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Fri 23rd Oct 2015 - Friday Opinion |
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Subjects: Greene King and MRO, JD Wetherspoon’s return to Muswell Hill, the magical new Grand Central Station and loyalty, the old-fashioned way
Authors: Jamie Rollo, Glynn Davis, Ann Elliott and Victoria Searl
Greene King and the challenge of MRO by Jamie RolloWhat is the MRO? Tenanted and leased pub companies rent their pubs to tenants or lessees in return for a discounted property rent, the ‘dry rent’, and above market prices for tied beer, the ‘wet rent’. The pub-owning company is also likely to provide other services, known as special commercial (or countervailing) or financial advantage (SCORFA) such as business development advice, training, and discounts/concessions. The provision of these benefits is one of the means by which a tied tenant can be said to be ‘no worse off’ than a free of tie tenant. The beer tie refers to a condition in a lease which requires a tenant to buy beer through the pubco rather than on the open market. The purchasing scale pubcos enjoy from this tie means they generate additional discounts and thus income that individual free-of-tie pubs would not have access to. During 2014 the government introduced a bill to give tenants the right, under certain limited circumstances, to change the freely-negotiated commercial terms of their agreement. This Market Rent Only (MRO) option enables some occupational tenants of large (500+) pub companies to elect to opt out of the supply tie at certain points or after certain events during the term of their lease agreement and therefore occupy the premises on a standard commercial property lease, paying rent only. While pub companies will be able to increase rent in return, it is likely that total income will be adversely affected, with a transfer of profit from pubco to tenant. Indeed, a tenant will presumably only choose to go free-of-tie if this increases his expected profits, so almost by definition MRO elections must be negative for pubcos. The regulations have been described as likely to have the biggest impact on the industry since the Beer Orders in 1989 and will potentially affect 30% of pubs in the UK.
How big could the profit transfer be? London Economics (LE) used data provided by the pubcos and estimated the current profitability of each pub. To model a tenant going free-of-tie, LE started by removing the wet rent. This would increase the pub’s profitability by the amount of the wet rent and in turn the dry rent, which is set as a share of expected profits. The increase in the dry rent depends on what share of expected profits pub companies get. To give an example, if the wet rent was £10,000 then removing this increases the pub’s profit by £10,000, if the dry rent is 50% of expected profits (the industry norm) the dry rent increases by £5,000. The uncertainty around these shares meant LE estimated scenarios with assumptions of 35%, 50% and 65%. At the mid point dry rent would rise by £5,000, meaning average pubco profits drop by 25% from £20,000 to £15,000, less any SCORFA savings. So the transfer is equal to half the difference between wet rent, the premium tied licensees pay for beer, and SCORFA. Intuitively this is because paying a premium for beer is justified by the benefit of SCORFA, so if the wet rent is higher then the SCORFA licensees are paying too much. The halving is because any excess wet rent reduces operating profit and thus dry rent too: the licensee already gets half the excess back through reduced dry rent, and under the MRO option they get the other half back too. LE calculated a median profit transfer at £4,250 per pub, with a £0-9,750 range, but noted another method of calculation got to £8-13,000 per pub.
Using BBPA figures, we get to an average profit transfer of £15,000 (£53,000 per pub down to £38,000), or £10,000 net of a £5,000 SCORFA saving. Greene King has larger and more profitable pubs than average and therefore the profit shortfall would be higher than average too. We estimate it generated £36,000 per pub in wet rent (significantly higher than the £19-21,000 LE figure), and the same in dry rent, so similar maths suggests a £23,000 net profit transfer, or a circa 30% hit. In reality, freehouses would not receive the same discount as Greene King, and if it continued to supply the pubs on a free-of-tie basis its Brewing division would benefit, suggesting a smaller profit transfer of perhaps 15-20%. On pro forma EBIT of £85m, this could be a £13-17m hit, or 5-7% of group profit before tax.
