M&C speaks to Enterprise Inns’ chief executive Simon Townsend and chief financial officer Neil Smith about the potential for operating brands and for working with branded food operators. They reveal the 12 segments which will underpin growth across the estate as well as informing disposal decisions, and explain why they are varying the agreements in the Managed Expert division to appeal to more operators. Townsend also talks about how under-performing pubs opting for MRO will go into ‘a holding tank’ and explains why the company will be re-launching its tied offer prior to the introduction of the pubs code.
When Enterprise announced its H1 results in May it set out an ambitious reinvention of its core operating models. Six months on the company has now revealed more about how it is effecting this sea change across operating models.
The company has already made inroads in transforming its estate from a purely tenanted and leased business to incorporate managed and commercial properties. It plans to relaunch its tied offer in 2016 and is eyeing future conversion to a REIT.
At the end of the financial year, Enterprise Inns operated 5,069 pubs, broken down into 4,821 tied leases and tenancies, 213 pubs in its Commercial Property Portfolio and 35 managed pubs.
The latter was broken down into 21 Craft Union pubs and 14 in the Bermondsey Pub Company. Following the year end, Enterprise opened its first Managed Expert site in a joint venture with Rupert Clevely.
By the end of this financial year it expects the number of managed pubs to have risen to between 93 and 127 (Managed Expert: 8-12; Bermondsey Pub Company: 25-35 and Craft Union: 60-80). The target is 300-350 sites in the Commercial Property Portfolio leaving c4,415 tied leases and tenancies. After c215-220 disposals the estate would be c4,850-strong estate.
Managed houses
Asked what the company has learnt from its early experiences in the managed arena, Townsend said: “The key thing is that if you take a business that has been severely troubled then it takes a long time to get that business back on track – especially when you don’t have a recognisable, headline brand behind it. Some of the businesses we took on in Bermondsey in the earlier days were sites that had become available rather than being carefully selected. That means we’ve learnt to develop managed houses in the trickier situations, which is probably the best way to learn.
“You can see that on the more recent openings, where we have applied much more of a strategy to the choice of sites, that the results have been very encouraging from very early on.
“Craft Union has rolled out quicker, partly because it’s a simpler, wet-led model. It’s been predominantly northern-based currently so it’s quite tightly defined geographically.
“In the Managed Expert division, we have seen encouraging results so far. Rupert and the team have now had time to get the organisational infrastructure in place to support a pipeline of further openings. We have already identified another four pubs which will open over the next few months. We’ve got control of those already and investment plans being worked up.
“We have had lots of operators expressing interest. We are conscious that different operators have different circumstances so we’ve been evolving our approach to the model to take account of those different circumstances. Now we hope to crystallise some of those discussion we’ve been having into new Managed Expert ventures over the next few months.”
On how the model would be varied for different operators, Townsend said: ““There are those interested in capital growth, others more interested in revenue sharing and not looking for an exit. The manner in which we create the partnerships and value between the two parties involved needs to be flexible.”
Brands
On the potential to introduce brands within the managed estate to accelerate rollout, Townsend said: “We are not looking at brands at the moment but we are focussing around particular retail formats. By restricting our activities around those formats we have a much clearer idea of the kind of pubs and the kind of demographic that fits them. It also prevents our business becoming overly complicated.”
Smith: “We’ve got Steve de Polo joining us in January and his remit will be to build and evolve those retail formats and it could be that one or more of them should be branded. If that’s the case then we’re open to that.”
Partnerships
On whether Enterprise would look at the kind of partnership Punch recently announced with Harry Ramasden’s, Smith said: “We are completely flexible to find the best way of getting the best performance out of any pub, so if that was working with an established branded food operators then we would be happy to explore that. That could work either through the Managed Expert model or through a straight free-of-tie plus a percentage of turnover deal.”
“We have already got tie-ups with food operators in the form of our partnerships with Pieminister in Bermondsey and Banger Brothers.
“Brasserie Blanc another alternative – that is a Free of Tie agreement but we take a percentage of turnover.”
Townsend said: “We now have many flexible options to work with expert partners of all shapes and sizes. It’s the evolution of the traditional leased and tenanted model based around one core agreement into something much more flexible.”
Segmentation
The future growth of the managed estate, evolution of the tenanted and leased division and the disposal strategy will all be based around the company’s supply and demand segmentation. It lists 12 segments running through the estate. These split pubs across drink-led, food-led and mixed pubs along Premium; Upper Mid-Market; Mid-Market and Value sections.
Townsend said: “Segmentation has a huge role to play in helping individual tenants find the best market position for their pub. It looks at supply and demand dynamics in the areas around our pubs as well as the demographics, travel time, what is the particular head room. It brings a very consumer-focussed insight into what’s going on around each of our pubs and helping us challenge or provoke whether each pub should be moving to a different segment to best serve its community.
“We are currently operating our managed houses in four of the 12 segments. Craft Union is in the Value Drink segment. Bermondsey operates eight Meeting House pubs in the Upper Mid Market Mixed segment and six Friends & Family pubs in the Mid Market Mixed segment. Hippo Inns operates in the Premium Mixed area.
