UK: A BITTER BATTLE BREWING. - The legislation which forced the big brewers to cut back their tied estates way only a distraction from the core problems facing the industry: too few customers and too little attention to the harsh laws of retailing.

by Chris Blackhurst.
Last Updated: 31 Aug 2010

The legislation which forced the big brewers to cut back their tied estates way only a distraction from the core problems facing the industry: too few customers and too little attention to the harsh laws of retailing.

By now, Century Inns should have been home and dry. The operator of 300-plus tenanted pubs in north-east England was hoping, by floating on the stock market, to raise £30 million to cut debts and improve its pubs.

Instead, the day before the flotation, the Office of Fair Trading (OFT) announced an inquiry into the wholesale beer trade, and Century's potential pay day was postponed. Alistair Arkley, Century's chief executive, has reason to feel aggrieved: "It's not many companies that get a government release a day before flotation." In truth as he well knows, it was never going to be easy. The signs had not been encouraging. "Maybe we were not going to get what we wanted," he acknowledges.

If Century had gone to the City, it would have been disappointed - the combined share placing and offer would have got away but demand would have been slack. As it was, Century's became the third beer flotation to be pulled in little over three months: Ushers' was scrapped last December after being promised only three-quarters of the funds it wanted; and last October, Lazards removed its Brewers Investment Trust, formed to invest in quoted regional brewers.

Not that there was much wrong with Century. It is generally agreed that it is one of the best-run tenanted pub companies, a breed of many which, like the managed pub company, sprang up after the 1989 Beer Orders. Tenanted pub companies receive income from rents, discounts from the brewers (which are not normally passed onto the tenant unless sales targets are met, and then only in part), and AWPs - amusements with prizes, better known as fruit machines. In contrast, managed pub companies receive all profits and pay pub managers and staff a salary.

The trouble is that the City has lost faith in the new tenanted pubco, as they are known. Sadly, for Century, its rivals and the rest of the beer industry, for once, the City is right. Century may be one of the best but it was still heading for a prospective price earnings ratio of around 11 - not enough to whet potential investors' appetites. "If that is the best, how the hell are the others doing?" inquires a corporate financier, sceptically. The answer, in short, is not very well.

Take four tenanted pubcos, from a list of over 20. Sycamore Taverns was set up in 1992, paying £35.9 million for 308 pubs from Allied Breweries. Last year, it lost £1.1 million; its debts are £34 million. In July last year, Sycamore pushed back the payment of capital to its lead banks from five to seven years.

Cafe Inns was formed eight years ago and in 1992 paid £4 million for 28 pubs from Bass and Whitbread. Latest available figures show a loss before tax of £323,000 to the end of February 1994. Cafe's borrowings, typical of the industry, are high, giving it 146% gearing (Century's flotation would have cut its gearing from 150 to 40%).

Marr Taverns began trading in August 1992 with 26 ex-Whitbread houses transferred from its holding company, Marr Holdings, and 170 purchased from Bass for £26.7 million. The company made a profit of £1.1 million last year but is heavily indebted.

Discovery started life in 1992 and bought 223 pubs from Whitbread for £25 million. Financed half by debt, half by equity, the company made an operating profit of £1.77 million in 1993, of which £1.19 million was consumed in interest to banks.

These are four companies taken at random, none of them in great shape, all heavily borrowed, and all facing an uncertain future. Multiply that across the industry and a frightening certainty takes hold: beer retailing is an industry in poor health. These are nail-biting times for those tens of venture capitalists who have ploughed in hundreds of millions of pounds over the last few years. In one year alone - 1992 - such was the craze to get into pubs that one tenth of all the companies started by management buy-outs or buy-ins were in beer retailing. Suddenly, everyone it seemed wanted to run a chain of pubs - and people were happy to back them. Sadly, as they are discovering, Sid Perks in The Bull at Ambridge and Bet Lynch at the Rover's Return in Coronation Street, with nothing but the love lives of their regulars to worry about, are divorced from reality. Their real-life equivalents have plenty on their minds, most of its deeply perturbing.

