Tuesday, October 15, 2013

The Great British Pubco Scam

From Hansard 14.10.2013

Pub Company Business Models

Motion made, and Question proposed, That this House do now adjourn.—(John Penrose.)
10.5 pm

Greg Mulholland (Leeds North West) (LD): Before I start, I want to say that I will take interventions only from Members who have told me that they want to intervene, one of whom is the hon. Member for Easington (Grahame M. Morris), the vice-chair of the all-party save the pub group. Moreover, given that the Secretary of State will be able to say very little in response to the debate because of the current stage of the consultation, I have been told that I can speak for 23 minutes, so I will try to conclude at 10.29 pm.

We have all heard about, and many MPs have experienced first hand, the effects of the leased pub company model and how it has destroyed pub businesses, families and lives, but tonight it is the cold, brutal, harsh economic reality of this model that I am going to expose. I will also expose how not taking the right action now would be a disaster not only for many pubco publicans and the communities that stand to lose their local pubs, but for the recovering UK economy.

Perhaps a better title for my speech would be, “The Great British Pubco Scam”, for this whole sorry saga is a tale of one of the worst examples of reckless, irresponsible capitalism this country has ever seen—a get-rich-quick scheme for a greedy few that has marred lives and closed thousands of pubs and that has caused losses of billions for the UK economy, pension funds and the Treasury.

Turning to the history, the large, leased pubcos are not pub companies in any real sense. They are highly leveraged property companies whose business model is based on charging unreasonably high rents and outrageously high prices for beer to their tenants. This goes back to the beer orders. Prior to 1989, most pubs were tied to the large brewers. It was believed, rightly, that this led to a substantial restriction in the choice of products available to consumers, so the beer orders restricted to 2,000 the number of pubs that could be owned by and tied to a brewer.

The beer orders, however, failed in one spectacular way, which the Campaign for Real Ale and others spotted: they clearly should have prevented any company, not just breweries, from owning and supply-tying more than 2,000 pubs. That was the tragedy and disaster of the beer orders.

A loophole was exploited by many and the anomaly was quickly spotted by bankers, speculators and financial engineers such as Hugh Osmond, Roger Myers and Guy Hands. The result was the formation of a number of so-called pub companies, such as Punch Taverns, Enterprise Inns, Unique Pub Company and Admiral Taverns. Those at the helm had little if any connection to the sector and very little empathy with it. Everyone wanted a piece of the action, and they all piled in to make money, with little interest in the pubs, the people who ran them, the communities that used them or the wider economic impact.

Aided by investment bankers, pub company bosses produced financial models and projections that assumed practically perpetual growth in the rents and beer prices

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that they could charge their captive market of tied licensees, who would be unable to resist such aggressive pricing strategies. Through securitisation and more conventional debt, large sums of money were raised to acquire a large number of pubs from brewers who were obliged to dispose of them and, after that, from other pub companies.

Seeing that they were on to a good thing, the pubcos, led by Punch, went on an acquisition spree, buying up pubs for more than their actual value, simply to inflate their share value artificially. In valuation terms, the same yield or multiple was applied to inflate portfolio values, with hypothetical wet rents being used, rather than actual numbers. To maintain the wet rent at as high a level as possible, beer prices have been increased year on year, substantially above the rate of inflation. So as to inflate artificially the pub and estate values, and then to borrow vast sums against that imaginary valuation, the companies were adding to the dry rents the profits achieved by wholesaling beer to create an overall rent. That led to the values being falsely inflated.

During the period of growth, Punch Taverns and Enterprise Inns found themselves in the FTSE 100 as their share prices peaked. However, it was not to last for long. From 2007, with the credit boom in fever pitch, retail investors kept piling in. Even though a prudent chief executive officer must surely have seen the writing on the wall, Ted Tuppen at Enterprise Inns was handing himself dividends and using company funds to buy back shares, including his own, at a rather fuller price. A quick look at the share prices of Enterprise and Punch, and to some extent even Greene King and Marston’s leased operations, reveals the profile of a classic pump-and-dump operation, with a huge surge like a giant heartbeat, then failure and the resultant flat line.

With positive broker comments and heavy financial public relations, the insiders exited and the gullible lost money. Pension funds, choosing to believe the hype from the companies and the endless positive messages of house brokers, stayed in and lost fortunes for pensioners. Naive retail investors did the same. The winners were the insiders and the directors; the losers were the publicans, their communities and the pensioners whose funds unwisely left money in the pubcos.

