Wed 11th Mar 2015 - Analyst - Govt has watered down Market Rent Only option Douglas Jack – Government has watered down the Market Rent Only option: Numis Securities leisure analyst Douglas Jack has argued that the government has given tenanted pub companies options to mitigate the effect of the Market Rent Only option, which would have ended the tie. He said: “The government said it will introduce exemptions to the Market Rent Only (MRO) option for “genuine franchise agreements” and pub companies willing to make “significant investments”. In our view, the risk and uncertainty surrounding the MRO option has largely been priced in – now its likely impact appears to be declining, with operators gaining new means to minimise its potential negative impact. The Small Business, Enterprise and Employment Bill is currently at the Report stage in the House of Lords. This bill includes the pubs code, which includes the MRO option. The government intends to use secondary legislation to allow tenants and pubcos to agree a waiver to the MRO in the case of “significant investments” and “genuine franchise agreements”, subject to definitions. The proposed amendments are sensible, in our view. As the beer tie finances capex, the MRO would dis-incentivise substantial long-term capex as it could allow the tenant to leave the beer tie in the middle of the capex cycle. We always believed franchise agreements would eventually become exempt once the politicians realised that they have no rent on which to apply a Market Rent.The outlook for the tenanted pub sector is gradually improving, in our view. Beer/cider sales growth was stronger in wet-led pubs than in food-led pubs in 2014, aided by an improving consumer, the FIFA World Cup and strong London trade. This has helped tenanted Ebitda to stabilise and debt to continue falling. To this, we should soon be able to add reduced uncertainty in relation to the beer tie.To the extent that tenants might wish to go free-of-tie (over the last six years, 98.3% of Marston’s lessees have rejected the company’s offer to go free-of-tie), there appears to be an increasing range of options to minimise the downside risk. We expect Punch Taverns and Enterprise Inns to trial franchising, with the latter also running managed pubs and considering creating a REIT. The proposed MRO amendments still have to get through the House of Commons. Nevertheless, their introduction is a positive development for Enterprise Inns (Add 125p), Punch Taverns (Buy 160p), Marston’s (Buy 180p) and other large pub operators, with tenanted/leased pubs.” Yesterday, Brigid Simmonds, chief executive of the British Beer and Pub Association, said: “It is good to see that the government has recognised the need to ensure the legislation does not deter capital investment in pubs. Whilst those who opt for a Market Rent Only option have the absolute right to source finance from anywhere, those who wish to remain tied should equally have the right to choose a partnership with their pub company and defer MRO in return for substantial capital investment. We look forward to the consultation in due course. There is no point in offering MRO to a franchise where no rent is paid, so we are pleased that the government has now recognised this and seeks to exempt these types of agreement from MRO in secondary legislation. Whilst extending the protections of the Statutory Code when a pub is sold will involve greater cost, this is considerably better than the proposal that such licensees would retain the right to MRO. Unfortunately this would have led to no pubs changing hands because of the effect on their value. We are concerned about the re-introduction of Parallel Rent Assessments (PRAs) for existing licensees, who of course now have the option of MRO. Comparing the profitability of a tied pub with a free-of-tie pub is not easy as has already been highlighted by RICS. It is essential that there is a link between a PRA and an MRO calculation which is both simple and easy to understand for both the pub company and licensee. The Bill needs to complete its Third Reading in the House of Lords and then return to the Commons. We will of course be ready to work with the government on the fine detail, through secondary legislation.”