Thursday, 6 June 2013

Where Did All the Money Go?

Statutory Instrument 1989 No. 2390
The Supply of Beer (Tied Estate) Order 1989

You will know if you read this blog that I'm not a fan of the big pub companies. I don't like the way they have morphed what was a debt free industry, into one that is mortgaged up to the hilt and that to pay for this they squeeze the life out of those daft enough to work for them. Of course the banks - it always comes back to them - aren't blameless here in allowing such debt to build up. And no. I'm not convinced by siren voices that say as long as you can service that debt, then what's the problem? I read then with no surprise that CAMRA, the Campaign for Real Ale has revealed that the majority of publicans tied to the big pub companies earn less than the minimum wage.

 " A representative sample of over 600 licensees were interviewed by research firm CGA Strategy, with the results showing that licensees tied to the big pub companies are substantially worse off than free of tie lessees. A shocking 60% of licensees tied to the big pub companies earn less than £10,000 a year. This compares to only 25% of free of tie lessees who earn less than £10,000 a year. The other end of the earnings scale also shows a stark difference in earnings, with just one in a hundred tied pub licensees earning over £45,000, as opposed to one in five who run free of tie pubs."

The government intends that the PubCos, having failed to put their own house in order, start to play fair with their tied tenants (by regulation), though of course they are resisting it as much as possible.  They talk about the the low start up costs, the support they give etc. etc. etc.  Just think how much support they could give to all their tenants as well as their own shareholders who have seen their asset value fall as debt soared,  if they didn't owe so much money in the first place.

At the time of the Beer Orders, there were very few pubcos as they would be recognised today. Pubcos were created from the disposal of the national brewers' public house operations following the implementation of the Orders. Concentration in public house ownership increased through merger and acquisition activity in the 1990s, until by 2000 the first of the 'large' pubcos, Enterprise, appeared with an estate of 1,500 public houses.[14] The rate of concentration has accelerated since 2003 with the acquisition by Punch of the Pubmaster estate (3,000 public houses) and the InnSpired estate (1,100 public houses), and the acquisition of the Unique estate (4,100 public houses) by Enterprise.  Source: Select Committee on Trade and Industry Second Report

Worse is that the money was taken out of the industry in the form of loan after loan to needlessly set up these miserable giants by a succession of takeovers as illustrated above.  The Beer Orders was an idea in theory that was good, but was too easily subverted by the then large breweries, all of which of course, have more or less disappeared up their own backsides long ago, taking even more money with them, while the government, having seen its own intent undermined sat back and did nothing.  It has been a sad  and sorry tale.

Going back to licensees, the Morning Advertiser reckons their wage equates to around £3.21 an hour given the hours that licensees work.

I suppose you can see why a lot of them are so surly.  While it doesn't help their case, they have much to be surly about.

The MA has their take on the story here. It ties in well with my comments on Monday about pubs. The CAMRA story is here.


Cooking Lager said...

As a siren voice. Equity has a cost too.

All capital has a cost, whether equity or bond. The difference between these two issues of paper is that equity has a greater legal risk as being the later in line in the event of insolvency and a potentially variable return. A bond is earlier in line and has a fixed return.

The interest on the bonds (or debt) of the big pub companies has long been lower than what you might reasonably expect the equity to deliver on the basis of the business generating a return on capital employed.

The fact that they cannot deliver a return to equity holders and barely cover their bonds is not because the bonds offer wonga rates on interest. It is poor trading.

If the capital structure is any problem it is that a highly geared capital structure magnifies both gains and losses. As these companies trade poorly the losses are magnified to an astonishing destruction of shareholder value. Had the companies traded well, the highly geared structure would have delivered returns to shareholders in excess of trading performance.

Really, old chap, look at their trading performance, not capital structure.

Tandleman said...

Bollocks. Their trading performance is as a result of debt in substantial part.

People who think debt can be ignored in any capital equation are theorists who get and continue to get the country in a mess.

Didn't have you down as Ed Balls.

Curmudgeon said...

When they took the loans out they probably expected a rather more rosy future for the pub trade than has actually happened...

Cooking Lager said...

Not bollocks at all. If you take on a £200k mortgage to buy a house, with 10% down, but have a good job, you have no problem. In fact you have made a wise choice in gearing up your income. In a good market you pocket all the gains, despite only putting £40k in the pot. If you sell for £240k you have turned a 10% return into a 100% return.

It is a problem in a poor market as you pocket all the losses too. A 10% fall is a destruction of 100% of what you put in.

But your trading performance (in this case your good job) is relevant in so far as it is the tool you service your loan with.

The problem really isn’t the property market going up or down, but your ability to maintain your earnings.

The debt is not in and of itself an issue. The fact that money is a tradable commodity you buy or sell is a good thing. Without it you cannot buy the house.

If you had the £200k in cash, is it wise to be mortgage free? Only if the cost of capital is greater than the return on capital. If you pay 5% for your mortgage but can make 10% elsewhere, it’s dumb to be debt free. If those numbers reverse, it’s dumb to hold debt.