Grahame M. Morris (Easington) (Lab): I pay tribute to the excellent work that the hon. Gentleman, who is my hon. Friend in this matter, has done with the all-party save the pub group. I associate myself and the Labour party—not only the Back Benches, but the Front Bench—with the excellent case that he is putting forward on the completely unsustainable nature of the pubco model, which exposes licensees to the double whammy of inflated pub prices and excessive rents.

Greg Mulholland: I thank the hon. Gentleman and hon. Members from all parts of the House who have seen this practice for what it is and supported the response to it.

Favoured funds were the providers of much of the debt funding. At the peak of the madness, as much as £600 million a year was being removed from UK pubs and paid, much of it overseas, to hedge funds in the US and other debt providers. I wonder whether the Secretary of State and his officials were aware of that.

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Famously, Larry Robbins of the $7-billion fund Glenview Capital Management described Punch Taverns’ hapless tenants as the source of ever more money for Punch and his fund. David Einhorn, the wealthy manager of Greenlight Capital in New York, was also a heavy investor in pubcos. Following a taped conversation between him, a broker and Punch Taverns’ CEO, Giles Thorley, it became apparent that his track was a little too inside and he was fined £7.2 million by the Financial Services Authority. I wonder whether the Secretary of State knew about that.

When someone has seen the writing on the wall and wants to get out with their bag of swag, what do they do? They find somebody else to hand it on to. Giles Thorley was the perfect foil for Guy Hands, who seduced him into running Unique Pub Company just as it was being sold to Enterprise. Hugh Osmond, also by now looking for the exit door, poached Thorley to Punch Taverns. As the share price was pumped in 2010, Giles Thorley, clearly seeing the writing on the wall, sold out and made his fortune, albeit a smaller one than those of his mentors. Mr Tuppen at Enterprise, with a lacklustre career prior to forming his pubco, could not believe his luck as he was courted by the City with seemingly unlimited money to buy more and more pubs.

With the securitised money washing through the pubcos, all that was left was a largely debt-ridden sector paying interest rates of up to 8.5% on billions of pounds. As we all know, the money was to be made by squeezing the life out of hard-pressed tied tenants, sucking others into the scam and then, when all else failed, closing and selling off run-down pubs for alternative use.

A key part of the scam was mis-selling, which the other vice-chair of the all-party save the pub group, my hon. Friend the Member for Northampton South (Mr Binley), has previously raised. Enterprise Inns, for example, conducted an in-house study of sales, profits and costs in a sample of its estate, and despite establishing a much higher level of costs from that quoted to tenants, it maintained utterly unrealistic low levels of business overheads that barely allowed for repair and maintenance, let alone staffing, training and business promotion. As we know, many tenants took on unsustainable businesses, losing their entire life savings before inevitable business failure. The situation was akin to loan sharks, with the misleading presentation of the proposition, attractive terms of entry and often initial discounts, but without the cold, hard, unsustainable reality and the wholly unrealistic future that went with signing up being spelled out.

Then there was the role of valuers. It is odd that Humberts was the chosen valuer of both large pub companies, Punch and Enterprise. It also helps them to have their own man inside the Royal Institution of Chartered Surveyors writing the valuation guidelines for the properties in their sector so that they can be applied in their favour. Yes, it is Enterprise Inns’ very own national rent controller, Rob May, who has been overseeing the process since 2005. At one time he was the chairman of the valuation party. Despite the obvious conflict of interest, the interpretation of the new guidance is still controlled by the group that Mr May participates in. Select Committees and the Government have identified that there was confusion in the interpretation and application of the new RICS guidance, and despite requests even from the Department for Business, Innovation

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and Skills, RICS has simply referred the matter to Mr May’s group. Did the Secretary of State and his officials know that?

Then there was another wheeze, involving rating. Knowing that most tied pubs turn over little money, would it not be advantageous for the pubcos to have a system of rating where all the usual rules were ignored in favour of a special scheme whereby the rates paid by a company’s tenants were artificially lowered using a scale based on turnover rather than the usual method of looking at rent? Of course, if the company’s tenants are paying lower rates, it can increase the rental burden at rent reviews and, of course, increase the capital value of its pub estate. Just £5,000 per annum per pub amounts to £25 million per annum across 5,000 pubs, and the capital value increases by up to £300 million all of a sudden. That was all helped, unwittingly, by the taxpayer. Did the Secretary of State and his officials know that?

