Mitchells & Butlers worth supping

InterContinental could give investors sleepless nights

Investors with a thirst for nostalgia will welcome next week's stock market debut of Mitchells & Butlers, the pubs half of Six Continents, which is about to demerge.

They will be hoping that the executive team, headed by Tim Clarke, Six Continents' chief executive, can recapture past glories for the historic Midlands brewer, which was acquired in the Sixties by what was then called Bass. Their hopes are unlikely to prove unfounded – not least given the amount of takeover interest.

With more than 2,100 sites, M&B is the country's biggest managed pub and restaurant operator. Although intense competition and trading hiccups at a number of rivals have meant managed houses (those owned by a pub company and operated by a team employed directly by the parent group) have been less popular as an investment than a round of Babychams, the quality of M&B's estate should position it ahead of the crowd. An extra plus is that the bulk of its units sit in affluent residential and suburban locations where rivalry is less fierce.

The bull case for the shares lies in the management's potential to squeeze earnings growth out of its existing estate. With a comparatively poor track record of cash generation (its return on capital lags its cost of capital), it will be thirsty for every last drop. First up will be the conversion of some 500 sites to various branded and unbranded formats at about £250,000 a pop. M&B has a broad sweep of concepts that span popular, if predictable, high street chains such as All Bar One and jazzed up locals such as Ember Inns. It also owns the Toby and Harvester family diners, as well as a range of other brands from the Seventies-themed Flares to the pseudo-Irish O'Neills.

Mr Clarke is a respected pub veteran so he should manage to froth up profits from the conversions. Investec Securities reckons the extra investment will drive 10 per cent earnings per share growth in each of the next three years.

The estate is 83 per cent freehold-backed and has a net asset value of £3.4bn. Although there is no hurry to gear up the business, Hugh Osmond's hostile bid for Six Continents illustrated the potential for clever financing tricks that could release untold riches for shareholders in the form of special dividends and share buybacks. The business will have debt of £1.3bn, which could safely be upped to as much as £2.2bn, particularly if the tide turns and M&B decides to get acquisitive.

There are reasons for investors to be cautious, of course. Recent weak like-for-like sales leave a slightly sour taste and there is also the threat from creeping regulation, which has left publicans rubbing sore heads across the sector. Extra red tape has already cost M&B an extra £40m over the past three years and licensing deregulation will inevitably have its price, as well as its opportunities.

Six Continents' broker, Cazenove, reports little interest in conditional dealings, with the grey market range set at 220p to 270p. The mid-price of 245p would include a takeover premium but if they can be picked up lower, a near-4 per cent yield should justify getting in a round.

InterContinental could give investors sleepless nights

When Six Continents checks out of the stock market for good on Tuesday, the question on everyone's lips will be whether its protégé, InterContinental Hotels, can look forward to an equally brief stay.

Despite having fought off one hostile bid – courtesy of Hugh Osmond – InterContinental finds prospective suitors are lining up for a crack at the tastiest pure hotel play on the London market. The Savoy Group's owner Blackstone, Kohlberg Kravis Roberts and CVC are among the private equity groups hungry for a pop at it, while Marriott, Starwood and Hilton are all running their slide rules over their arch-rival.

The war against Iraq may be all but won, but hoteliers are hardly anticipating a celebratory surge in bookings. Sleepless nights have become the norm for hotel investors and holders of InterContinental stock are unlikely to fare any differently. Lacking the cushion of its defensive pubs arm, the hotels group will be exposed to every weakness thrown up by the market – and with the genie of Islamic terrorism out of the bottle, the travel industry will remain edgy.

Richard North, the chief executive designate, has a three-point plan for InterContinental Hotels – which also includes the Holiday Inn, Crowne Plaza and Staybridge Suites brands. First up is slashing its inflated cost base by more than £60m annually by axing middle management and streamlining the organisation. After an intensive capital expenditure programme that has seen the bulk of the InterContinental estate refurbished, the focus will be on driving historically low returns.

Next comes a vigorous review of the group's estate, with the aim of reducing its £3.8bn asset base, selling off non-strategic InterContinental sites and separating property ownership from hotel management wherever possible. Lastly it plans to extend its network of hotels through franchise and management contracts, at minimal cost to the group.

The main snag is that this all requires investors to put a heap of faith in Mr North, a man who is a canny finance director but a chief executive virgin. Mr North may have beefed up his management team by hiring a string of industry bigwigs, but they have yet to prove their worth at InterContinental. While the group argues it is heavily geared to a sector recovery, owning or leasing one-third of its estate, this is no good if bookings remain weak.

The grey market range for IHG shares has already priced in hefty takeover speculation and with better plays around, such as Hilton, these shares should be avoided.