It is no coincidence that 1992 was the year of lift-off for the new tenanted pubcos. That was the year that Beer Orders came into effect, the time - following the Monopolies Commission report, The Supply of Beer in 1989 - by which the major brewers had to have scaled back their tied estates. The theory behind the report was sound enough. Pick an industry, any industry. The chances are that it won't be as vertically integrated as brewing, where the companies that make the stuff also control where you drink it and how much you pay. Even the food supermarkets do not have that degree of dominance.

Faced with that stranglehold, a Conservative government - even one that traditionally relied upon the beerage for support - decided to act. Brewers were forced to limit the number of tied houses they owned and required to put guest beers on sale in their pubs.

About £2.5 billion-worth of businesses were bought and sold as brewers responded in different ways to the Beer Orders. Some brewers, notably Boddingtons and Greenall's, stopped making beer altogether, to concentrate on developing pubs. Ruddles, Theakstons and Devenish all found themselves with new owners. The major brewers, Grand Metropolitan, Bass, Whitbread and Courage, were all obliged to rethink their business. For most of them, that involved a wholesale reduction in their pub chains. Their loss meant someone else's gain, as the new tenanted pubcos sprang from nowhere. Today, 20% of pubs are controlled by this new breed of landlord. The Government should be congratulated.

Rubbish, say the big brewers. "The Orders meant that a change which would have evolved naturally has been crammed into a short space of time. Consequently, a lot of people have been hurt. We were forced to give notice to quit to 2,000 employees in 1990; in the whole of the previous years there was perhaps one notice per year," said Peter Jarvis, chief executive of Whitbread, who led the brewers' opposition to the Orders. "There have been some benefits, like the new entrants into the business and some more variety, but I think the industry was moving in that direction anyway. It has cost the industry perhaps £500 million in write-offs and provisions and has not had the desired effect. Overall, it has been a great distraction."

Philip Bowman, head of Bass Taverns, agrees. "We spent two years grappling with the Beer Orders rather than driving the business forward and meeting the expectations of our customers."

The best thing that could have happened after 1989, say some dispassionate observers, would have been for the major brewers to absorb the strictures about selling guest beers, to free up their ties and, instead of selling their surplus estates to a new operator, to have closed them. In that way, at a stroke, the oversupply which was gripping the industry could have been dealt with. But that didn't happen: the pubs we sold to companies who took on high levels of debt to enter an industry that was, and remains, oversupplied.

From 1975 to 1992, over 10,000 new pubs opened in Britain, taking the total to 83,300. That trend, though, has not been matched by corresponding increases in alcohol consumption in pubs or pub visits: alcohol now accounts for 6.4% of total consumer expenditure, as opposed to 7.5% in 1975; 12% of adults were teetotal in 1979, today the figure is nearer 20%; in the key, big-spending 18-24 age group, the non-drinking proportion was 7% in 1980 and is 12% today - and rising; pub visits by 16-24 year olds have declined by 11% in the last six years alone, caused by a drop in the numbers in that age group and the surge in alternative leisure activities, such as keeping fit, clubbing, and the cinema (young people no longer go to the pub for the evening and stay there). Pubs may have grown in number but their increase is nothing compared with off-licences, which have soared 43% since 1975.

In the main, there is nothing wrong with the new pubs; they are brighter and better located than their older counterparts. The problem is the small, grotty pubs which sell only a few barrels a week. While brewers opened new pubs, they did not close the old ones. As a result, the pub market has 10,000 pubs too many. The brewers' response to the Beer Orders should have been to close their surplus pubs - but they didn't. Faced with a remit to shed pubs, they sold them. "It is not perhaps a coincidence that 10,000 is very close to the Number of pubs sold by the major brewers and mostly bought by the new pub retailers," says Phillip Robinson, brewing analyst at James Capel. It could be argued that the long-term rationalisation needs of the pub industry have been delayed (not removed) by the introduction of this fresh capital.

At Bass, Bowman admits to having been taken by surprise. "I thought more pubs might be sold to individuals than was the case. In practice, all the purchasers haven been pubcos. Their emergence in the early '90s was a phenomenon driven by the Beer Orders."

