Tuesday, 26 November 2013

The root of all evil?

This blogpost from Martyn Cornell: In praise of Ted Tuppen is a valuable antidote to some of the more hysterical anti-pubco tirades we have been seeing in the media recently. The whole thing is well worth reading, but the following paragraphs particularly stand out:
The call has been made for a mandatory free-of-tie option to be offered to pubco tenants. I can tell you what will happen if that is brought in: large numbers of the best currently tenanted/leased pubs will be turned into managed houses, and those pubs not suitable for a managed operation that look as if they will not bring in an adequate return to their pubco owner as free-of-tie operations will be sold to the highest bidder – likely to be Tesco, Sainsbury’s or Morrisons...

...There’s a good argument for saying that if it wasn’t for the pubco model and the support it provides licensees, even more pubs would have gone under in Britain than have so far. As one of the longest-lasting and most-successful pubco chief executives, having outlasted at the wicket most or all of his rivals from the early 1990s, Ted Tuppen can walk away from the crease, pulling off his batting gloves, with plenty of satisfaction.

If the tie was completely abolished, then what incentive would there be for a pubco to lease out a tenanted pub without any “wet rent”? It would become a pure property operation, and it might as well rent the premises out as a supermarket or a nail parlour. The pub market would polarise between high-profile, heavily-invested managed houses, and a long tail of often struggling, tatty and underinvested free houses. If a free house did well, it would be attractive to the managed house operators; if it didn’t, it would be even more vulnerable to conversion to alternative use than pub company pubs are at present. A few successful independent free houses with committed owners would thrive, as they do at present, but that would be far from general.

As I said in the comments, the anti-pubco campaigners never come up with any realistic alternative ownership structure for the industry. To imagine all pubs as stand-alone free-trade operations is pie-in-the-sky, to see them as council-owned “community assets” even more so. If property owners do not stand to gain from the business success of their properties, then what is in it for them?


  1. So would you get into bed with Enterprise/Punch if you fancied a move into the pub game? Or would you have more sense?

  2. He'd open a free house of course. I don't think the complaint is wholly the tie. More the debt that makes the whole thing unbalanced.

    The old "a bit for me, a bit for you, everybody's happy" is what no longer exists and what was there before the pub companies started their dog eat dog growth.

    It's "a lot for me, little for you and nobody's happy".

    The basic premise that more pubs might have closed is likely true to a point, but takes little else into account.

    I might write something a little less rosy myself.

  3. He does say, to be fair:

    "Now, there’s no doubt that one model, the highly leveraged pubco, turned into a slow car crash, as running up billions of pounds of debt to buy thousands of pubs and grow as big as possible turned out to be an OK plan in an economy that was doing well, but an absolutely dreadful idea in an economy that was tanking and with income from pubs falling."

    Ultimately the problem with pubcos is debt and leverage, not the business model itself.

    And it's hard to see what would have worked better in practice - except maybe keeping the old Big Six in operation and letting them slowly unwind the bottom end of their pub estates.

    If you criticise something you need to offer an alternative.

  4. If the capital structure was ungeared aqnd equity based then rather than pay interest they would need to pay dividends.

    Equity owners demand more than bond holders as equity is a higher risk paper.

    Opting to reduce dividend payments would reduce share price & market capitalisation of the business and prompt interest from asset stripping private equity. The creative destruction that ensures assets are best utilised in a market economy.

    Read the annual returns guys. These companies have suffered poor trading conditions.

    If gearing is bad, how come the German car industry is successful despite a capital structure of mainly bonds held by Deutche Bank and only a few shares quoted in Frankfurt? It's not a difficult one. It's because people buy the cars. They trade well.

  5. Cookie. All very true, but then there is gearing and reckless expansion. Think RBS and HBOS.

    Nor do BMW sell or try to sell, a bad product to people that can't afford it.

  6. As I have commented before, if there is a problem with the pubco model it is not with its mode of corporate finance, it is with its inflexible and unresponsive structure. Large bureaucratic organisations are often the first to struggle when market conditions change swiftly, as they have in the pub market in the past 10 years.

  7. With that, Tand, I can agree, because now you are not blaming debt but bad decision making.

    Bad decisions which would kybosh an enterprise regardless of capital structure. A simple lack of understanding the difference between price and value when purchasing an asset. Chapter 1 of either of Ben Grahams books.

