Pizza Express: someone has got to take a hit somewhere

The appointment of financial advisors this week shone a fresh spotlight on the precarious situation at Pizza Express.

The celebrity figureheads at Jamie’s Italian and Carluccio’s had already put their crises into the public consciousness, yet the prospect of Pizza Express facing the same woes is an even bigger moment.

The brand is credited with creating the concept of casual dining and is the UK’s biggest and most enduringly popular restaurant brand with close to 500 sites.

So how has such a popular restaurant chain ended up in this situation, and just how serious is it?

While Pizza Express’ latest 2018 financial figures were nothing to celebrate, in the context of a sector wide slowdown, flat like for like sales of 0.1% might be considered in line with expectations.

And according to various industry insiders, the some 470-strong UK estate is still trading well.

“From everything I’ve seen, Pizza Express is still trading profitably at an operational level,” says Peter Martin, MCA contributing editor. “It’s not haemorrhaging market share, it’s popular, people are still going.

“There is a sound business there. It’s part of the fabric of eating out.”

The problems were foreshadowed in the same financial report earlier this year, with international expansion and debt raising red flags.

As well as the familiar sector-wide cost headwinds in the UK, the company cited challenging conditions in parts of its less mature, 100 strong international estate, developed under Chinese owner Hony Capital, which resulted in group EBITDA down 15.3% to £80.2m

Meanwhile pre-tax losses during the year widened from £28.7m in 2017 to £55m, driven by falling profits and net interest charges of £93.1m.

More recently, in the second quarter of 2019, EBITDA fell 11%, while its debt rose to 7.9 times EBITDA, compared to 6.6 times a year earlier.

“The problem is it’s been over complicated from a financial point of view, it’s almost as simple as that,” says Martin.

Beijing-based Hony Capital bought PizzaExpress in 2014 for about £900m from Cinven, and in a familiar play for private equity, debt in the business has accumulated over a number of years.

While some creditors are shareholders, a significant portion is third party.

The restaurant group has £465m of secured bonds due in August 2021 and £200m of unsecured notes due a year later, respectively indicated at 84 and 23 pence on the pound, according to data compiled by Bloomberg.

Financial analyst Mark Brumby of Langton Capital likened the debt pile to a waterlogged home, representing a “horrible liability”.

He warned the unsecured bonds were highly likely to have been sold on to less scrupulous creditors.

“If your house is underwater, there’s no immediate trigger to get evicted,” Brumby explains. “But it’s a problem that can’t be allowed to persist forever, because when you move out, you’ve got this horrible liability before you can move on with your life.

“Pizza Express is in that kind of situation.”

With gross debt of £1.1bn Brumby points out the level of debt against the estate is significantly higher than the individual units, which would cost of around £600,000 to build each site.

With the 14x debt to EBITDA, Brumby says for a leasehold company this is intolerable.

“It’s the third-party loans which are going to cause a problem,” he says.

“When debt is traded at 28p – it’s very, very likely the first people you sold the debt to have traded it on and taken a haircut – and possibly to some fairly unpleasant people.

“Back to the house, if its underwater, and your bank sold your debt to some leg breaker, it’s a pretty unpleasant position.”

So what options are there? Some have speculated a company voluntary agreement (CVA) could be on the cards, though others argue it’s the international business and debt which are the problem, not the UK estate.

The issue is complicated by the prospect of getting the bondholders to thrash out an agreeable resolution.

Another plausible outcome is to split the UK and international business, though again, this is no easy task.

“Someone has got to blink and take a hit somewhere,” Martin says. “Do you sacrifice the business or sacrifice peoples’ investment?

“Otherwise that debt will kill it, and that would be crazy.”

One former insider said the future of the brand rested with Hony Capital, who could look at a potential debt for equity swap, which is what Casual Dining Group did last year, slashing its debt liabilities in return for shares in the business.

“If the bondholders take over the company, they will restructure it, and then I’m sure they will restructure the debt and find good operators to run the business successfully – it would insane not to.

“There’s fundamentally a decent business there. But there has to be that will.”