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.
2.0 CONSIDER
THE MAJOR
PROBLEMS THAT
EXIST FOR
THE MAJORITY
OF THE
25,000 OR MORE
TIED TENANTS
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.
4.0 STABILITY
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.
5.0 PROFIT
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.
6.0 FREEHOLD
VALUATIONS, ACCEPTED
PRACTICE AND
MALPRACTICE
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".
7.0 AN ILLUSTRATION
SUGGESTING THE
EXISTENCE OF
ASSET MERGING
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!
8.0 IN SUMMATION
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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