What a difference an auction makes

Recently I gave a speech at an industry conference on mergers and acquisition trends in the pub industry. Included in the presentation were some recommendations for buying and selling pubs, including some "do’s and don’ts". Some recent deal activity in the market has brought these simple rules to the fore. There have been three large deals announced in the last four weeks: on 2 December, Punch Taverns (Punch) sold 545 pubs for £162.5m to Pubfolio Limited, a new company managed by County Estates Management(County); on 12 December, Spirit Group sold 364 managed houses to Globe Limited, a new company owned by R20 for £345m. The pubs will be managed by S&N Pub Enterprises (SNPE); on 3 December Wolverhampton & Dudley Breweries (W&D) made an agreed bid for Burtonwood (Burtonwood) which valued the company at £155m. Each deal represents some interesting trends in the M&A market, and even, surprisingly, some not such great examples of "best practice". The Spirit and Punch pubs were acquired by companies with strong property skills and long association with the pub industry but with little or no background in brewing. Burtonwood, of course, was a regional brewer until it sold its brewing interests to Thomas Hardy Brewery several years ago, although it did retain a stake until March of this year. Punch acquired InnSpired for 8.0x house profit (year to October 2004) in September 2004. In turn it sold 545 pubs to County for 10.3x house profit, retaining 471 pubs for a multiple of house profits of 6.5x (pre-transaction costs). In effect, Punch sold the pubs to County for much more than it paid for them and it paid a lower multiple of house profits for the 471 pubs it retained, even though those pubs are some 80% more profitable than the 545 it sold. If Punch had paid a similar multiple for InnSpired to the one County paid Punch (say 10.0x house profit), it would have paid £420m, rather than the £335m (a saving of £85m) it actually paid to the venture capital firm that sold it. Punch was able to buy InnSpired at a significant discount because it was prepared to take the risk of repaying the InnSpired securitisation but the £85m savings more than compensated Punch for the extra cost and risk. To put this in perspective, a year ago Punch acquired Pubmaster Limited for £384,000 per pub. The retained pubs of the InnSpired estate cost Punch only £340,000 even though the average profit of the InnSpired pubs is £9,000 per pub higher. R20 is acquisitive, having just completed the Laurel town centre business for £151m and the Spirit deal within the same two-week period. The Spirit deal is interesting because although R20 own the pubs, they are operated by SNPE. R20 is acting as a property investor since its focus is on property and SNPE gets the not-so-coincidental benefit of a beer supply agreement to supply the acquired pubs. Although the price R20 paid (£345m or 10.8x house profit once the pubs are converted to leased pubs) looks expensive, it is only a 9.3% yield (the reciprocal of the multiple), which is very attractive as a property investment. R20 will have to pay SNPE a management fee, but with a blue-chip covenant as the manager, R20 will have no trouble finding a property investor to sell their investment to at these yields. But what about the W&D acquisition of Burtonwood? Why is it so cheap in comparison to the Punch and Spirit deals? Are the pubs lower quality? According to the Burtonwood accounts (53 weeks to 3 April 2004) the company Ebitda was £16.4m or at house profit level, it was £20.6m, excluding central costs of £4.2m. The Burtonwood average house income of almost £46,000 (based on 449 pubs - the company has since acquired 16 pubs for £6m) compares favourably to the Punch pubs sold to County, which averaged £29,000 per pub. The W&D offer values Burtonwood at just 7.4x house profit. Why is it so cheap compared to the Punch (10.3x) and Spirit (10.8x) deals? There is no sign that Burtonwood conducted a meaningful auction. Certainly none of the regional brewers and pubcos that I spoke to had been contacted. More than one of them had approached Burtonwood in the past to express an interest in acquiring the business. Further, it is difficult to imagine a worse time for Burtonwood to sell the company. Five of the major players in the pub market today – R20, SNPE, Punch, Greene King and Enterprise – are all busy integrating recent deals. If you were advising Burtonwood on the best time to sell the business, you would advise them to wait until mid-2005, when all of the major players will have finished integrating recent acquisitions. Burtonwood directors and family shareholders provided W&D with a "hard irrevocable" undertaking to sell their shares to W&D at the recommended offer price of 550p, even if a higher offer emerges. The only other recent pub sector transaction where an irrevocable undertaking was given was the Eldridge Pope sale but the Pope family retained the ability to sell their shares to another bidder in the event that a bid emerged that was more than 10% higher than the bid from Michael Cannon. The Burtonwood family shareholders have no such right. It is hard to escape the conclusion that the Burtonwood directors and family shareholders have sold their shares cheaply when compared to the Punch and Spirit deals. To put this in perspective, had W&DB paid the same house profit multiple for Burtonwood that County paid for the Punch disposal (10.3x house profit), the enterprise value of Burtonwood would have been £208m, almost £53m higher. This would have valued the Burtonwood equity at approximately £172m or 795p per share, some 45% higher than the value of the current offer. This sounds like a huge increase but sector share prices have soared during the last 24 months. For example, the Punch share price today is four times the share price at the low point of February, 2003. So is this a "done deal"? The promise to sell by the Burtonwood shareholders, come what may, might put off some bidders but someone might emerge. Or, the non-family shareholders might decide that they would be better off holding on to their shares, in which case W&DB will have to decide whether it wants to have a controlling stake in another public company. W&DB and its advisers have done a clever deal. Hats off to them. I wish I could say the same for Burtonwood and its advisers. It is hard not to reach the conclusion that a properly timed auction could have made considerably more money for the Burtonwood shareholders. Peter Hansen is principal of PC Hansen & Co, the leading adviser to the sector on acquisitions, disposals and refinancings. The company advised on the recent sale of 545 pubs by Punch Taverns to Pubfolio.