It is hard to know how many pubs will convert the MRO option. The key issues for a tenant include the increased level of fixed cost in the business (as rent becomes 100% fixed), negative impacts on cash flow (rent paid in advance rather than linked to beer sales), and the value assigned to the Special Commercial or Financial Advantage (SCORFA) that the tenant receives such as business development advice, training, and discounts/concessions. By definition, tenants will only select the option if they believe they will be better off, meaning the company’s profitability will suffer. Our discussions with experts in the trade suggest the vast majority of those asking for advice will switch across. On the other hand, Greene King has indicated that the numbers will be low, even immaterial over a 5 year view, commenting that “the introduction of this option will create significant additional red tape for the ultimate benefit of just a small number of licensees across the UK”. Even if the level of MRO take-up from Greene King tenants is lower than the pub industry average, given the quality of support given to tenants and the option to convert pubs to managed sites, we think the company will still be forced to give inducements to those that remain.
At one end of the spectrum, Enterprise Inns is embarking on probably the most ambitious transformation a pub company has ever undertaken. The company plans to use a broader range of operating models to optimise its 5,200 tenanted and leased pubs, so it can minimise the loss of income for pubs that take up the MRO option, and maximise the profits for better quality pubs that it could manage directly. Within the next five years Enterprise plans to sell circa 20% of its pubs, convert another circa 20% to a commercial property company, and convert another circa 15% to managed houses, leaving it with circa 45% of its current estate under its existing tied tenanted model. This should leave a business with a higher quality (if smaller) income stream. Additional value could also be created by separating the different businesses one day (managed pubco possibly acquired, commercial propco possibly converted to a REIT with a lower yield than the group trades on). While optically sensible, managed pub conversions may require additional overhead and higher capex (including some low returning spend), and even most tenanted pubs are too small in terms of unit revenue to warrant direct management. Pubs converting to free-of-tie leases under the MRO option will likely see a 10- 20% drop in income as the rent increase will not fully cover lost beer margin. The remaining tenanted pubs may have to be offered incentives to remain tied, and it could struggle to reduce central overheads in line with the drop in tied pubs.
Greene King has some advantages though. First, the company has a national managed pub division, giving it the existing skills and overhead to convert tenanted pubs to managed and avoid a profit transfer to the licensee. Second, it has a brewing business, so if it does lose out on a pub going free-of-tie, it may still be able to supply the pub on a market contract and retain some beer margin. Third, its Pub Partners business has performed better on a like-for-like basis than pure pubcos such as Enterprise and Punch, suggesting Greene King’s tenants have been squeezed less and supported better in the downturn. The timing of conversions will generally be dictated by lease expiries: the average tenure of a Greene King pub is 5-6 years, suggesting that the reshaping of the tenanted estate will play out gradually over a 5-6 year period. While it is theoretically possible that the company could buy out a tenant mid-lease to take a pub into its managed division, it is in practice quite expensive.
We think Greene King could shrink its tenanted estate by at least another 25%. Greene King has reduced its estate by 38% over the last 5 years, to 845 pubs, and at FY15 results management indicated it was seeking to reduce the (existing) tenanted estate further to 750 pubs. The Spirit acquisition has taken the number of pubs back up to 1,270. Spirit reduced its tenanted estate by 26% over the last 5 years. Given beer volume trends remain weak, and the MRO makes the outlook tougher still, we think a further 25%, or circa 300 pubs, could be sold, leaving a total of around 1,000. The quandary Greene King faces is that multiples on disposals are low (e.g. 6x EBITDA on its disposal to Hawthorn Leisure), and sitting on the cash or paying off debt is dilutive.
Jamie Rollo is a leisure analyst with Morgan Stanley
JD Wetherspoon’s return to Muswell Hill by Glynn DavisAlongside a row of gleaming hand-pumps sit two glass domes placed on the end of the long pewter-topped bar covering a large tasty-looking carrot cake and pile of fruit scones. They are complemented by an enormous vase containing an arrangement of pampas grass and palms. The scene is reminiscent of images in the bible of Victorian pub architecture – Mark Girouard’s authoritative book ‘Victorian Pubs’ – where the boozer is shown in all its glory from the days when it really was the centre of many people’s lives.
What I describe is not a tarted-up Victorian pub at all, but is a thoroughly modern affair that has just opened in north London’s Muswell Hill. The Mossy Well is the latest JD Wetherspoon to open its doors, a return to the area of London where the company was founded in 1979. Having made a visit during its opening week it struck me that the company just might be running the modern incarnation of the Victorian pub. This unit typifies the type of pub the company now operates. Although largely one open space the reality is that The Mossy Well like its newer sister pubs has many different areas, which are sufficiently differentiated as to provide a natural habitat for all types of pub-goer. Just like their glorious Victorian predecessors they increasingly cater for all strata of society.
