An attempt by Birmingham pub group Mitchells & Butlers to take advantage of lower tax property rules is a test case for the sector, but the owner of the Harvester and All Bar One chains faces a huge challenge.
As an operator of only managed pubs – which are run by the business rather than leased to tenants – M&B must demerge into separate operating and property companies to meet the rules for conversion into a lower tax Real Estate Investment Trust (REIT).
A REIT’s properties must be for rental, not owner occupied, and 75 per cent of its profits must come from rental income.
“This is the major problem for the managed pub groups, all of which own and occupy the premises,” said Lehman Brothers analyst Julian Easthope.
M&B is prepared to pursue that route “as soon as practicable”, but analysts say it would be impossible at present due to conditions in global debt markets, given that the company’s debt would need to be renegotiated. Converting to a REIT would appease 29 per cent shareholder Robert Tchenguiz who has consistently put pressure on M&B’s board to release value from its £5 billion property portfolio.
Mr Easthope estimates a REIT conversion would give the business a valuation of £1.12 billion or 277p per share, with the REIT being worth £502 million and the operating company £621 million. That compares with the current share price of 235.75p.
That is based upon the property company paying an interest rate of seven per cent on its £2.35 billion debt and the operating company having a price/earnings ratio of eight times – the same as Punch Taverns, Britain’s biggest pubs group. If, however, M&B were able to negotiate at its current rate of six per cent and the operating company were to trade at 10 times earnings, Mr Easthope estimates the business would be valued at £1.77 billion or 437p per share, with the REIT worth £997 million and the operating company valued at £777 million.
Analysts have given a mixed reaction to M&B’s plans with some expressing fears that the operating company would be left crippled by forced rental increases in what is already a highly competitive market affected by a slowdown in consumer spending.
Douglas Jack of Panmure was highly critical of the plans, saying a REIT structure could “destroy value” for shareholders. He estimates M&B would achieve a tax saving of only £21 million a year, against an initial cost of £200-225 million for the restructuring required. Mr Jack described this as “a dire return for a structure that could severely impair the business model.”
However, Mark Brumby of Oriel Securities reckons a conversion would be “not necessarily a bad thing.”
“The starting rent for the opco, the principle of capping rent rises and retaining some flexibility as to the treatment of assets and the price and availability of debt remain crucial,” he said.
If M&B were to be successful in using the ‘opco/propco’ structure to convert to REIT status, other operators such as JD Wetherspoon, Greene King and Wolverhampton’s Marston’s, which have previously ruled out such a move, would come under pressure from shareholders to follow suit. M&B’s last attempt at working with Mr Tchenguiz ended in failure as it lost £391 million on hedging arrangements put in place over a property deal that collapsed when banks pulled out of loan arrangements.