposing the deal, it is being shrewd: Punch is clearly undervalued; if M&B doesn’t happen, the price will bounce; if it does then, longer term, there must be significant upside, and it should still win.

The cash sweetener offered to M&B shareholders has also seen the institutions that believe the deal will happen chopping out of Punch in favour of M&B shares.

Of that cash sweetener, it is probably not enough. The £175m on the table equates to about 45p an M&B share. Many believe this will need to be nearer £1 to get the deal done.

Punch has talked of £50m to be had in synergies and cost savings, although analysts suggest the number is nearer £100m. It is a moot point. The really difficult thing it seems to me, is to know how much “fat” to cut.

M&B does carry significant costs but how much is surplus and how much is critical? It is almost certainly its expensive-looking central structure that makes it one of the sector’s best operators. For example, do you scrap the $75,000 Harvard programmes for senior managers as an elaborate expense or do you recognise it an essential cornerstone of building and developing a great senior leadership team?

The Punch board will effectively run this business, albeit at arms length. The worry is that they try to adopt the same low-cost Spirit model ie they may mess it up.

Of course if the deal does happen, the enlarged group will possess a managed-pub management team capable of closing the performance arbitrage that currently exists between M&B and Spirit.

Another interesting point is this: if this deal doesn’t happen, does this process put Punch in play? The situation has highlighted the debt-to-equity ratio at Punch and the fact that at almost £5bn, its debt dwarfs its £1.7bn equity. A predator could offer a 50% premium to the current share price, and in reality, only be offering an 11% premium to the current enterprise value.

There is also a range of options available to M&B that may assuage an understandably perturbed set of shareholders, such as asset disposals, asset swaps (Whitbread, anyone?) and perhaps even acquisitions. There may even be other merger bedfellows out there (Whitbread?).

It remains to be seen if private equity will be able to table an alternative M&B offer.

If the Punch deal does happen, the repercussions will be felt across the industry. There will be onward sales - bottom-end leased pubs plus possibly the high street M&B operations of All Bar One, Brown’s and O’Neill’s.

It will also be interesting to see how other companies react. For a start, I would put money on there being a discernable shift of attitudes in Bury St Edmund’s and Wolverhampton to a merging of the Greene King and Marston’s businesses.

Clearly, a lot of things are in the air.

For now, we will wait and see. This will not be a quick process and the best thing for M&B is to probably do nothing - for now, at least.