The front-end of the building and bar areas are for those just on the sauce, whereas the sofa-type seating located further into the space accommodates the coffee-and-cake crowd and couples. Deeper into the bowels of the pub and upstairs on the mezzanine it is diners and families that feel most at home. The outside space out front and in the back garden serves the smokers and groups of youngsters looking for a more raucous night out. Such is the size of the group’s new pubs they arguably have the ability to be all things to all people. It is all a far cry from the early days when JD Wetherspoon founder Tim Martin opened his first just around the corner from The Mossy Well.
It was a small unit and typified the pubs that he opened in those first few years. They were wet-led boozers catering for the drinker – predominantly male. Fast forward to today and what he has brought to Muswell Hill this time around is a fully-formed operation that represents a quantum leap forward. It runs to 907 sq m and the location – being an expensive, family-oriented (it has good schools) part of town – highlights how Wetherspoon is now able to attract all demographics. Such a gargantuan unit would simply not work without pressing the right buttons for many groupings.
On my visit all society was in evidence at The Mossy Well – from babies in prams to doting and dotty grandparents. And all levels of affluence. Along with the buildings’ infrastructure, what also makes its broad appeal possible is the fact the company has successfully managed to pull off that magical balance of being able to deliver both a high quality product and a low price-point. The drinks list now runs the full gamut – from the bog-standard £2.49 lagers and bitters to a constantly revolving cask offering. This month happens to be its International beer festival when an array of one-off brews are available from UK brewers and a batch of interesting collaborative beers from domestic brewers teaming up with top international producers
The range runs through to some classy craft beers including Crafty Dan 13 Guns American IPA and Sixpoint Bengali in cans alongside bottles of Erdinger, Duvel and Devil’s Backbone IPA. The latter can be had with a foot-long hot dog and chips for a grand total of £5.49. By my reckonings such a brew would be £4.50 on its own in many other London boozers. Over the years the food menu has been developed into a pretty impressive affair. I recall judging a major pub food awards competition around 12 years ago and Wetherspoon’s won in the Multiple Operator category when in reality it was largely focused on simple curries, steak nights and a bit of experimentation with the likes of crispy duck wraps.
What it presents today is, again, a quantum leap forward. From Superfood pasta (including rocket & kale pesto, sugar snap peas and soya beans) to BBQ pulled pork Burritos, and Shanghai noodles to Eggs Benedict at breakfast time. This is a world away from JDW circa 1979. Apart from the price that is because none of these dishes comes in at much more than £5. It is a menu that is as varied as it is lowly priced. When combined with its multi-faceted pubs – that are predominantly carved out of interesting old buildings such as cinemas and banks (The Mossy Well was an Express Dairy building and former tram-shed), which gives them some character, then Wetherspoon’s offers a combination that is increasingly tough to compete against. The Victorian ideal of a pub is not dead, long live the new incarnation of the Victorian pub.
Glynn Davis is leading commentator on retail trends
The magical new Grand Central Station, Birmingham by Ann ElliottOh. My. Goodness. Oh. My. Goodness. The new Grand Central Station in Birmingham is so stunning that I was totally lost for words when I went to see it this week. I have traipsed through that awful New Street station in Birmingham so often and have come to hate it. Much as I like Birmingham itself, it’s been such an unwelcome welcome to a great city
But this new building is beyond beautiful. It’s simply gorgeous. The development has cost over £700 million, spreads over 450,000 square feet, is home to 170,000 travellers a day and is expected to attract over 50 million visitors a year. On a dreary Monday afternoon it was heaving. Goodness knows what it will be like at the weekend. Not everyone agrees with me though (http://www.theguardian.com/artanddesign/architecture-design-blog/2015/sep/28/birmingham-new-street-station-foreign-office-architects)
It has a magical combination of retail and food concepts working side-by-side. It all flows so freely and naturally. A champagne bar fizzes near Foyles, Paul is within croissant eating distance of Pandora, Tortilla is a few strides away from Tiger. The eating areas are beautifully designed – vibrant and exciting with masses of colour, noise and energy.