    I mean we all know why Enterprise trade badly. For that we don’t have to read an annual return. Clarkey could tell you why he prefers chucking his money away in overpriced craft beer bars to Enterprise pubs. Mudge could tell you why he prefers Robbies or Hydes pubs to any of Tuppens gaffs. I could tell you why I prefer Timbos Spoons and you could tell us why you prefer cockney boozers or Deutsch kneipen. IS there anyone commenting that thinks his local Enterprise pub is the best place to spend money in that actually has a choice of something else?

    It boils down to trading badly and you all know why they trade badly because you are engaged in the market as active participants in the form of punters chucking your money at pubs.

  8. Cookie. I'm also talking about reckless gearing. So debt does come into it.

    I could live in a much bigger house and have a much better car, but the pay off would be a bad decision. I'd have less money to spend, couldn't have retired early and would be subject to market changes, which for the most part I'm not.

    Maybe if the PubCos had been a bit less avaricious, there could have been more happiness all round?

  9. Your example of “reckless” is not a great example, pal.

    In your example, you use the example of buying a house you cannot afford with a debt you cannot service. It doesn’t make debt a bad thing, only stupidity a bad thing.

    In your example let’s say your ability to service your debt is dependent on your wages from a job you do. You can solve this by increasing your income. Get a better job, get some lodgers in to the extra rooms you are buying. So long as the extra assets you buy with leverage is serviceable it is not reckless.

    Likewise, buying a second home. That should be self-funding from the use you put it to. Either people pay you to live in it, or a business is run from it. With your London gaff, you might do neither.

    It doesn’t matter how you buy it, whether equity or debt. With debt, the bank wants its interest. With Equity, the equity holder would logically want a return.

    Even if you buy a second home with money you have and are not expecting a return, you are forgoing a return. There is a capital cost. That is the return that money would make you in an alternate investment. Bank interest, share dividends etc.

    Each extra pub a pub co buys has a capital cost. It doesn’t matter whether debt or equity is chosen. The logical choice it to choose the lowest cost of capital. Equity holders expecting 7%? Bank willing to accept 4%? Choose the bank every time. Choose debt so long as debt is cheaper. Debt is not reckless. Equity holders desperate to give you money at a lower return? Issue more shares.

    What is dumb or reckless is failing to understand the price/value equation of the asset. You would only buy an asset that returned you a return on capital employed in excess of your cost of capital. It has to be in excess because the people you represent are the current equity owners.

    Buy an asset returning 10% at a 4% cost of leveraged capital and your new asset is giving your existing equity owners that 6% as a freebie above their existing return.

    Nothing reckless unless of course you have misunderstood the price and value of the asset you are buying, if you have misunderstood that, then that is your problem, not whether you have borrowed the money or not.

    As for would the world be better without greed? Nope but I've droned on enough ;)

  10. If you have a high debt gearing, you are more vulnerable to a decline in business, which has been the pubcos' problem. They have suffered from both a cyclical and secular downturn in the market.

    And you are quite right to point out that the lack of a USP is a major flaw in the business model - nobody would ever go to a Punch pub just because it was a Punch pub.

  11. Mudge
    If the company is publically listed, gearing is no worse than equity.

    For sure, bond holders have a legal right to their percent.
    Shareholders get what they are given, but if the shareholders don’t get a return in excess of bondholders, the share price falls. This values the business at less than net market value of assets. This makes the business subject to hostile takeover and asset stripping.

    A private company may have the advantage that shareholders are limited in regard to what they can do with their shareholding, thus making asset stripping difficult.

    If you are publically listed, there is no hiding place for bad trading, whether geared or not.

  12. "would the world be better without greed?" Cookie, aren't you keeping up with the Holy Father?

  13. That's where you went wrong Stringy. If you only have time to read one book, pick one of Ben Grahams. They are at least consistent in the truth they offer.

    God has lots of books out, and as far as I can see not a lot of consistency in any of them, just a lot of odd balls claiming there version is right.

    And Ben Graham doesn't bang on about coveting your neighbours oxen (why not if they have a better one?), the gays (quite nice people by and large and the camp ones tell funny jokes), sex outside marriage (always worked for me, but I've never had it inside marriage so I cannot compare) or making silly claims about greed being bad ;)

  14. Inside marriage is actually better.


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