Pub Companies - Business and Enterprise Committee Contents

Memorandum submitted by Brian Jacobs

  Further to my original submission to the Trade & Industry Select Committee in 2003-04 there has been no improvement in the financial relationship between Pubcos and Tenants and in fact that submission could be reissued today virtually without amendment. The recommendations of the Trade & Industry Committee fully satisfied the requests for improvements contained in the submissions, with the exception that it was envisaged that the supply tie should be removed because of the intransigence and disingenuous practices of the Pubcos.

  Although the Business & Enterprise Committee has tabled specific questions the prime core issue is that the tied tenant should not be financially worse off than if they were free of tie. Adoption of this principle would allow tests to develop and exist that would go towards ensuring that the tenant has a liveable income and the consumer a fair price. Consider the following.

  1.1  The Pubcos having paid excessively for their acquisitions, or overvalued their pub estate, all with a view to maximising their borrowing placed themselves in a position which does not allow them the financial flexibility to observe the Trade & Industry Committee recommendations; this is probably the driving reason for their subversion.

  1.2  Although implanting statutory remedies today to support the Trade & Industry Committee recommendations may seem to be a solution it has to be recognised that the Pubcos have squandered four years when they could have put their house in order but refused to do so.

  1.3  The four years of avoidance and pure bloody-mindedness by the Pubcos has had a dramatic and disastrous impact on the Pub trade. The impact of some of these issues are examined in greater detail below.

  1.4  Enforcement of Recommendations 144 and 145 coupled with the removal of all supply ties including machines, and the total removal of all Upward only rent reviews is the only practical remedial step which requires the least statutory requirement.

  1.5  The effect on trade of 2.4 above would be to remove the anti-tenant and anti- consumer effects created by the Pubcos. Whole detail would permeate through the rent construction and the tenant structure and thus create transparency.

  1.6  The BESC should not be deflected, by concerning themselves about the possible financial impact on Pubcos, from securing the core issue which would protect the existence of the British pub, the tenants and the consumer from the existing malpractice.


  2.1  Tenants pay excessive prices for the beers, and in some cases for wines and spirits as well.

  2.2  The rent, relative to real profitability, is excessive due to the fact that Pubcos consider that the principle of competent tenant should in fact be interpreted as a tenant who is exceptional and capable of turning back the tide of history to perform at a substantially higher level of profitability. This has been achieved by Pubcos overestimating turnover and gross profits, underestimating operating costs and more importantly ignoring and excluding the available open market discounts, denied to tenants, as well as the failure to account for their hidden share of income extracted from the AWP machines.

  2.3  Currently the tenant of a tied pub is substantially financially worse off than if they were free of tie primarily by due to the failure to properly account for open market discounts denied to the tenant. This unacceptable practice has been perpetuated by RICS and embraced by Valuers and Arbitrators. In Dodds v West Register (Public Houses III) Ltd. Cite: [2008] All ER (D) 246 (May) Court: Chancery Division] the High Court has recognised the total failure of an arbitrator to take account of discounts and the importance of making a proper adjustment. The Judge concluded:

    ||. the absence of the claimant's "open market discounts" amounted to a serious irregularity pursuant to section 68(2)(d) of the Act, resulting in substantial injustice to the claimant, which had arisen as a result of the arbitrator's failure to address that entry in the claimant's trading accounts.

  2.4  The Pubcos control the usage of AWP operators, take a royalty per machine from those operators and also take a share of the AWP when it is emptied. The Pubcos fail to account for that share when calculating the rent. The T&ISC recommended:

    (i) 129.  The machine tie improves tenants' takings from amusement with prizes machines (AWP). However, as free of machine tie tenants retain 100% of these takings as income, while tied tenants by pubcos' own admission receive an average 50% of these takings, it appears from the information the pubcos themselves submitted that in many cases free of tie tenants make more money from their second tier machines than tied tenants do from their more up-to-date models. In our opinion, pubcos do not add sufficient extra value from their deals to justify their claims to 50% of the takings from AWP machines. We remain unconvinced that the benefits of the AWP machine tie outweigh the income tenants forgo and we recommend that the AWP machine tie be removed.

