Thursday 24 April 2014

Fancy a pint - part 2

Loyal Betaville readers may recall that a few weeks ago I published a post about FTSE 250 pub companies Mitchells & Butlers and Greene King.

For those readers that don't remember, I noticed that both companies had almost identical market capitalisations. And after speaking to an excellent source, I noted speculation there had this year been some loose discussions about the two companies combining.

Well, I have stumbled across a juicy bit of gossip (and believe it or not this wasn't while I was down the pub) that adds a curious twist to my previous tale.

I understand that Mitchells & Butlers has been taking a serious look at buying Orchid for between £250m and £300m although I'm not sure the company will pursue the deal.

Orchid runs more than 250 pubs and restaurants in the UK and is reportedly "on the market". Matthew Goodman over at The Sunday Times wrote a piece earlier this month claiming Spirit, another listed pub company that announced figures today, was taking a look at buying Orchid. Here is a link to The Sunday Times article: 

The interesting thing here is that Orchid's main lender is Deutsche Bank, which also happens to be one of the corporate brokers and a financial adviser to Greene King.

There is also some confusion as to who actually owns Orchid, which runs the Country Carvery, Bar Room Bar and Living Room chains. The business was set up by private equity firm GI Partners when it bought a bunch of pubs from Punch Taverns in 2006 for £571m.

Since then several reports have suggested that Deutsche Bank took control of the business. However, people close to the financial institution insist Deutsche Bank is not the owner of Orchid and is just a lender. Confused? I am.  

Still, my sources tell me that there are clear Chinese walls between the part of Deutsche Bank that advises Greene King and the division of the bank managing the Orchid book. But it does look rather awkward from the outside.

I guess, though, it doesn't matter because the odds on a £4bn merger of Greene King, which is also advised by Lazard, and Mitchells & Butlers appear to be worsening, according to my sources.

If anybody wants to know why, they can find me in the pub....

Mitchells & Butlers and Deutsche Bank both declined to comment.

UPDATE: What a remarkable coincidence. Deutsche Bank's equity research team has just upgraded Mitchells & Butlers to a "buy"! I pasted a summary of the note below:

Deutsche Bank - Equity Research - Europe
UK Pubs & Restaurants - The Chips are up 27 April 2014 (129 pages/ 4262 kb)

Long term growth in eating out provides scope for real growth
What we are seeking to do in this note is to update investors on the real scale of the revenue and profit opportunity for pubs by placing the industry in its broader total eating and drinking out context. After 8 years of repositioning, all of the sector’s major groups are now in much better shape, operationally and financially, than they have been for the past 25 -30 years. With improving employment, rising real wages and the UK economy turning up, the Pub & Restaurant sector – focused on affordable treats for value conscious consumers - appears to be in a sweet spot as far as the future is concerned. We have upgraded our view on all of our companies.
Out of the fire – and into the frying pan – chip sales are on the up
The last six years have seen some of the worst trading conditions that the pub industry has experienced probably since the Second World War. However, whilst beer volumes have fallen heavily, the eating out market has continued to grow – declining in nominal terms in only 6 out of 196 quarters since records began back in 1964. This has provided the pub operators with scope to transform their businesses from rear guard defensive operations into ones capable of real growth. We have seen some recovery since the previous peak of 2007, but most of the quoted groups’ profits remain below peak levels.
A large and very fragmented market in which to grow and take share
The drinking out and eating out market in the UK is worth around £70bn of annual sales. The quoted pub and restaurant groups dominate the overall space, withMitchells & Butlers (#1), but with less than 3% of revenue share. JD Wetherspoon(#3), Whitbread’s Costa & Restaurants combined (#4), and Greene King (#6), plus Compass Group’s UK sales (#2), McDonald’s UK sales (#5) and Sodexo’s UK & Ireland sales (#7) all generate over £1bn of sales each.
Valuation & Recommendations – our 5 year forecasts show sustained growth
Because of their repositioning, and because they are looking into a period of economic upswing that should play to their strengths, we have argued in this note that the target price EV/EBITA multiples should increase by one turn of their 10 year forward averages. Our investment preferences are driven by the groups that are self-funding most or all of their growth – as a hedge against the rising cost of debt. We have increased our FY’15 & FY’16 forecasts for Greene King (BUY), M&B(upgraded to BUY from Hold), and for Spirit (Hold); and have downgraded Marston’s(Hold) FY’14E only. We have maintained forecasts for JD Wetherspoon (Hold), which, along with Spirit, is the most operationally geared group in the sector. We have maintained Enterprise Inns (BUY) as our special situation. We have upgraded our target prices for all of the pub retailers by between +13% and +43% (see table column right). In addition, we are initiating coverage on The Restaurant Group(Hold), which, our analysis suggests, has been the best performer over the past decade, and may well be over the next five years as well - much of which is in the rating.
Results and Risks
We have published our previews for the forthcoming results and IMS statements (see side table for dates) plus the individual company risks in the Company Pages starting at page 64. These also have headline details of our forecast changes.

Geof Collyer, Managing Director, Leisure Team, +44-20-754-75325

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