According to a research study published by Standard & Poor's Ratings Services, the operating success of a U.K. pub company depends largely on the quality of its pub portfolio and management's skill in extracting value from the estate. This maxim, which holds true of both managed and tenanted estates, has lately assumed greater importance: in the past two years, securitized deals in the sector have focused primarily on financing the buyout of poorly-performing portfolios of managed pubs and their conversion into tenanted pubs, to increase portfolio value through efficiency gains.

The U.K. pub industry continues to be an active issuer of public debt, with transactions ranging from secured bonds to whole business securitizations. Furthermore, investor interest has returned with the formation of Mitchells & Butlers PLC out of the pub business formerly owned by Six Continents PLC, and the announcement by Scottish & Newcastle PLC of the sale of its 1,450 pub-and-restaurant estate in April 2003.

"Two credit strengths fuel the growth in debt issuance in the U.K. pub sector," said Anna Overton, a credit analyst at Standard & Poor's Corporate Ratings Europe. "First, the stability of demand and steady cash flow generation inherent in the pub business. Second, the favorable property aspect arising from pub owners' large portfolios of discrete U.K.-based freehold and long-leasehold properties."

The U.K. pub industry offers opportunities for growth in the consumption of high-margin premium products, albeit against the threat of declining beer volumes and retail price pressures. As a result, the performance gap between individual players in this market is set to widen in the medium term.

Pub operators' business strength and the stability of their cash flows are analyzed with reference to six main operational factors, namely:

  • The existence of a managed or tenanted business model;
  • The revenue mix;
  • The use of branded concepts;
  • The number and geographical spread of individual pubs;
  • Capital expenditure requirements (that is, maintenance and development); and
  • Property ownership rights and duration of leases.
After a spate of merger and acquisition deals in the past 10 years, concentration in the U.K. pub industry is high, with the top 10 groups accounting for about 43% of all U.K. pubs and a similar share of pub revenues. Another 30% is owned by smaller leisure groups or brewers that hold portfolios of less than 650 pubs, while only about 20,000 pubs out of the U.K.'s total population of 60,000 pubs remain under fragmented or individual ownership. Of these 20,000 premises, about one-half are likely to be of good quality, with the remainder being less favorably located.

Two distinct business models differentiate pub operators in the U.K.--managed pubs, which cover 20% of pubs, and tenanted pubs, which cover 50%. The remaining 30% of U.K. pubs are individually owned. Although estate quality is critical to the success of both types of estates, each model offers different factors for success that determine the quality of earnings for an individual operator. Managed pubs, for example, are run as a fully owned, fully operated business, with the operating company taking responsibility for full profit and loss and capital expenditure. Tenanted pubs, by contrast, provide two principal revenue streams: the rent paid by tenants, who trade for their own account; and the margin on beers and other alcoholic and nonalcoholic drinks sold to tenants.

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