Spirit exit runs into problems

Spirit Group, the UK pub company, is in early-stage talks with rivals Punch Taverns and Mitchells & Butler over a proposed takeover that would provide an exit for private equity owners Texas Pacific, Blackstone, Merrill Lynch and CVC Capital. As we go to press, the potential bidders, both of which are listed on the LSE, have been put under pressure to declare their intentions. Speculation suggests that a bid of around £2.5bn (US$4.6bn) is being prepared for the remaining 2,000 properties, which is thought to be some way short of the private equity groups’ expectations.

The private equity consortium initially acquired the group in May 2002, when Punch Taverns de-merged its managed inns portfolio prior to its stock market listing. In October 2003, Spirit bolted on the pub estate of Scottish & Newcastle for £2.51bn, taking the number of units under management to about 2,600. In the interim period, the group has disposed of 360 pubs to Robert Tchenguiz’s Globe Taverns and a further 130 Premier Lodge hotels to Whitbread. Spirit is also reported to be in exclusive negotiations with Alchemy Partners over the disposal of a further 200 high street bars.

There are other major deal-breakers other than price. Peter Hansen of sector specialist corporate finance boutique, PC Hansen & Co, said: “Of the 2,000 properties, Punch would probably want around 600–1,000 of the smaller units for conversion into tenanted pubs. M&B would be interested in about 500 pub restaurants, especially the Chef & Brewer chain. This leaves at least 500 that would have to be disposed of in a separate transaction. And many of these will be leases.”

Any break-up would be further complicated by a labyrinthine financing structure that includes multiple sale and leaseback and securitisation structures. A source close to the deal said: “There is a bond debenture in the business of £1.25bn that doesn’t split easily along the lines of the proposed break up. While it is theoretically possible, I do not know of any cases in the UK where there have been multiple operators of a securitisation.” While the private equity groups are believed to have recouped their equity through refinancings and disposals, this could be nullified if the sale-and-leaseback agreements have to be repaid.

The deal also represents the potential perils of private equity groups working in consortia. Greg Feehely, a sector analyst at Altium Securities, said: “The disposal is running into all sorts of problems, some people are saying that a break-up will crystallise more value than an IPO, but there are financial problems associated with any break-up.” According to press reports, CEO Karen Jones favours an IPO for the business, but most observers acknowledge that this would have to be a long-term goal given the recent performance of the group.

Other sources say that the exit complexities are causing some rancour among the private equity owners. One source close to the deal said: “If you look at recent newspaper reports, the parties have clearly been briefing against each other.”

Cinven and Enterprise Inns were the latest bidders to be deterred by the unruly financing structure. Enterprise reportedly walked away from the talks, leaving Cinven to find an alternative partner or an alternative route back into a sector that it knows well. It was keen to sell on parts of Spirit’s 2,000-strong portfolio to Enterprise, while retaining the bulk of the outlets itself.

The quoted markets are likely to be just as sceptical of a complex business of variable quality that is underperforming its peers.

One commentator said: “It is difficult to IPO a business of that size in the current market. Also, there is great concern about the impact of a smoking ban on UK pubs that is likely to come into effect in England in 2009 and in Scotland in 2006.”

Mitchells & Butler, which owns the All Bar One and Harvester chains, has appointed Citigroup to advise it on the deal, while Punch has hired Morgan Stanley. Spirit is being advised by Merrill Lynch.