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Wed 19th Nov 2014 - Market rent – Enterprise and analysts respond
Market rent – Enterprise and analysts respond: Enterprise Inns has criticised yesterday’s House of Commons vote that saw a vote by 284 MPs to 269 MPs in favour of an amendment by the Lib Dem MP Greg Mulholland allowing landlords an independent rent review and to buy their beer on the open market. The amendment to the Small Business, Enterprise and Employment saw 15 Tories and 24 Liberal Democrat MPs defy their party whips to support moves to loosen big tenanted pub companies control over the tie. Enterprise chief executive Simon Townsend said: “This amendment, which was not supported by the government, threatens to have serious unintended consequences for publicans and the industry at large. The government completed a thorough and extensive review of how best to enhance protection for tied tenants. As a result, it rejected the “market rent only” option as damaging to pubs, communities and the wider industry. Independent economic research, commissioned by the government, found that a “market rent only” option would lead to widespread pub closures, significant job losses and reduced investment in the sector. This amendment is a disproportionate response which proposes fundamental change that is wholly contrary to the findings of the consultation, from which the Bill was drawn up. We continue to believe the tie offers the best operating model for the vast majority of our publicans and, as we made clear in reporting our Preliminary Results yesterday, we take a flexible approach to all our lease and tenancy agreements and the proactive management of our wider property portfolio. In light of yesterday’s vote we will continue to assess all options to safeguard the interests of both our publicans and shareholders. In the meantime we will monitor the situation closely and await the government’s response to this unwelcome development.” Deutsche Bank leisure analyst Geof Collyer said: “UK MPs have voted 284 versus. 269 to include a market rent only option (MRO) for tied pub tenants. This private measure is widely interpreted as an attempt to end the beer tie through the back door. The measure is aimed at companies with more than 500 tenanted & leased pubs. There are several stages for the Bill still to go through, so we don’t know yet if the MRO will become law. So where does that leave the pub groups? Back on 16 June 2009, we published a lengthy analysis of the regulatory issues surrounding the pubco sector. But the principle of being careful of what you wish for remains. Around 1%-2% of licensees ask for a free-of-tie option each year from Enterprise. The vast majority appreciate the safer option of ‘low fixed plus turnover rent’, because it is better for cash flows. Breaking the tie in the way proposed by the above amendment will have significant consequences for the industry – which is why the government rejected the concept when it was proposed back in June 2014. Its own analysis suggested that the MRO would accelerate pub closures and job losses. The market will want to assess what the worst case scenario could be. Both Enterprise’s and Punch’s current ratings are already discounting a huge amount of bad news (circa 40%-55% discounts to Net Asset Value) that, in our view, includes this issue. Back in April 2013, the Business Secretary talked about a potential value transfer of circa £4.5k per pub, most of which was to have come from the MRO, though his department eventually rejected the concept. So is this the worst case impact? By way of mitigation, we would assume that the PubCos would do the following: (i) Scrap all discretionary support. (ii) Reduce central overheads by c.25%. This would have the potential proforma impact of c. 5% PBT downgrade for Enterprise & Punch. (iii) We would expect all development capex to cease. Over the past decade Enterprise has invested over £620m. Going forward ETI plans to spend circa £70m per annum (av. £14k/pub/year). Who will fund that? (iv) Enterprise has an embryonic managed pub division. At the rent reviews/lease break clause, the group may decide to take pubs back in house and run directly. (v) It is already renting 22 sites to convenience stores, all of whom are paying much higher – market – rents. On review, we would expect the PubCos to establish a market rent that includes all bids. By the end of the five-year rolling rent review process, it is not impossible that the groups will all be much better off – which could mean that their shareholders demand that a more aggressive pure property management stance be adopted now. Is this a storm in a half pint mug or a barrel of trouble? It could be seen as the latter, but is probably the former. The MRO is against both UK government policy and competition law here and in the EU, and we would expect the pub industry to appeal this amendment all the way through the courts. Enterprise also has the ‘nuclear’ option of converting into a REIT.” Numis Securities leisure analyst Douglas Jack said: “Even though self-regulation has been working, MPs have voted to add a Market Rent Option (MRO) to the Small Business, Enterprise and Employment Bill. Although this is likely to face more rigorous challenges, both by the House of Lords and legally, it is a negative development for the pub industry and Enterprise Inns (HOLD 130p) and Punch Taverns (ADD 175p), in particular. On rent review, Punch and Enterprise could consider transferring pubs into non-rent franchise pubs (why apply ‘market rent’ to pubs that pay no rent?). Alternatively, Enterprise and Punch could compensate for the loss of income by cutting capex and support (reducing pub viability) if tenants remove the tie (in order to purchase cheap beers). We estimate this capex and support are worth a combined £20k/pub per annum, financed by the central purchasing power that the MPs’ vote has endangered. The Bill will soon pass into the House of Lords which should consider these unintended consequences (such as accelerated pub closures and a cap on the growth of smaller pub companies). In addition, “there are serious legal and competition issues which must be faced, as it rides roughshod over what are previously agreed contracts, and creates an unworkable, two-tier market” (BBPA). Thus, we are not changing our forecasts at this stage, but continue to advise caution.”

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