One plus for the artificially created new pubcos is that their arrival coincided with a massive over production of beer. Brewers have been offering enormous discounts to persuade their non-tied houses to take their beer. This, in essence, is what lies at the heart of the recent OFT inquiry, the announcement of which killed the Century flotation. For a barrel costing £200 to a tied house, free houses can get away with paying £120.

The discount and the availability of pubs should be a godsend to any would be operator. "It's a heaven-sent opportunity," says David Bruce, founder of the Firkin chain and now a director of Grosvenor Inns, which owns the Slug & Lettuce, Hedgehog & Hogshead and Belcher's chains. Grosvenor, though, is a comparative rarity: it is a new pub company that is actually doing well: profits up from £764,000 to £854,000; gearing down from 32% to 23%. Three others - almost the only three - are Tom Cobleigh, Regent and J D Wetherspoon. The secret? Buy small, offer good food, real ales, show some wit and style. And where you can, choose your own sites and manage them yourself - thereby keeping the quality high and taking in all the profits.

Sheila McKenzie, who runs the 13-strong Slug & Lettuce chain for Grosvenor, says: "We want to create a place where people can go for some food, that feels contemporary and appeals to women." Put simply, she says, a small chain like hers "can do it better than the big brewers".

Realising the big brewers were unlikely to sell off their best sites, rather than accept second best, Grosvenor took a conscious decision to develop its own. Nor does the company employ uniform pub architects - every establishment is different and plays to its strengths. "Companies like GrandMet send the design department in to make it look like someone's front room," says McKenzie. "By the time they have finished it does not look like anybody's front room."

To show how it can be done she points to the Slug & Lettuce at Richmond Upon Thames. Bought for £320,000 from Whitbread - one of the few the company bought as a pub - and costing £280,000 to refurbish, its weekly turnover is now 10 times Whitbread's best week.

One venture capitalist who has made a study of the market for would-be entrants says the contrast between the focused, managed pub operators with good retail skills, able to offer added-value, and the tenanted operators who bought a lot of pubs lock, stock and barrel from a big brewer, is stark. "If you're a managed pubco and focused, you can make a lot of money ..." his voice trails off, leaving the fate of the more common, tenanted variety best left unsaid.

Bruce still cannot believe how slow the big brewers and some tenanted pubcos have been to wake up. "We've got pubs with £1 million a year turnover surrounded by others not offering people what they want. People are more selective - that's why mediocre non-branded pubs will suffer."

He is fortunate: Grosvenor has been able to cherry pick what it wants. The tied operators have not been so lucky. Having bought, in some cases, hundreds of pubs in one fell swoop, they are discovering for themselves an unpalatable truth: the ones at the bottom do not pay. If you take 200 tenancies, the chances are that 20% are going to find it pretty tough and will barely be profitable. They are being subsidised by the rest, says a banker who specialises in beer retailing.

Logic would suggest that the poor performers should be closed, but life in beer retailing is not that simple. If they shut them, they lose the rent and the tenancy forever. If they replace the existing tenant, they must find a replacement, and specialist management companies are currently charging £10,000 to £15,000 for that service. "What sort of people are they going to get?" asks the banker. "They will not find Alan Sugars working down there. So they are stuck." It would be much better, he says, if they bit the bullet now and put them out of their misery by closing them.

None of the tenanted pubcos' three main sources of income (rent from tied pubs; discounts from the brewers; and fruit machines) are looking too healthy. Rents, given the oversupply of pubs and slump in property values, are not likely to harden. People are drinking less beer and discounts on barrels are probably at their peak - some brewers are thought to be selling at cost to some of the more go-ahead operators just to get their beers in the pubs - and may come down, following the OFT inquiry. Moreover food is always a 100% earner for the tenant. There is always a source of conflict between the tenants who want to sell more food and the pub company that wants them to sell more beer. AWPs are a steady but not increasing income stream. In the words of the venture capitalist, "it all looks pretty fragile".

Backers of the tenanted pubcos have been faced with four choices: merge the company with another, to break costs out and gain some economies of scale; sell the company, as in the case of Centric, formed in 1992 and sold to Gibbs Mew in July last year; go for growth by buying more pubs; or float on the stock market.