Then there was the issue of full repairing and insuring leases. Suddenly, the company that owned a building did not have to pay anything for maintenance, inside or out—it was like a tenant renting a house or flat and then having to maintain the entire property. Of course, the pubco was heavily protected to ensure that it had as good an investment as possible by passing on as many costs as possible to the tenant.

The key to the scam, of course, is double-overcharging. The pubcos derive two rents. The dry rent is the fixed income for the property, the wet rent the large profit derived from selling beer to the tenant at inflated prices. In the recent Association of Licensed Multiple Retailers survey, we see that far from being lower than open-market free-of-tie rents, the dry rents alone that pubcos charge are higher. That is a de facto abuse of the tie. Worse than that, in a tied pub, with wet rent added to dry, rather than the usual rent of 10% of turnover, the aggregate rent is fast approaching 20% of sales, hence the incredibly derisory income derived by many tenants.

Perhaps the most suspicious part is the so-called wholesale price of beer—an artificial instrument maintained to ensure that excessive profits, over and above those that can be gained in the open market, are available to companies that own pubs. No one in the free trade pays the full wholesale price, or anyway near that amount, for any beer, and only unfortunate tied publicans are subjected to that excessive pricing. Far from being a discount, in reality tied tenants are paying more than any right hon. and hon. Member would by going to their local brewery.

To give one stark example, in six years an 11-gallon keg of Foster’s from Enterprise has gone up from £107, excluding VAT, to £151—an increase of £44. Data from wholesalers show that in the free trade that keg cost £77 six years ago and £87 today—an increase of £10. The same duty rates, and the same increased manufacturing costs and overheads apply, yet the price increase to a tied tenant has been nearly four and a half times that of a free-of-tie publican over six years for the same product. If that is not a manipulation of pricing, I do not know what is.

We then come to the enforcers—Brulines, or Vianet as it was recently rebranded, knowing its already damaged reputation. It is pertinent to note that the company was started by Derrick Collin, who was convicted for blackmail and conspiracy in 1986. He devised the flow monitoring technology that was to become Brulines. It is a rudimentary

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system, but instead of being used simply to check flow as a helpful tool, it is used, through intimidation, to threaten tenants and provide calculations for “buying-out fines.” It has not been tested in situ by any formal agency, and is shown to be highly inaccurate in several reports by experts, including one from a trading standards officer. It could be considered to be in use in trade, but at the moment it is not regulated under the Weights and Measures Act 1986. It has no CE mark, no other certification, and the lease documentation signed by lessees means that if they are threatened by such fines, they risk legal costs of their own to defend those charges. To be clear, no independent expert evidence as to the accuracy of the system has yet been heard in court, and I ask the Secretary of State to look at the issue again.

The situation is clearly a disaster for tied publicans, but also for the UK economy. Look at the collapse of share prices: 95%, 98%—perhaps only an 80% collapse from Enterprise. Punch Taverns and Enterprise Inns have arguably been in a form of passive administration for several years. They are zombie companies that do not pay dividends, and they have no growth plan or export potential. They just about pay the cost of their debt by selling off their assets. That asset stripping is happening now—slash and burn. Enterprise Inns and Punch Taverns, the two largest pubcos, collectively disposed of more than 5,000 pubs between 2008 and 2012—one third of all of their pubs. No other part of the sector has experienced anything like that level of disposal and failure.

A common technique used to generate even more profit is the use of “churn”, which involves forcing the failure of tenants over time and replacing them periodically. That enables the pub company to retain rent deposits, pursue personal guarantees, take new deposits and ingoing costs, and perhaps charge a higher rent over time to the new tenant. Data leaked from Punch in 2009 and released to the media showed that the pub company “churns” as much as 25% of its entire estate in any one year, and that average individual tenants might be expected to last no longer than three years in their pub. Enterprise Inns’ 2013 interim results reveal that of its 5,720 pub tenants, 1,463—more than 25%—have been in occupation for less than a year.

Such a situation is also bad for the taxpayer. The taxpayer-owned Lloyds bank had to write off some £600 million when Admiral Taverns went into administration in 2010. Similarly, Royal Bank of Scotland acquired just over 1,000 pubs in 1999 and sold them at a loss to Heineken—effectively the same people from whom it had bought them—in 2011.