  3.5  Rents are RPI index linked, by the Pubcos, ensure that there is an annual interim increase in rent. RPI adjustment is Upward only. At current rates of RPI this represents a 20-25% increase in rent over five years. Most new leases issued by Pubcos contain this ongoing clause which is both unacceptable and does not reflect the Trade & Industry Committee recommendation:

    151. We commend Pubcos which have already removed upward only rent review (UORR) clauses from their agreements. We consider this best practice within the industry and we call upon those Pubcos which have not already done so to remove such clauses as soon as is practicable.

  3.6  The Pubcos not only ignore the Trade & Industry Committee recommendations 129, 133, 144, 145 and 151 they actively subvert the Trade & Industry Committee through adopting the BBPA Code of Conduct. By ignoring Recommendations 144 and 145 Pubcos avoid the detail of transparency which would reveal their disingenuous assessments. The Trade & Industry Committee recommended:

    144. The industry could and should establish clear guidelines for the valuation process. Where they do not already exist, new national guidance for rent calculation should be compiled, and disclosure rules clarified. The profit assessment method of calculating rent should be carried out in accordance with national accounting standards and with knowledge, prudence and due diligence.

    145. Pubcos should provide their tenants with a comprehensive breakdown of how their rent was calculated. This should reveal the whole detail of the profit assessment and how the specific requirements of the lease conditions had been interpreted by valuers. The profit assessment should form an addendum to leases, with any subsequent review, to ensure transparency.

  3.7  The BBPA primarily represent brewers and the property owning Pubcos and erroneously hold itself out to represent the tenants in their retail capacity. The fact is the leases only give Pubcos property and beer supply rights and deny the Pubcos the right to interfere with the retail activity. The BBPA therefore exceed their authority to be the spokesperson on retail issues affecting the 25,000 plus tied tenants. The revised Code of Conduct from the BBPA totally ignored all of the T&ISC recommendations.

  3.9  It is plausible that the BBPA, through its membership, ensure that Pubcos and Brewers act in a concerted manner. Do the beer prices increase in harmony? Do the discounts given to Pubcos increase when the wholesale price does? Both are contrary to the public interest. Superficial examination suggests that the answer to those two questions is|| Yes! These are the questions which the OFT has been asked to examine.

  3.10  The RICS Guide to Valuation of Rent and Capital Values for Pubs totally ignores all the recommendations of the T&ISC. This could arise because the Chairman of the Trade-Related Group is a full time employee of a Pubco and the majority of the other members are employees of firms engaged by the Pubcos in matters relating to rent appraisals and/or property valuations. The expression "Gamekeeper and Poacher" come to mind.

  3.11  The Trade & Industry Committee recommended that the OFT review their monitoring process. To the best of my knowledge they have not. The Trade & Industry Committee said:

    38. We disagree with the definition of the public house market which the OFT has adopted in the past. We recognise that the licensing regulations are due to change. However, we do not believe that these changes will alter the shape of the market itself. Nor are we certain about the speed with which the new licensing regulations will be implemented by the licensing authorities. It seems to us that there is time for the OFT to reconsider its previous definition so as to more accurately define the market in question and to establish mechanisms for monitoring it.

    (ii)   Furthermore the OFT have failed to report on the issues of distribution, a positive change could assist tenants if implemented.

    (iii)  71.  In the distribution market for beer there is the strong possibility of anti-competitive consequences. We would hope that the OFT's latest consideration of market concentration in this area will not be their last. The distribution market should be kept under close and regular scrutiny.


  4.1  All of the above have a serious impact on both the survival of the British Pub and the financial stability of Pubcos both through the Profit reported and the presentation of asset values on their Balance Sheet. The elements that affect these are:

  4.2  The wholesale profit extracted from the brewers is in the form of discounts. It is understood that supplying brewers have increased their wholesale price in order to increase the discount given to the Pubco. Greater discounts retained by the Pubcos serve the needs of the Pubcos but they are in fact detrimental to the consumer. This was reported to the Trade & Industry Committee by the small brewers but the practice almost certainly permeates through to the bigger brewers. Bigger slice for Pubcos, means smaller slice for tenants and higher price for consumers.