As the latter is out - following the Century postponement and the City's probable lacklustre response - the pubcos have got to look to themselves to merge, sell or acquire. For many, to date, that has been an unappealing prospect.

"It is easy to knock the Government but this mess was not its fault," says a senor industry executive. "It created a situation which is better than it was, which meant that people like Bass could not own half the outlets, but the future looks bleak." The brewers who sold pubs in exchange for pubco shares are in no worse position than when they started. But the brewers who loaned money to the pubcos cannot expect to have it repaid until the company does something radical.

A head of steam is growing for a major restructuring, for the industry to finally rid itself of the dross, tend the problems of oversupply of pubs and overproduction of beer. That, though, would require tough decision-making - which, traditionally, has not been the industry's strong point.

One company that took such a step - and never looked back - is Greenall's. In 1990, Andrew Thomas, the Warrington-based brewer's chairman and chief executive, and Peter Greenall, its managing director, ditched 230 years of history and stopped brewing to concentrate on running pubs. So incensed was the Whitley family, partners in the Greenall Whitley firm, that they sold their shares. Seven hundred jobs in Warrington and Nottingham were lost. Feelings were running so high that Greenall even considered moving his family from Warrington.

Five years later, the courage of Thomas and Greenall is fully vindicated. From a large, regional brewer without a strong brand and 1,500 mediocre pubs mainly in the North-West, caught in a no-man's land between local and major player, Greenall's has become a focused, national group. In 1993, it paid £250 million for Devenish, taking its pub estate to 2,000. While the brewers it left behind saw their profits remain flat, Greenall's rose by 30% to £88 million. The group is on course to break the £100-million barrier and, with one or two further acquistions, to become Britain's first national beer retailer. Brewing is already a distant memory and they have not suffered at all - in fact, they have gained by picking up the discount from other brewers. "The paradox is, by not brewing, we have added to our flexibility of price and range," says Thomas. As for Greenall's own brand, it is brewed and supplied to Greenall's pubs by Tetley, based in Warrington. "We've got rid of a mind-set; now we can think about the retail customer, what he or she wants, what our target market is," says Greenall. "It's not just a question of focusing our money - but management as well. We've been able to concentrate on the food market where growth is well ahead."

Only now are other brewers waking up to what Greenall's has done. As a brewer, says Greenall, all that counted was turnover. The level of comfort in pubs was almost secondary. Serving beer is so much cheaper than supplying food, so "it was always game, set and match to beer". Food was nowhere. Greenall's has been ideally placed to cash in on the switch from beer to food - these days it is food that brings the drinkers in, not vice versa. Unlike the new pubcos, Greenall's has barely any debt to carry; it took some bold moves and is reaping the reward. It becomes obvious listening to them that more companies should follow suit. But, said Greenall, they will not: "There is a lot of emotion in the way people relate to their product."

Tony Portno, head of Bass brewing side, can foresee "pure rationalisation" dictating that other smaller brewers stop brewing to concentrate on pubs. "But tradition means they will carry on brewing even though their optimum move is to stop." His colleague, Bowman, agrees: "It is a significant, emotional move to withdraw from brewing - so far only Greenall's and Boddingtons have done it."

Such is the overcapacity in beer, that they may have to play some bold strokes. If only some of their customers, the new tied pubcos, who do not have any emotional ties, could also be persuaded.


Beer Cider Wines Spirits Total

1975 4.04 0.10 1.16 2.03 7.43

1080 3.81 0.17 1.20 1.95 7.13

1985 3.35 0.25 1.31 1.75 7.15

1990 3.35 0.24 1.18 1.43 6.20

1992 3.44 0.31 1.25 1.38 6.38

Source: CSO.


On-licences Off-licences

Full Restricted Licensed Registered Total

Clubs Clubs

1975 73.7 15.8 1.8 27.7 36.2

1980 76.4 22.0 3.1 30.1 42.4

1985 79.8 27.1 3.6 30.7 47.9

1992 83.3 31.9 3.8 29.5 51.9

Sources: Home Office (NTC Publications), Scottish Home Office and the Northern Ireland Department of Health and Social Services.

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