Quick Summary
Punch Taverns is a UK tenanted pub company (owns RE and leases it to pub operators) that combines a levered option with some attractive spin dynamics. On 8/1/11, Punch demerged its managed pub division Spirit to shareholders leaving the PLC with cash and a JV and the equity interests in the company's heavily indebted pub securitizations. While Spirit was the spin, it was also the asset that most Punch investors focused on and since the spin, Punch has been removed from the FTSE 250 and 350 and some sell-side analysts have dropped coverage of it because of its microcap status. These technical factors combined with investor concerns about what Punch will do with its heavily levered pub securitizations have left the company trading at ~40% of the company's cash and other assets (23p). With ~5p per year of expected cash burn at the PLC, the current price provides an investor with a multi-year option on a recovery/restructuring of the pub estate that could provide total shareholder value of 50p-100p in blue sky scenarios.
Capitalization and Valuation
Punch has 645mln diluted shares. At a 10p share price, the company would have a market cap of GBP 65mln. At the PLC level, the company has 83mln of cash, 9 mln of PLC bonds and expects to receive 20mln up cash upstreamed from the securitizations in H2 for adjusted cash of 112mln (17p per share). The PLC also holds the company's Matthew Clarke JV which has a book value of 49mln (8p per share). Netted against these assets are PLC liabilities for the Pubmaster Pension scheme and some onerous leases which have a total value of 12mln of 2p per share. Thus, net PLC assets are 23p per PUB share.
In the Punch A and B securitizations, the company has 2.5bln of debt and 79mln of cash (post upstream) for securitized net debt of 2.4bln. It is important to note that the debt in each securitization is non-recourse to Punch and non-recourse to the other securitization.
Upside
A true upside scenario is driven by the successful turnaround of the pub business underlying the securitization. Punch is undergoing an aggressive disposal program as the company looks to sell off underperforming non-core locations to focus on a stronger core estate of ~3,000 pubs. If the company is able to successfully dispose of the non-core estate for the GBP 630mln (~book value which is inline with prior divestitures, mgmt has stated they are confident of GBP 650mln of proceeds), then the remaining core pub business could generate 215-235mln of EBITDA. Using peer multiples of 9-10x EBITDA, then securitizations would then have equity value of 20-85p per share which combined with other assets would suggest a share price of GBp 50-100p.
Another source of upside could come from a debt for equity swap for the securitization bonds. If we assume a more manageable securitization net debt/EBITDA of 7x and swap securitization debt at a 25% discount for PLC equity at 10p, then the company would provide the bondholders 700mln shares leaving the PLC with 1.35bln shares outstanding. Based on 10x EBITDA and 7x net debt/EBITDA, the securitization would have 755mln of equity value or 56p per share which would justify a 66p share price when combined with the other assets. Please note that this exercise is merely an example to show the potential for material upside available under 1 restructuring scenario. Small changes in the assumptions have material impacts on the share price.
Downside
The much more likely scenario is that the securitizations continue to struggle and do not have equity value. Outside of the securitizations, the major assets are Matthew Clark (8p) and PLC cash (17p) offset by pension and onerous leases (2p) for a total asset value of GBp 23p. However, some portion of these assets will be used for EBITDA support payments to the securitizations. In CY 2011, these support payments will represent a new cash outflow GBP 21mln and based on my estimates, I could easily see those payments increasing to a net outflow of 30mln in 2012 (5p). Thus, each year that the securitization does not turn around and the PLC continues to support it, we could see a continued valuation bleed. If we assume 3 years of cash support and cut the value of Matthew Clark in half, then Punch would be worth 5p. It is certainly possible that this asset could be bled to 0. Based on my conversations with management, I do not believe they will throw good money after bad, however, this outcome is certainly possible thus the position must be sized appropriately with the understanding of the potential of total loss. Steve Dando the current CFO of the Punch was the CFO of the parent entity pre-spin and chose to go to Punch to support this turnaround. He has stated that ongoing compensation for him will be mostly in equity but I do not know the details.
Overall, I believe that while the upside is very uncertain and difficult to predict, it is also potentially quite material and the company has a long runway to attempt to achieve this turnaround. Thus, I think PUB provides an attractive option-like risk reward as well as some interesting spin dynamics. Again, I want to highlight the fact that this position is a levered option in my opinion and could be a 0 and should be considered only by people who are comfortable with risk/rewards of that nature.