    52.  It was suggested to us that small brewers found it difficult to gain wholesale price "listings" for their products from Pubcos because small brewers' price differential, or discount, was considered too low by pubcos. 63 One small brewer told us when they tendered their product to a particular Pubco, the Pubco "had no interest in the price we would actually sell our beer to them for, or even what the price to the tenant would be. What they were interested in and were very interested in was DISCOUNT". Their tender was rejected due to the low discounts they were quoting. The small brewer re-tendered the following year quoting a higher wholesale price: "our solution was simple for the following year—up went our list prices and up went our discount, the price we quoted was exactly the same but the Pubcos' slice goes up".

  4.3  The information regarding actual discounts that are available have not been released to over 98% of tenants as recommended by the T&ISC.

    125.  As with any commercial contract, we believe the actual details of Pubcos' contracts with individual brewers should remain confidential. However, we believe that Pubcos should advise their tenants of the average discount they receive, how this compares to the free market discounts available, and how much of this discount Pubcos are passing onto their tenants.

  4.4  Listing fees payable by suppliers continue and are not conducive to competition. As the Trade & Industry Committee reported:

    51.  SIBA told us Pubcos demanded fees for listing them on Pubcos' wholesale price lists. These were not "listing" fees in the normal meaning of the term but marketing fees to advertise the small brewers' brands which would be put into the marketplace. These could be a serious financial commitment for the small brewer which was paying these fees without any guarantee of the volume of its product it would sell. The expense could be prohibitive, with the result that small brewers could not compete with the national, or even regional, brewers. Small brewers would rather deal directly with local tenants "so when it comes down to marketing they have got the ability and the resources to pop down to their local pubs and go and talk to the licensees and do their marketing that way and also stand.

  4.5  The income from AWP machines in the form of both royalties from the suppliers and the unaccounted share of income when the machines are emptied continues. The T&ISC observed:

    132.  Pubcos' tenants, who are tied for AWP machines, pay higher rents for AWP machines than tenants who are not tied. This is due to Pubcos' practice of extracting royalty payments from AWP operators to become a Pubco's nominated supplier. We feel many tenants may not be aware of these arrangements. If the AWP machine tie is not to be removed quickly, there is no reason why pubcos could not immediately introduce more transparency about their contractual relationships with their nominated AWP operators.

  4.6  The effect of the above acts against the principle that "the tied tenant should not be in a worse financial position than if they were free of tie". This unsatisfactory situation has been perpetrated by Pubcos and endorsed, quite wrongly, by the BBPA and RICS.


  5.1  The Pubco profit is enhanced by the retention of income that should have been released for the benefit of the tenant. Their practice slowly starves the tenant of income and higher product prices create higher retail prices which in turn create consumer price resistance causing a further downward spiral of turnover and tenants profit.

  5.2  Pubco replacement of tenants have historically been filled from the fairly large pool of people who are of the opinion that running a pub sounds a good idea. Pubcos feed that belief. The Trade & Industry Committee recognised the issue when they stated:

    (iv)  158.  The Pubcos have argued that if tenants do not agree with their rent assessment, they should not have entered into the lease or accepted the rent review. We do not share this view. In the relationship between Pubco and tenant, the tenant is in the weaker bargaining position. Pubcos should recognise that they have a responsibility to ensure they do not exploit their position of economic strength. All tenants should be treated fairly and rents should be reasonable and sustainable.

  5.3  The development of a nationwide register, containing the full details of how the profit has been assembled and the rent assessed, would have created greater transparency for new and existing tenants. This has been resisted by Pubcos and RICS. Pubcos feed on obscuring facts. Should a register be developed the deception perpetuated by RICS suggest that it should not be trusted as the custodians of this information. If a register is developed another more impartial custodian must be found, perhaps the Valuation Office coupled with the Land Registry.

    (v)  157.  We believe it would be preferable for the industry to develop a nationwide register of rent reviews, accessible by professional valuers representing both sides of the industry. Although we believe the proportion of rent reviews not resolved amicably is small, such a register would increase transparency and reduce contested reviews.


