Spirit poised to buy £2.5bn S&N pubs

Scottish & Newcastle was last night poised to reveal that it has agreed the £2.5bn sale of its 1,500-strong pubs arm to Spirit Group, a privately-owned rival, leaving it focused on expanding its brewing empire.

Barring last-minute hitches, or a comeback from one of the other two short-listed bidders - the Laurel Pub Company and Nomura - Spirit is expected to enter exclusive talks to add S&N pub brands from Chef & Brewer to Bar 38 to its own Two for One and Mr Q's concepts.

Separately, it emerged that Punch Taverns - Spirit's former stablemate - is in exclusive talks to take over rival Pubmaster in a deal worth up to £1.2bn. The pub industry has been in flux since the Government set an upper limit on how many pubs the country's major brewers could own in 1989. That sparked a process that saw one in six British pubs change hands and most of the country's major breweries wind up in foreign hands.

S&N's board of directors spent the weekend locked in talks over the detail of Spirit's offer. They had to hammer out the terms of a continuing beer supply agreement for brands such as John Smith's and Kronenbourg - a potential dealbreaker for the brewer. It was not clear last night how Spirit, run by chief executive Karen Jones, had got over the hurdle of being tied into a prior beer supply agreement with Carlsberg-Tetley that runs until 2007. Laurel, meanwhile, is free to renegotiate its own beer supply deal in 2005.

Another sticking point for Spirit and S&N is an estimated pension liability of some £50m under the accounting standard FRS 17. The brewer's managed pubs and hotels arm made operating profits of £227.7m last year on £1bn of sales.

If successful, Spirit will also acquire Premier Lodge, S&N's budget hotel brand, which it is likely to sell on for up to £500m to either the Whitbread-owned Travel Inn or Travelodge, the budget hotelier bought by Permira from Compass last year. Both groups have stated their desire to own Premier Lodge, spending the past few months courting each of the hotel brand's potential new owners.

S&N, which appointed Tony Froggatt as chief executive in July, has worked hard to ensure a vibrant auction process, promising £1.5m to each bidder to cover their costs. It extended its 30 September deadline for final bids in order to stretch out the bidding war. This allowed Nomura, the Japanese bank whose initial interest in S&N's estate sparked its ultimate sell-off, to table a last-minute bid on Friday in partnership with PAI, the French private equity group.

The extension was necessary after several bidding groups regrouped, with many teaming up with former rivals. Spirit's bid includes backing from CVC Capital Partners, which had previously tabled an offer with Cinven. The managed pub company, which operates more than 1,000 pubs that were once part of Allied Domecq, also has support from Texas Pacific and Blackstone. Its main debt providers are thought to include Royal Bank of Scotland and Merrill Lynch.

Punch Taverns, which demerged Spirit ahead of its flotation last year, is also looking at other pub companies such as Mitchells & Butlers, recently spun off from Six Continents, in the event that Pubmaster's shareholders decide not to sell.