Opinion: life after leverage in the pub trade

A couple of news events from the past week speak a little more of what the next year or so holds for a slug of companies from the eating and drinking out market.

Namely, a period of upheaval, as companies renegotiate their banking terms, restructure their balance sheets and the banks write off debt.

Back in April we wrote about life after leverage. In some corners of the market, this process has begun. Mostly though, it has not.

News broke in the Sunday Times of a £450m writedown at Lloyds Banking Group against the £850m of loans it has provided to Admiral Taverns, the hybrid pub-property group, given the significantly diminished value of the group's portfolio.

Then Punch Taverns announced plans to raise £350m through share issues, a huge undertaking for a company with a current share capital of £400m.

These two very different pieces of corporate activity are part of the same theme: how the sector makes the painful journey to a world with some more equity, and a lot less debt.

Why must this happen? In the face of a changed trading environment, cashflows are under severe pressure, given the demanding debt obligations many companies have signed up to. At the moment most companies are servicing their interest requirements, but at the expense of the operating business.

In a sector that requires constant and heavy investment, companies have taken their eye off the future, in order to survive today. Not investing in these businesses is akin to turning off the oxygen tank.

History tells us that if companies don't invest, they eventually stop paying their interest charges because they can't generate enough cash. It is a slow and painful death. It is why the sector must get hold of some cash and lose some debt.

In a way it is what Lloyds is doing with Admiral — boiling down the debt, freeing up cashflow.

In issuing shares, Punch is following a path recently trod by Greene King, although its needs seem a little more pressing. If successful it will pay down that worrying convertible bond and make opportunistic purchases of longer term bond debt.

Hoping for a solution​

One of the pub market's leading M&A practitioners, Peter Hansen, of Sapient Corporate Finance, urged the banks to take proactive steps to address this sector issue. Speaking at the Tenanted Pub Company Summit Hansen said: "At the moment the banks are just hoping for a solution — they haven't taken the painful decisions that they need to."

Hansen said the banks needed to lead a pan-sector restructuring process.

In some parts of the market, such as the high street bar segment, this meant crashing businesses together — there were "too many companies with the same product" — to drive profits through the removal of duplicated costs.

But in most cases, it meant dialling down the debt through the painful process of writedowns. If they did not take writedowns, the banks would end up owning these assets, and those assets would decline with the market. In the last downturn the banks rushed in to take ownership and then put businesses up for sale in a depressed market.

The overriding message was that it was not realistic to expect white knights to suddenly appear on the horizon when the economy rights itself, and for those white knights to be comfortable with the current levels of leverage.

"Nobody is going to put cash into this sector until debt comes down," said Hansen. "Property finance and private equity will only buy in at conservative debt levels."

Hansen said that broadly, the sector needed to get its debt down to below six times underlying profits (ebitda, post group overhead), and probably nearer to five.

Clearly some companies will not require help but this debt disease is a widespread problem. The solutions will be varied and more news on this subject will emerge in the coming weeks.

The message to the banks is clear: don't ignore the problem but don't rush in to take control. Take the hit and let the healing begin.