  6.1  What should be the accepted practice:

    6.1.1  The Open Market Freehold value for a pub is, and should be, based on the retail profit they can generate free of tie. Such retail earnings would be before interest and taxation [EBIT].

    6.1.2  It is generally accepted that "Open market value" is defined as the best price at which the sale of an interest in property might reasonably be expected to have been completed unconditionally for cash consideration on the date of the valuation assuming a willing seller and that no account is taken of any additional bid by a purchaser with a special interest. In today's market place there is a significant need to exercise a duty of care when considering a mortgage with the credit market operating under stress. A sensible valuation could reasonably be based on three to three and a third times factual EBIT with borrowing limited to 65%-70% of the total value. This level of borrowing could be considered prudent and reasonably acceptable as an alternative to cash.

    6.1.3  The issue of a purchaser with a special interest highlights the exclusion of supplementary streams of income such as wholesale profits which are quite separate to the retail operation and also extra profit generated through special persona or brand.

    6.1.4  For Public companies such as Pubco there is a legal requirement to ensure that the Balance Sheet of the company should satisfy the cardinal rule that it reflects "a true and fair view". That principle necessitates Tangible asset values not only to reflect sustainable open market property values but also that they represent the net realisable value, which would normally be determined according to the principle of orderly disposal unless the entity is in financial trouble.

  6.2  But the Pubcos appear to take a different attitude with regard to valuations.

    6.2.1  When a Pubco desires to purchase of a pub it also considers the other supplementary income streams, not available to the open market, such as listing fees or wholesaling profits which they would enjoy either through trading or tied lease. Their purchase price would include the tangible asset related to retail profit and the intangible asset relating to the other streams with the values of the two elements separately displayed in their Balance Sheet. But are they? The capital value of the intangible asset would be extinguished by the loss of the supply tie, and/or the wholesale business.

  6.2.2  Merging of intangible and tangible asset values is not only contrary to Accepted Accounting Practice but would deny adequate depreciation and overstate implied security value. If, as is suspected, the merging asset values has been practised that would account for the existence of greater borrowing. Such practice, if proven, would mirror both the Enron debacle as well as embracing the issues surrounding the "sub-prime" market because the Balance Sheet would fail to represent a "true and fair view".


  7.1  Taking just one Pubco. Examination of the published audited 2007 accounts of Enterprise Inns plc, relating to 7,783 pubs indicate that the average pub for the company:

    Is valued at £736k [£5710 million/7763].

    Has average goodwill attached to it of £60k.

    Has borrowings against that valuation of £736k amounting to £492k [ £3,819 million/7763] which is 67% of the value they have placed on the asset.

    Is supported by shareholders funds of an average of £191k, [£1,463 million/7763]which would be diminished by 32% in the event declared goodwill was written off.

    Has an annual rent of 33k which has risen 18% from 28k in 2003.

    Rents have been structured rents on the basis that the average pub can earn for the tenants 33k per annum plus any benefit of living in. [Enterprise have no factual evidence to support that hypothesis]. There is good reason to believe that their estimate could be out by at up to 50%, because they ignore actual data and rely on unsubstantiated opinion, which would mean that even for a sole tenant the income would be below the equivalent National Minimum wage as would the 33k be for a "couple" working 60 hours each per week.

    Accepting their rent and profit assumption for the average tied pub, taking a view on what discounts could be earned in the open market, the average profit trading as an independent free of tie could be extrapolated to an average pre tax profit [EBIT] of £80k per annum.

  7.2  To consider the simple question of what the freehold value may be revolves around the retail profit and its ability to service debt as well as provide a liveable income. Using the Enterprise data the EBIT would be £80,000 per annum.

  7.3  Consider what level of debt the provable 80,000 joint income for a couple could support. A prudent lender may consider three and a third times income provided the borrower could fund a third of the purchase price. Borrowing would be in the order of £267,000 against a sensible purchase price not exceeding £400,000. Given the same profit base as Enterprise this is vastly different to the £736,000 valuation and £492,000 borrowing reflected in the Company accounts. It would appear that Enterprise is borrowing more than the average pub may be worth.