The situation is clearly bad for the economy, but is it bad for everyone? The obvious and sad answer is no. Despite the share prices tumbling, pubco bosses still managed to find the resources to pay themselves astonishing returns. Last year Ted Tuppen of Enterprise Inns received a basic salary of £640,000, as well as a bonus of £329,000 and pension contributions of £160,000, resulting in his taking home more than £1 million. This is clear and grotesque reward for failure—something that my right hon. Friend said he would stamp down on.

There is some very worrying lobbying going on. There is baseless, hysterical and thoroughly dishonest scaremongering to try to persuade my right hon. Friend

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and the Under-Secretary of State for Business, Innovation and Skills, my hon. Friend the Member for East Dunbartonshire (Jo Swinson), and also the officials. Much of that, I am glad to say, has been dealt with through the Fair Deal For Your Local “Setting the Record Straight” report. I gently remind the House that in its report of 2008-09 the Business, Innovation and Skills Committee commented about pub company bosses that

“in evidence to us both Mr Thorley of Punch and Mr Tuppen and Mr Townsend of Enterprise Inns made assertions which, on investigation, proved to give a partial picture, or on one occasion were positively false.”

Even this year we have had the chief executive of the so-called British Beer and Pub Association—in truth, the big brewers and pubcos association—making two factually incorrect statements when appearing before the Committee on 11 June, and then saying on “Sunday Politics South East” on 9 June that the Government had their own figures on pub closures, which they clearly do not.

The solution is clear and it is what people are afraid of. The solution suggested by the Select Committee is for tenants and lessees of the large companies—I stress that this applies only to large companies; it would not apply to family brewers—to have the option to pay an independently assessed market rent only. That is the only way to stop the endemic overcharging. I was delighted and the House was delighted, having made clear its views in a unanimous motion, that the Secretary of State made clear the Government commitment when he said in a letter to the Chair of the Select Committee in January that

“the Government's proposals would address abuses of the tie, through enshrining the principle that ‘a tied licensee should be no worse off than a free of tie licensee’ in the Code”.

The only way to do that is the Select Committee solution—the market rent-only option, also known as the free-of-tie option with open market rent review. There is a positive future with that—increased certainty and confidence for brewers, more jobs and investment in brewers, good news for smaller brewers, who would have greater access to market, and good news for consumers, who would see a greater choice of beer and a cheaper pint in pubcos. I ask my right hon. Friend to look out for the new research coming from the Federation of Small Businesses tomorrow, and I ask him to sit down with his officials and look at that before he makes any final decisions.

The market rent only option would save pubs because it would stop the kind of asset stripping that is going on around the country. The provisions of tied leases and tenancies enable pubcos and others to circumvent the Landlord and Tenant Act 1954 security of tenure protection. When sites are very valuable for development, pub companies are changing terms and applying pressure to drive tenants out. I can show my right hon. Friend cases—there are some close to him—where that is clearly happening.

In conclusion, pubs will continue to be viable businesses, despite changing times, but they will no longer be a guaranteed source of over-rentalisation for property companies, whether they brew or not. That model is gone. It is nearly dead, but without the market rent only option it will take down thousands more pubs in its death throes. The great British pubco scam has done

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huge damage to pubs and the UK economy, but as long as the overcharging is allowed to continue, this will happen. I gently point my right hon. Friend, for whom I have great respect, in the direction of his 2010 speech about “spivs and gamblers” and the reckless behaviour that brought the UK banking sector to its knees. Having heard what I have reported tonight, can anyone think that that is not a perfect description of what has happened in this sector?

There is clear support for reform in the House, as 81 coalition MPs have signed the early-day motion or expressed their support for the Fair Deal For Your Local campaign, which is calling for a market rent-only option. My right hon. Friend can be clear that we can and would win a vote in this House. The hon. Member for Chesterfield (Toby Perkins) has indicated that it would be assured of the support of the Opposition and we would also have the support of the hon. Member for Brighton, Pavilion (Caroline Lucas), who represents the Green party.

In 1969, a Monopolies Commission report recommended the market rent-only option. It was needed then and it is certainly needed now. I believe that my right hon. Friend can and will be the person who has the courage finally to do it. The choice for him and the Government is stark, although they could ignore the campaign, not introduce a market rent-only option, let things continue and be blamed for the continual asset-stripping of pubs and the destruction of other small businesses. We need action now not just to assist thousands of publicans and save pubs but to provide a boost to local economies and to the UK economy.

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