Moulton and a white-hot market

An hour with Jon Moulton, the managing partner of private equity firm Alchemy, is always time well spent. The financier, whose firm’s leisure interests include Inventive Leisure, Q Hotels, Tattershall Castle Group and Parkdean Holidays was on typically good – and typically robust – form last Friday, shooting from the hip on a range of issues. One of the main thrusts of our conversation was about leverage (he talked, I listened), with Moulton warning that the ever-inflating debt bubble could be about to burst. He told me: “Everything has gone to the end of the plank. The quality of debt being put in place at some companies could not get much worse.” Moulton is not opposed to painting a picture of doom and speaks openly of profiting from any precariously positioned businesses that should topple over. He also has a penchant for portraying his business as something of an accident and emergency ward for broken businesses, which may be rather unkind to some of Alchemy’s investments. But he warned that companies in a range of sectors were “hanging on by their fingertips”, with dangerous capital structures and precarious levels of debt. “They are gambling,” he said. “Over the past decade, it has been impossible to miss when investing in anything with property. But now people are taking real punts.” He pointed out, as other’s have done recently, that today deals are being struck whereby annual yields are below the average cost of capital, giving credence to the “punt” assertion. “In the past people have paid too much, but then six months or a year down the line have been able to revalue and refinance. Take a punt, get rewarded – it’s a classic bubble ingredient.” Everyone wants to be the first to predict doom and gloom. Many have began to talk of “the top” in terms of the market and the economic cycle, but when someone like Moulton speaks out, it is probably worth taking note. The eating-out bubble? Some have suggested that there is a bubble developing around restaurant prices, following the £140m Tragus paid for Strada last week, and given that Carluccio’s share price now equates to almost £4.5m a restaurant. The Strada deal does at first look toppy. Tragus has spoken of a multiple of around 10 times profits although this is after synergies and cost savings. At £2.55m per site, it is at roughly a 50% premium to the £1.7m Cinven paid for Gondola last year. But as Tragus CEO Graham Turner pointed out, the respective businesses are at very different life stages. He said: “We’re not buying 50 restaurants, we are buying a business that can get to 150 in the UK, no problem.” And that is the point. If Tragus can do what Strada’s previous proprietor managed, the deal will come to look cheap. There were raised eyebrows when in 2005 Richard Caring paid £57m for 30 outlets, 25 of which were branded as Strada. He added another 25 Strada units at an average cost of about £700,000, equating to £17.5m. Without even considering some funding out of cashflow from the existing business, he has invested about £75m, banking a profit of about £65m. On this basis if Tragus can open 100 more, they will create about £180m of value, on current build costs against the £2.55m they have just paid per site. In all likelihood the value-per-site will diminish as the brand grows but Tragus will still create enormous value if it can add 100 more, achieving the £1.7m per site Cinven paid for Gondola. There is also concern that while the prices paid for restaurant businesses forge ahead, the eating-out market may be slowing after Mitchells & Butlers warned of a “mid-market squeeze” on consumers. This was fortified by latest house-price data that suggested outside of London and the South East, all was not well. One analyst, who asked for his comments not to be attributed, told me on Friday: “Are these guys expanding into a headwind?” Turner says: “All I can say is that wherever we open a restaurant, the demand is there instantly and it is very strong. Each year we are seeing more people comfortable with eating out, more often.” In some ways the restaurant expansion of today reminds me of the bar expansion of the late 1990s, when investment capital flooded the high street. The same is happening now on the high street and in the myriad mixed-use developments. But in many ways it is very different. For a start, back then beer was in decline and today food is in growth, and there would seem to be enough demand to meet this growing supply, because of all the social changes in Britain driving people to eat out. The restaurant market is also a fragmented industry, with chains competing against ma-and-pa operations, so there is plenty to go for. How consumers will react when they have less money in their pockets remains to be seen. But eating-out does feel like something we just do now, and unlike boozy bars, we all have to eat – three time a day, seven days a week. What we will probably see is a polarisation between the really strong brands, and the also-rans. But as Moulton warns, companies should mind the leverage.