7.4  What is the point of this examination?

  7.4.1  The examination above, based on an average of 7,500 pubs, appears to demonstrate that the Enterprise asset valuation and borrowing is verging on the unbelievable and unviable. Their continued existence would appear to rely on cash flow extracted through excessive rents as well as the high prices they charge for beers etc. It also suggests that if all the other Pubcos are operating with similar propositions then none of these Pubcos have any real scope or ability to manoeuvre financially. The financial manacles deny them flexibility.

  7.4.2  The original recommendations made by the Trade & Industry Committee are as valid today as they were four years ago. The Pubcos will not want to reveal their financial predicament even though it is obvious and therefore will seek to suggest that they have done everything possible towards the T&ISC recommendations and that they are helping tenants by reducing or rolling up some rents. The proof of Pubco defiance can be seen by the number of pubs being closed, abandoned or even tenants buying out of tie in an attempt to survive. They may blame everyone and anyone for their dilemma but fundamentally it can be seen to have been caused by greed. Hopefully the BESC will not be deflected from defending the consumer as well as the 15,000 to 25,000 tenants requiring transparent and ethical support to ensure their survival.

7.5  The impact of current trading

  7.5.1  The past year has seen pub turnover fall by more than 10% at the same time as operating costs have risen by 10-15%. Recognising that historically the best average rate for pre rent profit to turnover was 25%, and the rent was half, means that these economic changes result in the average tenants income/ profit falling from 12.5% of turnover to 2.5% of turnover. That is an income drop of 80% which will take most tenants into a poverty trap. It cannot be ignored that the fall in turnover and increases in cost stated have not yet felt the full brunt of the credit crunch, loss of employment or negative equity. Economists have indicated that the downturn could continue for a couple of years before bottoming out and then take several years to recover.

7.6  For the British heritage of Pubs to survive

  7.6.1  Tenants need:

    To be able to buy at much lower prices, which can only be achieved by a release from tie.

    Real competition to be encouraged between suppliers and wholesalers.

  7.6.2  Landlords should:

    Ensure rents embrace and adopt the principles of paragraph 144 and 145.

    Abandon all upward only rent reviews including annual RPI indexation.

    Allow tenants to select AWP machines from suppliers of their choice, and for the tenants to receive the full income.

    Examine and adjust their Balance Sheet property values to reflect Tangible Asset values based on realistic retail profitability, debt service and liveable income in the current market.

    If appropriate apply financial reorganisation; if necessary banks/bondholders may have to convert to equity for the company to survive.

  7.6.3  The BBPA should be required to:

    Re-write of their Code of Practice to embrace all T&ISC recommendations, and remove the subversion relating to the rent not reducing below base lease rental. Perhaps the Code should be drafted by the BBPA and approved by Fair Pint and the BESC.

  7.6.4  RICS:

    An independent review is required of their Trade Related Valuation Faculty. Perhaps their panel should be extended to include other disciplines, such as a Accountant and Lawyer.

  7.6.5  For Auditors and Directors:

    The principle that the balance sheet should show a "true and fair view" is under the microscope. Did the Auditors of these Pubcos validate the asset values? Did they test for intangible and tangible asset values being merged? Did they test the asset values against banking and bond covenants? The existing evidence indicate that standards are not being met. They need to be!


  8.1  Pubcos have bondholders, debt to service and shareholders to satisfy but those goals should not be achieved at the cost of the tied tenant surviving on what is not a liveable income, or for consumers being burdened with an uncompetitive inflated price.

  8.2  Pubcos may argue that supermarkets are the cause for the downturn in pub trade. Reality is that they get the same discounts but do not pass them on. This is clearly seen from the deviation between off sales and on sales retail prices. In the last 20 years Off sales increased by 47%, On sales 151% while the cost for production has been the same for both.

  8.3  It would be irresponsible to allow the financial greed of Pubcos to irreparably damage the tradition of British Pubs, renowned for the service and congeniality that they give to the community. They need to survive. Removal of all supply ties, and the requirement for transparency will not solve all the ills but at least the trade would be on a fair and competitive footing.

9 September 2008

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