The pubs are different only in so far as you as an individual with a trading position are separate from the market price of your main asset. Your ability to maintain a good job does not affect the price of your house.

With a pub, the asset is linked to the trading performance and poor trading makes the pub worth less. At least as a pub. It might be worth more put to alternate use.

The link is not that the debt causes poor trading, but poor trading fucks the whole shebang of ability to service the debt and value of core asset.

If these pubs had the capital structure you propose of equity only, the result of poor trading would have been to some degree mitigated. The companies would not have looked so fucked. In fact they would have been prime takeover targets for asset strippers looking to put the pubs to better use. Whether that is as pubs, in anyones guess.

py0 said...

Pubs cos have a lot of assets tied up in land and buildings, it does at least in theory make sense if these are paired with non-current liabilities like debentures or bonds in order to best maintain a decent level of day to day liquidity.

The point, ultimately, is that if you decide to massively gear up your company in a bid for expansion, you better make intelligent enough use of your influx of capital in order to significantly increase your net turnover so that covering your interest payments is a given.

Ultimately you can look at it two ways: either it wasn't the borrowing of the money that sunk the pubco's, its the fact they didn't use it wisely enough, or you could be of the opinion that the necessary increase in turnover was never going to be possible even with an intelligent investment in NCAs, so taking on debt was only ever going to end badly.

Tandleman said...

"The link is not that the debt causes poor trading, but poor trading fucks the whole shebang of ability to service the debt and value of core asset."

Which is why you have to be a tad careful. They thought it was a stick on that they could keep going no matter what happened. Things have been bad enough but how would your theory look if interest rates rose to 10%? Property rates haven't kept up and while you can sell off the odd prime site either as a going concern (as they have done) or sell the land and buildings for another use.

As py0 says:

"or you could be of the opinion that the necessary increase in turnover was never going to be possible even with an intelligent investment in NCAs, so taking on debt was only ever going to end badly."

That's why you have to be careful. That's why the markets rate them as so much junk.

The theory is fine but in practice it is bollocks. The proof is there. The companies are fucked. By poor trading or debt doesn't matter in the end.

Cooking Lager said...

Pyo I agree with most of that save the last paragraph.
If I owned 100 pubs and wanted to own 101 and decided to borrow the money to buy the 101st as that afforded me the lowest cost for that sum of capital then my decision would be based on the cost of capital for that 101st pub compared with the additional returns from that 101st pub.

I would only expand my pubco if I calculated the former of your 2 scenarios would occur. I would accept the possibility of the later as risk but would not proceed if that were my expectation.

Another factor to consider is one of portfolio. It is the same as being a private rental landlord of houses or of having a stock market portfolio of shares. In the game you have 2 forms of risk. Specific risk and market risk. The former is the specific risk on 1 house, 1 pub, and 1 stock poorly performing. The market risk is that of the whole market poorly performing. You cannot mitigate for market risk. You can for specific risk. You do that through portfolio theory

The bigger or wider your estate, or portfolio, the more houses/pubs/stocks in your portfolio the lower the impact on the performance of the whole portfolio for the under performance of one element.

A big estate of pubs is less risk than a small estate.

Cooking Lager said...
This comment has been removed by the author.
Cooking Lager said...

@Tand. Yes you have to be careful when borrowing money but actually they have been.

The scenario you paint has not occurred. The % rate on pubco bonds is lower than they ought to be able to pay equity holders. They have not been stiffed by higher interest charges.

As for why they are fucked. It matters in so far that debt is often unfairly blamed and is a necessary tool for a functioning capitalist economy. People need to buy and sell money.

Otherwise capital decisions are only in the hands on those with capital.

Those without capital need to be able to buy from those with capital for businesses to start.

If we wanted to start a pub, we would want to obtain the capital to do so, from somewhere. We would be better off borrowing it than asking for it from the sharks on Dragons Den.

py0 said...

less risk but more exposure?

Cooking Lager said...

You have the same exposure to market risk whatever your portfolio size. The death of the pub market would affect you whether you had 1 or 100 pubs.

The specific risk or local factors associated with one pub (the local steel works closing throwing your regulars on the dole) are mitigated in a portfolio of 100.

If you have 1 rental house, one bad tenant (specific risk) is 100% of your portfolio. It is 1% of a portfolio of 100 houses. The market risk is related to factors that relate to the whole rental market.

If you own shares in Tesco, the specific risk is the horse meat scandal. If you have a portfolio of supermarket shares you have bought the sector, your risk is mitigated by the upswing in Sainsburys that didn’t sell horse burgers.

Tandleman said...

You are actually mad. In your world nobody gets it wrong. Whatever hsppened to both financial and business due diligence?

If you have a hundred good pubs/horses/properties/cakes you can safely buy a 1000 more shite ones and that makes things better.

That worked for the Co-op, Lloyds et all did it not? Get bigger - crash and burn. Too much theory, not enough reality Old Son.

Tandleman said...
This comment has been removed by the author.
RedNev said...

Never realised it before: Cooking Lager is Pangloss!