“In terms of getting the majority of pubs through the segmentation model so we can then start having conversations with publicans about the insights that come from that, we’re probably talking about the next year to 18 months.”
Commercial property portfolio
Enterprise has insisted it is committed to maintaining high quality in its free-of-tie arm and that pubs which don’t fit the criteria will not be permanently allocated to this division.
Townsend said: “The important thing about the commercial property portfolio is to make sure quality characteristics of that portfolio are high. That means great properties that are well-located with strong covenants.
“I have said before that I strongly believe taking MRO will not be the best option for some pubs. In cases where MRO results in a pub which is not performing at its best we will of course abide by the legislation but it will go into what you could call a holding tank until such times that a future event may allow us to negotiate a better outcome that brings that business into an alternative operating model. But if the pub has all the right characteristics then it will sit firmly within our commercial property portfolio.”
Enterprise has said that when it believes the scale and economics of the Commercial Property Portfolio are optimal it hopes to “be in a position to secure the potential benefits of conversion to REIT status, were the board to determine that it was in the best interests of shareholders to make such election at the relevant time”.
Townsend said that of the 28 properties added to this division in the last year, four were on turnover-related rents.
On the scale of opportunity within the estate, Townsend said: “As our capability and scale of commercial property operations grows we would see enhanced opportunities to recognise, identify and secure development opportunities in under-utilised space. The upper parts of some of our urban sites in particular present the potential for development that does not impact on the operation of the pub.”
Smith added: “In one of our managed properties we have redeveloped the upstairs which is currently our own office space but there’s no reason why in the future we couldn’t let it.”
Evolving the tied model
Townsend said the while tied leases and tenancies would form the core of the estate for many years to come it would be under a ‘reinvigorated model’.
He said: “The forthcoming legislation means that for some agreements in some circumstances our returns are less certain so we have revised our approach to the operation of tied agreements.
“We retain the desire to invest. But we are extremely unlikely to invest in long tied leases going forward unless the current consultation provides an acceptable waiver mechanism that protect landlord’s investment returns to a substantial degree.
“It’s also unlikely that we will grant new long-term tied leases, except in exceptional circumstances and the main focus will be on shorter term traditional tied tenancies. Our support activity, which has helped so many pubs thrive in good times and survive more challenging times, will be targeted at the right publicans on the right agreements and I believe the merits of a tied agreement will become even more pronounced when confronted with the stark realities of operating in a free-of-tie world.
“For this reason we will be re-launching our tied offer in the Spring, prior to the implementation of the new legislation so any publican considering MRO can knowledgeably compare their agreement to that which would be available if they took up a standard commercial free-of-tie property agreement.
“I believe one of the unintended consequences of MRO will be reduced investment in the tied and leased sector and consequently more business failures. Perversely business failure of a publican who opted for MRO may provide us the opportunity to secure a more attractive outcome for the asset through one of our alternative business models.
“Where a better and more sustainable return can be generated from an under-performing pub by running it as a managed house we will be using our right under the Landlord and Tenant Act to occupy selected pubs at the end of their lease term.”
MRO
Townsend said Enterprise would be formally responding to the Government’s consultation on the pubs code but asked for his initial thoughts, said: “The way the consultation process shaped out it looked like there was nothing worse in there. We were encouraged initially at the seeming withdrawal of the Parallel Rent Assessments because that appeared to be the one item that everyone was in agreement about – that it was burdensome, unworkable and inappropriate.”
Analysts corner
Leading analyst Anna Barnfather, of Panmure Gordon, reiterated her Hold recommendation for Enterprise Inns, saying the company was embarking on what would be at least a five-year transformation with significant execution risk.
She said: “Selling underperforming assets into a buoyant property market and transitioning into a hybrid pub manager-tied-commercial property-company should unlock significant value in the long term. However, debt levels are high and operational leverage is increasing at a time when supply and inflationary cost pressures are mounting. While these results demonstrate progress with improved trading, reduced business failures and steady transformation, 2016 sees the next stage in implementing the MRO, which could destabilise the tenanted business.”
Mark Brumby, of Langton Capital, said: “Enterprise has reassured that it has moved into the execution phase of its transition and has shown that this need not be associated with a sharp drop in profits.
“The group insists that it has a ‘clear line of site’ in terms of its transformation. It will release KPIs alongside its half year and full year numbers and it is to host a capital markets day in May next year.
“Trading is a shade better. The Rugby World Cup will have boosted revenues in October, real incomes are rising and the group’s less-good pubs have gone.
“Enterprise promises us more of the same alongside a continued evolution towards a multi-strategy pub company in which it concedes that one size will not fit all.
“Making money from tenanted and leased pubs should still be possible but the ‘spreadsheet approach’ of yesteryear may be gone for good.
“Fortunately, Enterprise has a portfolio of good pubs and, though it may have to work harder for its money, its future appears secure – in which case its share price is perhaps a shade too low.”