As it says on its website: “At Grand Central, you’ll find more than 60 premium brands, including one of the largest John Lewis shops in the UK, with over 50% of our shops and restaurants being new arrivals to Birmingham. So there’s sure to be plenty to catch your eye. When you’re done shopping – at least for a bit – take time out at any of 20 restaurants and cafes.” It feels like more than 20 restaurants to be honest.
Ed’s Easy Diner looked fantastic – the best representation of this brand I have seen. And it had more customers than any other place. I loved the Tortilla site with its clearly presented brand story. YO! Sushi was fantastic, two screens at the entrance providing a really lively and compelling welcome to their restaurant. Pho is doing a storm there and really brings Vietnamese street food to life. I don’t know the Caffe Concerto brand at all but it seems to serve the older generation well and was full of them. Paul, Square Pie and Five Guys all seemed to have pulled out the stops.
I am sure that Nando’s will be its usual success there but it’s an odd frontage lacking the openness that characterises most of the other brands. You just can’t see in. Handmade Burger Company is a bit like that but you can at least see glimpses of its superb retro interior from the outside. Carluccio’s has fantastic merchandising emphasising the freshness of its deli and restaurant products. Costa is just Costa. Not quite sure about Muffin Break. Pret has an awesome site on ground level all on its own though soon to be joined by Wasabi (from memory).
Joe and the Juice has probably the best site outside the entrance to John Lewis on the balcony but it’s just so slow. So slow I left the queue and went in search of drink somewhere else. I liked the Leon site but my Salmon and Avocado Super Pot was lacking the tomato, basil and caper sauce Vierge and not particularly good value for £4.20 (I think) for takeaway. The SSP brands in the old station don’t stack up well against their new, shiny, glitzy competitors but having seen what SSP have achieved with their new concepts in Stanstead, they will be on the case.
My favourite site was the new All Bar One on the outside of the station just by an entrance. It’s a real move forward in terms of design and looked amazing. I didn’t have time to eat there or indeed to see all the new concepts. Next time. Worth just getting the train, having a look around then getting back on again and coming home with a warm glow in your heart about the state of the British hospitality market.
Ann Elliott is founder and chief executive of leading sector marketing and public relations agency Elliotts
Loyalty, won the old-fashioned way by Victoria SearlIn meetings and interviews, the subject of loyalty will invariably come up. Usually, someone has been reading an exciting article, littered with wild claims about an app increasing repeat visit by a zillion %, or loyal customers who will walk miles just for the chance of getting another 20p added to their points card, (interesting how those articles are always co-written or sponsored by a peddler of such apparent magic). Other leaders are so keen on finding the holy grail, they’ll throw big piles of hard cash at the subject, in return for a system that quickly gets them such coveted ‘loyalty’ via the medium of offers (aka bribes).
But like popping round for ‘Netflix and Chill’, with a pizza under one arm and a bottle of Blossom Hill in the other every now and then doesn’t lead to marriage, the odd 30% off doesn’t lead to long term brand love either. Which brings to me the crux of what does, and I experienced it first hand the other weekend. Walking through the leafy lanes of south east London with my other half, we happened across a pub. Not a smart one, with fancy wine and organic plates, but a slightly tired boozer, with not a witty chalkboard in sight. Being half northern, half pool shark, we popped in for a quick half. It all seemed okay. Rugby on the screen, proper landlady on the pumps. Every missing husband in SE22 propped up at the bar. Nothing special. In fact, we were already draining our glasses to leave. But then something special happened.
The landlady came over, and with a friendly smile, put down a plate of sandwiches in front of us. “We always give out a bit of food on a Sunday lunch” she explained. And that small act of kindness, of welcome, of generosity, moved us both. And to cut a long story short, we were there so long that day (spending cash and chatting to the bar staff and regulars) we nearly missed the start of Downton.
Not only will we be going back, we’ve already told a load of local mates, and suddenly a frazzled old boozer is on our social radar. No soulless discount, no card to swipe a thousand times to earn a treat, genuine, warm hospitality was all it took. It wouldn’t be right not to mention the lovely landlady in question, so to Sandra, at the Man of Kent near Nunhead, we’ll see you Sunday!
Victoria Searl is a brand and marketing expert for restaurants
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