Mitchells & Butlers lines up cream of Orchid estate: Mitchells & Butlers (M&B) is in exclusive talks to buy 170 Orchid Pub Company sites, 155 of which are freeholds, City contacts have told Propel. An analyst told Propel: “I understand that M&B is not taking any onerous leases or unprofitable pubs – it is essentially the cream of the crop in an overwhelmingly freehold estate. Around 60% of the 170 sites are in the prosperous part of the south and the north-west, the latter being an area where M&B has been traditionally under-represented. The Orchid carvery estate, a number of which are arterial road battleship sites originally developed by Tom Cobleigh, will plug very neatly into M&B’s Toby Carvery estate, which is one of the four brands that the company is keen to expand. The Orchid carveries offer substantial upside to M&B in terms of greater scale and buying power. Another major attraction for M&B is Pizza Kitchen and Bar, the Orchid brand that achieves 20% food sale in wet-led pubs. The brand has been described as a genre-buster and could be utilised to boost food sales at wet-led M&B pubs.” Orchid is currently achieving 40% Return on Investment in its current round of capital expenditure and Ebitda is forecast to rise by around a third to £40m in the current financial year, which means a suggested sale price of £256m would be 6.4 times Ebitda. Orchid is also developing a family-friendly format, All Inns, that has enjoyed considerable success. Last month, Orchid reported it is to add 26 family-friendly All Inns after a 23% rise in like-for-like sales at the existing 16 in the past 12 months. The company’s Return on Investment in the segment is nearly 40% and average weekly sales have risen from £17,000 to £21,900. 

    

Propel Opinion by Paul Charity: Fortune favours the brave. M&B, which has lagged its major competitors on the acquisitions front in recent years, looks to be in pole position to buy the largest remaining substantial UK freehold pub estate likely to come to market. The purchase price works out at £1,505,000 per pub for run-rate site Ebitda in the region of £235,000. It is arguable that M&B would be buying well given JD Wetherspoon is investing £500,000 more per site and achieves average estate Ebitda around £200,000 per pub. The 170-strong target Orchid acquisition would also be shorn of its problem sites – many have been sold in recent years and the remaining 40 or so problematic sites would enter administration. Given that M&B is able to capture synergies as a trade buyer not available to private equity buyers, it is perhaps remarkable that Colony Capital has, reportedly, offered just £10m to £15m less than M&B. For M&B, an acquisition of Orchid would be a sizeable boost to company morale and positioning given its travails in recent years. One plus would be the opportunity to apply Orchid’s trading expertise and templates in areas, such as the value-food market, where it has been struggling in recent years – as well as the opportunity to plug geographic gaps in its estate-spread. One surprise in the Orchid sale process has been the retirement of Greene King from the fray. The company took the slightly surprising step of making a formal announcement last Friday where it claimed the Orchid estate did not meet its strict acquisition criteria. Greene King has not been shy of a paying a full price for quality assets in the past. On this occasion, Greene King appears simply to have been out-bid – and will be smarting. 

   

Douglas Jack – we believe an Orchid deal would be earnings accretive for M&B: Numis Securities leisure analyst Douglas Jack has issued an ‘Add’ note on Mitchells & Butlers with a Target Price of 525p, after news of its interest in buying 170 Orchid pubs. Jack said: “We believe the deal is a good one for M&B, at a price it can comfortably afford. Estimating that the deal could be 7-9% earnings accretive, we would use recent weakness as a buying opportunity. The estate comprises: food-led brands like The Great British Carvery, Thai Dragons and Oriental Restaurants and All Inns; Fuzzy Ed’s bolt-on play-barns; and a wet-led estate. M&B is outbidding private equity firms Colony Capital and Starwood Capital by £10-15m. However, as a trade buyer with £0.25bn of excess cash sitting at PLC, M&B can afford to. After all, M&B is likely to close Orchid’s St Albans head office, which cost £8.6m in the year to December 2012. M&B’s central cost saving alone could offset its incremental financing costs for the deal. M&B currently earns little interest income on its £250m of PLC cash. We believe a new banking facility would cost close to LIBOR +2%, but provide ample headroom. Thus, incremental interest costs should be £5-10m, implying 7-9% earnings accretion, by our estimates. In addition, M&B is also likely to target high returns from converting many of Orchid’s sites into its own brands. We estimate M&B would be paying a post-synergy Ebitda multiple of c.7.5x. The combination of an estimated c.13% cash return, a low cost of financing and no need to raise equity should make this transaction strongly earnings enhancing. Our only concern is that the resultant capex commitment to the Orchid estate could be used as an excuse to further postpone a resumption in the dividend.”