Tuesday, August 11, 2009

AHA. An open door!

As everyone here will attest Vic, complete stranger's intrusions are more than welcome on Sir Peter Gasston's Camberwell blog. And what a good, simple, down to earth question too.

This may seem over simple an answer but believe me, I've spent years working on this with others burrowing away at what's broken in the pub industry, to find the banal and stupid reality and have not got it wrong. There may be small exceptions to the rule below but by and large it all holds true.

Pubcos are Private Equity companies who stayed in their asset stripping game too long. They got their fingers caught in the till and there's not a lot can be done about it. They got lazy largely because, until the current financial mess made their gravy train hit the buffers, it seemed their conga like charabanc in the world of pubs simply had no end. As the two pubcos who began the current form of operation - Punch and Enterprise - way outperformed the rest of the pub market, year after year, the other, smaller and perhaps more traditionally minded pubcos found the new model irresistible and copied them. Some 'family' brewer laggards, such as Youngs and Thwaites, are still now converting their estates from managed to fully repairing and tied leased even though it's obvious to most ordinary people that none of it is sustainable in any way shape or form.

The collective business model of pubcos has simply been to totally, comprehensively, shift all fundamental repsonsibility for the operation of their business, whether financial, practical, legal or day to day, onto onto the shoulders of thousands of 'entrepreneurial lessees' who willingly invest in their 'own' individual businesses (that is the thousands of 'units' (pubs) which pubcos lease to individuals) while the pubco, from the outside, appears as responsible 'partners' working together with their lessees in the operation of their very large, and very unrealistically profitable, property portfolios.

The model is simple: Devolve ALL responsibility and concomitant costs for a pub's operation, from foundation to rafters and everything in between - over to individual lessees by contract: Make available to market property leases with Fully Repairing and Insuring liabilites (common in the property rental business) from which people will run their own entrepreneurial business and reap whatever financial rewards they deserve for their hard work and endeavour. What is NOT common in other property letting situations if that these leases come with legally binding product supply contracts which mean, at least, that all beer sold by the lessee has to be bought through the freeholder's price list, and at most ALL products they use, from mopheads to french fries. The freeholders (pubcos) advertise their wares using language like: 'we operate the highest quality portfolio of pubs in Britain, offering an unrivalled package of core branded products, backed with the dedicated business support of our team of highly trained experienced trade Business Development Managers to individuals who want to run their own business secure in the knowledge that they are working with the best in the business' blah blah blah.

The bottom line is that these conditions imply the pubco works in 'partnership' with individuals but the reality is VERY different. The contracts confer no legally binding obligation for shared responsibility of operation of any aspect of the business - except the right of the pubco to profit from rent AND on all products supplied to the lessee. The ENTIRE costs and responsibilities of running the operation, maintaining every aspect of the property from foundations to rafters; keeping up to date with ALL legislative obligations, whether general health and safety issues, from building code certification to climate change levy on decrepit buildings, and local and national fire, gas and electrical compliance, licensing implementation, employment law, minimum wage legislation to every aspect of marketing, promoting and long term investment in the business are entirely the responsibility of the lessee.

This means the lessee carries ALL the costs and obligations of operating the porperty and the freeholder NONE. Neat business model for the pubco who spends NOTHING directly (unless it's on capital investment in which case the lessee's rent increases to repay the pubco's outlay - they don't give anything without taking back - at userer's rates of return) on the business other than looking after the 'team' of BDMs and their company cars, performance related bonuses (resulting from making sure rents increase above inflation and that lessees never buy 'out of tie'), their pensions and industry related incentives, sporting days out, training and free products - which lessees are never entitled to of course.

Lessees are milk cows nothing more nothing less.

How this came about is The Fundamental Problem facing pubcos now. They all have gone hell for leather to jump on this free for all bandwagon. They all agressively increased the size of their estates by acquiring new properties at ball breakingly high prices as the property market rocketed, with pubco property values artificially infalted by the notion that there is unlimited, ever increasing future income based on rents and tied supply always going up and up. They borrowed to buy their new buildings and securitised their debts against future income and in many cases even sold their existing freeholds to banks and other 'Private Equity Partners' while retaining 'operational responsibility' for 'managing' the estates, using the proceeds from the sales to borrow MORE money with which to buy MORE pubs which they then let to individuals as above, who, eventually began to start LOSING money and sufferign BUSINESS FAILURE as all of the figures began to fall apart once their margins had been squeezed so much that laying off staff and working all hours god sends to compensate could no longer take up the slack for a failing business losing cash.

The two biggest pubcos' borrowings are so high that the annual interest payments alone amount to £700 million between them. This equates to £40,000 per pub in their estate. JUST TO REPAY INTEREST on the two pubcos' borrowings. ALL the other pubcos have gone down this route and are now ALL in DEEP doo doo with the financial crisis and people's drinking habits moving away from beer to other products, with pubs closing left right and centre because they cannot afford to keep on paying the sky high rents and beer prices as their income falls so does the income of the pubcos.

Is this a sustainable business model? NO. Pubcos are knackered.

Something like that.

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