Analysis: Enterprise's call to auction
Eyebrows have been heading northwards. Enterprise Inns is heading to the public auction market next week with seven of its best boozers tucked under its arm offering sale-and-leasebacks.
If it goes well, it could come back with 100 or so more, raising £200m plus. What's going on? It's been a long time since a sizeable pub sector company of Enterprise's standing chose the auction market as a route to raise cash. And it's unfortunate that the two most recent pub sector sales-and-leaseback specialists were, er, a little dodgy.
Provence made £80m in public auctions while London & Edinburgh Swallow Group (LESG) made north of £200m. Both were, as it turned out, selling really poor quality investments, effectively gulling investors into parting with excessive sums by offering bloated rents. It was a kind of legal scam, relying on a heady property market and naive, cash-rich investors.
Many of these investors saw rents paid for just a few years in what amounted to a pub Ponzi scheme. When the auction market stalled, the cash stopped arriving at the front end to pay rent to existing owners of Provence and LESG freeholds. What swiftly followed for both companies was an implosion of the model. It was a case essentially of caveat emptor — and not enough folk saw the impending train crash.
In Enterprise's case, it's a very different kettle of fish. There are wealthy people out there at the moment receiving a derisory rate of interest on their savings from the major banks. Enterprise is offering seven of its finest, top-decile pubs for sale — six are in prime London trading areas and one is in Windsor.
Investors are receiving an average of around £150,000 per pub of rent from Enterprise, a return on investment for buyers of around 6% to 7% if prices hit guide levels at the auction. Enterprise promises to pay the rent for 35 years (a new lease is created on the day of the auction), subject to five-year rent reviews and no indexation.
An investor looking at these Enterprise freeholds has no guarantee Enterprise will be around in 35 years' time — it's a period of time roughly twice the length of its current history. But buyers will own the freeholds of pubs that are about as good as you find in the UK. Enterprise is offering between 80% and 90% of its total house EBITDA as rent — it's earning a total of around £170,000 per pub on this batch of seven. The sitting tenants, such as Geronimo, may well be making an average annual profit in the £70,000 to £100,000 range per pub, suggesting total pub earnings, landlord and tenant combined, are in the range of £240,000 to £270,000. It makes them at least as good as the average Mitchells & Butlers managed pub chipping in £240,000 EBITDA a year.
Low returns
Enterprise is taking advantage of the very low returns on cash available in the economy at the moment to leverage the value of its freeholds by targeting private investors.
More traditional buyers like the family brewers that Punch targeted for some of its best London pubs paid nothing like the 14 to 15 times earnings that Enterprise hopes to realise here.
Enterprise's current leasehold component is just 181 short leasehold pubs, creating a rent obligation for Enterprise of £2.6m per annum. It's clearly decided that it can afford to carry a few more leasehold pubs (and a larger rental obligation) within the estate. Nevertheless a 35-year lease is a long obligation, and Enterprise earnings at these seven pubs will amount post-sale to around a third of its average pub EBITDA of just short of £70,000 per annum.
It's giving up (or else its shareholders are) the chance to benefit from increasing freehold values over time. Its economic interest would be reduced to the smallish rump between what it earns from its tenant and pays to the freeholder. That rump may diminish, bearing in mind its rentalising beer income, to nothing or worse, but is unlikely to increase by a lot. What has become apparent, I think, is that the need to sell top-quality pubs is a key test of whether companies got the strategy completely right in the boom years. Those selling top quality pubs didn't, those buying quality pubs did.
Enterprise has a £1bn bank syndicated facility to refinance within the next 12 months. The radical, albeit imaginative, auction route provides a way to raise much-needed cash while avoiding selling pubs to better-positioned rivals. It also shows that major tenanted pub companies have plenty of options available when it comes to raising cash to pay down debt.