Cooking Lager said...

Well, yeh I am mad, that’s what cheap lager does to a man, but that's not the point. Nobody sets out to buy a duff pub. Every one is intended to be profitable, but the effect of a duff one is less the more you have.

Me and you Tand could scrape the money together to buy a boozer, I reckon. But why bother? That is too unambitious.

We could leverage that as a deposit on ten boozers. In fact why capitilise our business at all? Instead of capitalising it with share capital we could stump a tenner each in for equity and lend the rest of our investment to the business. Then leverage that as a 10% deposit with the banks. There’s tax advantages too in so far as the business paying interest rather than dividends. Kerching ! If we can figure a way of a punter buying a beer in Rochdale but the transaction actually occurring in the Caymen Islands, another kerching.

As for it all going tits up, don’t panic. Our liability is legally limited and we will make sure we get paid back first.

Curmudgeon said...

I reckon in secret you're one of the Dusanj brothers, Cookie ;-)

Tandleman said...

If you'd just said it's all about kerching and legally limited liability without all the other guff, we'd have been in agreement from the start. (-:

Cooking Lager said...

The point I've been making is a simple one. That debt per say is not an evil. It is a tool whereby those without capital can make capital decisions.

But most of the gubbins mentioned does occur in the world of private equity. You may think it mad.

Gordon Brown made the rules that made it tax efficient to structure a company with debt rather than equity. He did it to help start ups.

The following has never been done with pubs, but amazon do it and you have all shopped with amazon:-

The next question I have is regarding our chain of debt riddled boozers. If we offer beer for 1 Tand token per pint, and sell Tand tokens on our website from our Caymens listed holding company, then our pubs do not sell beer. Our pubs deliver our service, but we sell the grog from the Caymens.

Would Mudge, Nev etc buy Tand Tokens if our grog ended up cheaper?

Paul Bailey said...

In all this debate about assets, leverage, capitalisation, tax advantages etc., areas my non-financial brain is struggling, in some cases, to grasp, Tandleman's original point about the pub-trade being a debt-free industry seems to have been missed.

However much CAMRA may have detested the "Big Six", they were still brewers who understood the beer market and the pub trade. Step forward the Beer Orders, applauded by CAMRA at the time, and seen by many as a means of freeing up the supply of beer, only to find the big brewers side-stepping the issue and the establishment of the PubCos.

Almost a quarter of a century later we are left with the dire state that the pub industry is in today, (for reasons already explained). The Beer Orders may have been implemented with the best of intentions but, as with most government interfeerence in a free market, the outcome didn't comply with the original aim.

I believe this is known as "the law of unintended consequences", and it can apply in all sorts of different situations. Put another way - "Be careful what you wish for!".

Curmudgeon said...

"Put another way - "Be careful what you wish for!". "

Which is why the proposed reforms of the leased pub market, while undoubtedly well-intentioned, may well not have the desired effect and lead to a further shake-out.

If you regulate something more, and it is struggling already, you are likely to end up with less of it.

kaiserhog said...

This is not going to be popular but here goes. The Pub trade seems a bit limited by CAMRA's arbitrary and capricious definition of "real ale". They are almost completely resistent to any technological innovation that makes easier for the publican to present, serve and store their ale.

Second, you get what you pay for in terms of cleanliness and service, if lesse's don't earn a living wage how can you expect them to put back much of anything in their business.

Third, if more publicans actually owned their pubs then maybe they would take more pride in them.

Just my two cents.

Anonymous said...

I am not a Financial expert , but I know there is no money in most tenancies,there has been enough press about it, so I believe if you go into it with no decent business plan and no experience in the pub trade , then more fool you.
I would like the government or councils to bar pubs from ever being sold as private property, as in the south atleast this is what the pub companies are after , even if a pub does well , the rents go up to make it untenable. They want the land and property. Mordern greed is awful, some people would sell Windsor castle for flats if they could, the greedy bankers should be hung for robbing our country.
As for being limited by real Ale , it ain't that important yet!

Cooking Lager said...

You make an interesting point Paul. I made a point earlier but it was part of a wider point and is worth considering. What if these zombie pubco’s were debt free? What if the capital structure was equity based?

The market does not like underutilised assets. The market seeks to utilise an asset in the highest value manner. Smaller family brewery pub chains being private companies are not subject to hostile takeover. They are subject to disinterested third generation shareholders, but not the stock market.

For larger publically quoted companies it is a disaster to have an underutilised asset base. If the market capitalisation of the business falls (share price x number of shares issued or market price of the whole business) below the value of the net assets (the pub estate) they are going to get a hostile takeover. Paying dividends on equity is not a nirvana and better than paying interest on bonds.

If the business trades poorly & announces poor result after poor result & cuts dividends the share price plummets. Other companies ask themselves whether they can do better with those pubs.

Has these companies been debt free the likeliest outcome would have been hostile takeover and asset stripping with only the better performing pubs remaining as pubs.

The basic problem was not capital structure, it was the people in charge did not know how to run a chain of pubs and make a quid out of doing that.

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