Heineken turns the clock back on pub ownership

Why has no one noticed that Heineken’s proposed acquisition of about 1,900 pubs in the Punch Tavern group actually nullifies the Beer Orders, a bill introduced by the Thatcher government in 1989 to force the big brewers to divest their large pub estates? Provided the transaction is not vetoed by shareholders bowing to publicans’ protest, brewer Heineken could become the third-largest pub operator in the UK.

This would herald a return of sorts to the 1980s, when the six biggest UK brewers owned around 33,000 pubs. In an effort to increase competition and give consumers more of a choice, the Beer Orders decreed the big brewers couldn’t own more than 2,000 pubs, implying a divestment of 22,000 pubs.

But instead of selling some pubs and keeping the rest, the big brewers created something new - pub companies or pubcos for short - to which they sold all their pubs. Since pubs were such a profitable business, investors piled into what became known as the pub retail industry. By 2009, 27,000 or 43 percent of all UK pubs were owned by pubcos, with the biggest two - Enterprise Inn and Punch – controlling over 15,000 in total.

Pubs became a game that revolved all around money rather than beer. The fact that pubs generated more money than shops and offices – through a combination of rent, wholesale profits on beer, and slot machine income – meant they were deemed to have a suitable “securitisation model” by the banks. Pubcos could borrow vast sums from banks and expand their empires, based on the promise of future returns.

Thus, rather than severing the tie between brewers and pubs, the pubcos re-established it. In actual fact, pubcos were nothing but real estate companies and uncompetitive beer wholesalers, which forced their tenants to buy all their beer from them.

For investors, the model worked until the 2007 recession, supermarket pricing of alcohol, the smoking ban and the change in drinking habits conspired against the industry. Pubcos have been struggling since and a lot of underperforming pubs changed hands while plenty of them closed for good.

The number of pubs allegedly dropped to under 50,000 in 2015 from 58,000 in 2006, with brewers now owning one fifth and pubcos and independents two fifths each. At the same time, per capita beer consumption declined to 67 litres in 2015 from 86 litres in 2006.

Roger Protz, the UK’s pre-eminent beer writer, said that “Enterprise and Punch caught a terrible cold when the banking crisis caused a major economic crisis. In order to pay off some of their massive debts – and at one stage in 2014 the burden of debt almost sent Punch into administration – the big two have sold off swathes of perfectly viable and successful pubs.”

All this is to say, pubcos may be having problems but pubs can still be a good business and attractive to brewers. The rationale for brewers to own pubs, then and now is: market share. With four international brewers competing in the shrinking UK beer market – Heineken, Molson Coors, AB-InBev and Carlsberg – a tight grip on the pub industry can serve as a safeguard against market share loss.

When Heineken, together with Carlsberg, bought Scottish & Newcastle (S&N) in 2008 and Heineken took over its UK business, the Dutch inherited S&N’s 2,000 strong pub estate, which they quickly pared down to only the profitable ones while buying up other estates.

In December 2016, Heineken won a brief bidding battle for the 3,300 pubs in the Punch Tavern chain in a joint GBP 400 million (USD 498 million) bid with real estate specialist Patron Capital private equity. They intend to divide up the portfolio so that Heineken, for the price of GBP 305 million (USD 380 million), will receive 1,900 pubs, ultimately increasing its pub estate to around 3,000.

The unsolicited offer is 40 percent higher than Punch’s closing share price on 13 December 2016, the day before the bid emerged.

Heineken said it would refurbish the acquired pubs and ensure they could sell food. It expects to benefit from economies of scale and increased sales of its beer and cider.

This has maddened Punch’s tenants because the Dutch tend to ensure that Heineken-owned brands make up 85 percent of what is on offer. This will also upset rival brewer Molson Coors, the producer of Carling and major beer supplier to Punch, whose brand could be kicked out.

In a letter to the industry adjudicator in January 2017 the pub operators have appealed for guidance on whether they can apply to sever the supply tie with Heineken in order to stop an unwanted deluge of Strongbow cider and Foster’s.

The pubs could be spared an enforced stock strategy under a new system brought in last summer.

Under the new rules, tenants will be able to request a rent assessment every five years, or whenever there is a significant change in the price they are charged for drinks, or in their trading conditions. They will then be able to renegotiate their rent or switch to a “market rent only” arrangement where they are able to buy beer from any supplier.

This option is not available to Scottish pubs, causing heightened concerns among Punch pubs north of the border.

Punch shareholders will vote on the offer on 10 February 2017.