Beer, bonds and brokers

Nomura may now be Britain's biggest pub owner, but it's more interested in securities than serving drinks. Liza Roberts reports

When Nomura Securities became Britain's biggest pub owner last week, more eyebrows than pint pots were raised in the City, even if the purchase may lead to cheaper beer.

After all, Grand Metropolitan and Fosters Brewing Group had been eager to unload the 4,300 public houses of their jointly owned Inntrepreneur and Spring Inn subsidiaries as low-yielding, non-core businesses. The price - pounds 1.2bn - struck some analysts as expensive, especially as pubs face declining beer consumption and increased competition from theme bars.

So what does a Japanese brokerage company know that these veterans of the drinks sector don't?

For one thing, Nomura has had two years' experience in the business. It bought Phoenix Inns in 1995 and manages 1,130 pubs. More importantly, the Japanese brokerage believes there is gold in those public houses, in the form of 4,300 long-term leases.

All that steady cash flow can be "securitised" - a complex technique used by bankers to convert cash flow into securities - to fund the acquisition. The business of the pubs is, to a large degree, beside the point.

Nomura is not letting on precisely what it will do, but a spokesman says securitisation is "almost certainly" in its plans, and a sale or flotation in a few years is likely. Securitisation is something Nomura's London operations has made a specialty in the past two years.

Led by Guy Hands, the managing director of Nomura International's Principal Finance Group, the company has completed more than $11bn in securitisations since 1995, including the pounds 944m securitisation of Angel Trains, which the government sold as part of its rail privatisation programme; the pounds 904m securitisation of Annington Homes, a group of 57,000 Ministry of Defence houses; and the pounds 249m securitisation of Phoenix Inns.

Last week, Nomura emerged as the likely buyer of the William Hill betting shops chain. There was no comment, but betting shops are another strong cash flow business which would make a good securitisation candidate.

Pub rent-backed bonds would take the form of a bond backed by rental income, with a pool of leases as underlying collateral. The income would be used to make the interest and principal payments on the bonds. "Over the years they will expect a reasonable payback from the bonds, and then they presumably intend to float or sell the estate in a few years' time," says Matthew Jordan, an analyst at ABN Amro.

By selling, Nomura could shift the leases off its balance sheet, freeing up its capital for new business. Because the bonds would be backed by a pool of assets, they would be likely to have high credit ratings, and interest payments would probably be lower than on the underlying leases. The difference would be Nomura's profit margin.

"The value of the assets depends on how you can finance them," Mr Hands said recently. "Clearly, the more cheaply you can finance the asset, the more cash flow is left over and the more valuable the asset is. What one is really saying is that the assets are worth more because of the cash flows they generate than because of the value of the asset."

Potential investors say pub-backed bonds could be attractive. "It's a way of producing high-yielding fixed-interest securities, and that's why we would consider it," says Paul Mingay, investment manager at Norwich Union. The fact that the securities would be backed by pubs will not necessarily be part of the equation, he says. "We'd look at the strength of the leases."

Securitisation expert Brian Olasov, a capital markets consultant at the law firm of Long Aldridge & Norman, says the broader market wants bonds like these. "There is so much appetite at the institutional-investor level for a securitised product," he says. "I would think that this would be a pretty successful placement."

Nomura is not commenting on how the securities will be structured, but Mr Olasov predicts they will be issued in tranches, with a likely AAA- grade for the top level. Yields in the upper teens to low 20s are likely for the lower tranches.

Nomura emphasises that its immediate objective is to improve the pub business. "The aim is to create value," says James Turner, director of the Grand Pub Company, which Nomura established to run Phoenix, and which will manage the new acquisitions. Mr Turner will first visit as many pubs as possible. "We need to look at each and every site to see how we can develop each one - whether that's investing in the site, or focusing on commercial incentives, or, in some cases, selling."

A key part of the strategy to improve pub profits is to renegotiate a six-year-old beer supply contract between the Inntrepreneur and Spring Inn pubs and Scottish Courage, a subsidiary of Scottish & Newcastle, to which the pubs are "tied". Nomura's Phoenix pubs are not tied to any brewery.

The Scottish Courage contract expires on 28 March, the same day the Inntrepreneur and Spring Inn acquisition is due to be completed. "There's a fair amount of purchasing power within these estates which we would share with licensees," Mr Turner says.

Combined, Inntrepreneur and Spring have about 3 per cent of British beer sales. "The obvious thing they can do to improve profitability is to decrease the beer prices," says Russell Duckworth, analyst at Deutsche Morgan Grenfell. "There should be scope to reduce them fairly significantly."

Some of Inntrepreneur's lessees have taken the company to court in an effort to extract themselves from the ties, and to work out lower beer prices. "Those problems have to be sorted out if Nomura is eventually to float the group or sell it for the right price," says Matthew Jordan. He calculates that Nomura paid about pounds 100m more than his estimate of the pubs' value in two years' time, when Nomura might consider a sale or flotation. And his figure factors in increased profitability from presumed beer discounts.

Nomura will be bucking more than steep beer prices in its quest to add value. In the past decade, pub beer sales have fallen about 10 per cent, according to Tim Hampson at the Brewers' and Licensed Retailers' Association. Fewer young people and fewer heavy industry jobs means fewer men regularly consume three or four pints at a time. The market today demands more food in pubs, and a more family-friendly atmosphere, he says. That means many pubs require refurbishment.

Some analysts question whether Nomura will invest much in the pubs, pointing to the 20-year leases requiring tenants to make full repairs and improvements. Mr Turner says it is too early to say how much the company is willing to invest.

Still, Nomura says it is confident it can recoup its investment. "Whatever exit we eventually decide on, we will have hoped to have added value and to exit from it with a profit," Mr Turner says.