Where are the next M&A deals?

Any discussion of M&A should start with the market environment since it has been a challenging year for pub operators. In its never-ending quest to make life difficult for pub companies, the UK Government has increased the minimum wage, introduced the national living wage (NLW), and raised property rates, particularly for successful operators – a penalty for success. It also introduced a new tax on soft drinks, the market-rent-only (MRO) option, the apprenticeship levy and increased duty on beer. The irony of Brexit is that we have rid ourselves of the wrong government. On the bright side, at least Donald Trump isn’t Prime Minister.

The industry is used to these sorts of headwinds and has proven remarkably resilient over the past two decades. The industry will adapt to this too.

However, the new taxes and regulations have different effects on different parts of the pub and bar market, with many of the taxes and regulations falling hardest on food-led operators. Brexit has led to a fall in the value of the pound, which has stirred food inflation. Also, if the Government follows through on its threat to curb immigration, it could have a disproportionate impact on food pubs, particularly in the south of England, which rely on immigrants for much of their front-of-house and kitchen staff.

Wet-led pubs have advantage

There has been significant investment by casual-dining operators and delivery services such as Deliveroo, which has increased capacity as fast as or faster than demand. However, the more serious effect is to raise the standard and variety of food offers, challenging established operators.

Wet-led pubs, which have fewer staff and employ fewer immigrants, are less affected than food-led pubs, particularly smaller pubs that are exempt from rates. Smaller, family-run pubs also aren’t as directly affected by the minimum wage and NLW increases. Wet-led tenancies have fared the best.

It isn’t surprising then that tenancies are performing as well or better than managed houses, especially when one considers that tenancies don’t require either the intensity or the frequency of capital expenditure.

Tenancies haven’t escaped entirely, though. MRO will have a disproportionate effect on tied, long leases, particularly those with 10 years or more remaining on the lease. This will have the biggest impact on Ei Group and Punch, even though less than 20% of their pubs have leases with 10 years or more outstanding.

With this as a backdrop, what is the likely impact on the M&A market?

The tenanted market has come alive in the past 12 months. Heineken and Patron Capital have shown the underlying value of tenanted pubs despite the burden of excessive debt. Their bid for a number of Punch pubs, subject to a Competition & Markets Authority review as we speak, will strength-en Heineken’s position in the UK beer market but should also lead to further disposals and considerable shuffling of assets in the next two years. This is likely to provide growth opportunities for other tenanted pub operators, including Admiral Taverns, Hawthorn Leisure and New-River. We would also expect Patron Capital-led Punch pubs will play an important role in the consolidation of the tenanted sector.

Managed pubs on market path

Similarly, wet-led managed pubs have performed well relative to food-led operators, which have to compete with both casual-dining concepts and the grocery retailers such as Tesco, Lidl and Aldi. Town centre wet-led pubs have struggled for years with excess capacity but Stonegate Pub Company and Amber Taverns continue to thrive in the town centre. The market has been helped by JD Wetherspoon’s sale of more than 60 pubs in the past 12 months, some of which have been converted to food-led pubs. Both Stonegate and Amber Taverns have performed well and each has a strong investment thesis, which will appeal to private equity. As and when either come back to the market, there will be considerable demand to fund further expansion.

We believe there are a number of managed pub businesses that will come to market in the next 12 to 18 months, looking to raise funds for expansion. Some operators will be looking to repay existing investors who have had a very successful run, as Piper Private Equity did with Loungers last December, and to attract new investors.

There are nimble, smaller operators that have an exciting future such as ETM Group, which opened Greenwood at the Nova development at Victoria this year and Oakman Inns. Both will have no trouble in attracting private equity investment.

Eye for the big deal

Where will the big deals come from? Heineken and Patron have shown that there is value to be unlocked within tenancies and a number of owners of tenancies today for the right price. It is not inconceivable that several thousand leased and tenanted pubs could change hands in the next few years. Although MRO is an issue, tenancies have demonstrated resilience to multiple challenges and with capacity coming out of the pub market, tenanted pubs are in better shape than at any time in the past decade. There are new business models based upon the independent operator model championed by Amber that have proved successful, including the Punch ‘Falcon’ agreement and the Ei Group Craft Union estate.

Who will supply the capital? The likely investors for the pub and bar segment fall into two categories. UK private equity has focused on small- to mid-market capitalisation businesses that have a proven track record of growth and need capital for expansion. If a business has a brand or concept that appeals to consumers, there is a market for funding from private equity.

Other investors are looking for businesses with strong freehold property backing, and the larger the better. These cash flow investors are interested in stable, secure cash flow with opportunities to expand through acquisition. This is well suited to the wet-led market where significant opportunities exist for consolidation. Many of these investors are based in North America but not exclusively. There is interest from Asian investors as well.

We think the next 12 to 18 months will be an exciting time for the sector after a relatively quiet few years. The sector demonstrated resilience after the last recession and is up for the challenge ahead.

■ Peter Hansen is the founder of Sapient Corporate Finance