Stonegate Pubs - Incentivised

All,

Please find our unchanged analysis here.

Stonegate has increased the number of pubs included in the transaction (to >1,000 versus c.800 originally) and raised only £600m (versus an original target of £1bn). This is partially explained by this transaction not being an outright sale, with Stonegate placing the pubs into an SPV, raising debt and retaining the equity. However, the reality is no buyer was found at these valuations. It is less proceeds, but ultimately it provides Stonegate with the finances to incentivise investors into an Amend and Extend (A&E) operation. An A&E allows TPG (the owner) to retain control of the operations and retain exposure to both the rump estate and the SPV upside from an expected EBITDA performance in the coming years.  

Stonegate has had to sell >1,000 pubs (vs an original estimate of 800) and has only raised £600m (vs an original target of £1bn). The pub sale deal from Stonegate raises £609m in cash for the company vs the £1bn initially expected. Instead of an outright sale, Stonegate will place the pubs into an SPV, raising debt, but retaining the equity. However, it provides Stonegate with the finance to incentivise investors into an Amend and Extend (A&E) operation.

Investment Considerations

- The transaction is disappointing in size, but it does provide enough cash for a credible A&E operation.

- Trading in the high 90s, the SSNs do not offer the type of returns we want to back an A&E. If either no sale happens or there is prevarication over executing an A&E, the downside in the bonds is at least 15 points given the size of the estate.

- Shorting the bonds when the company has enough cash to tempt investors into extending maturities is not attractive either. We are surprised at the strong positive reaction to this deal.

- The pub portfolio is currently valued at £3,723m on the balance sheet. The cap rate for the pub sale is 9% vs our assumption of 5% being used by Stonegate on the overall estate. Applying 9% instead would imply a value of £2bn. At 65% LTV, on £2.2bn of net senior debt, the intrinsic value is 60p/£ (our previous mail estimated (64c/£).

What is the impact on Stonegate’s capital structure:

- The impact of the pub sale on leverage is small. Through the SSNs, our 2025 leverage forecast falls from 6.4x to 6.2x.

- Achieving easily financeable leverage of 5.5x would require an EBITDA of £400m, whereas our model (adjusted for the pub sale) forecasts £350m in 2025.

- However, the transaction does provide the funds for an A&E operation.

Stonegate needs to execute an A&E operation soon:

- The transaction must happen in the first half of 2024 as Stonegate has £2.1bn of debt maturing in March 2025. At current valuations, investors are incentivised to support the A&E whilst waiting for EBITDA to recover and cap rates to fall. The metrics are tight but feasible.

- Paying 5p/£ as an extension fee and repaying £500m of bonds => £600m. The bonds would be extended to March 2028 (in line with the 2nd Lien), with the coupon raised to 10%.

- EBITDA of £350m would be set against Interest of £250m - £275m and Capex of £75m.

The terms reflect that Stonegate needed to make the sale:

- The yield is 9.2% (EBITDA £77m, debt £638m, equity £201m).

- The loan has a five-year term and will be at SONIA +650bp.

- The proceeds to Stonegate will be £609m, as there is an Interest reserve and fees.

- Stonegate will also receive a £201m Promissory Note from the vehicle. Interest will be 14% (all PIK). The note is subordinated to the loan and will mature later.

- One positive is that there are no guarantees from Stonegate.

Credit metrics in the vehicle are stretched to maximise the debt levels:

- Net proceeds are £400m less than management hoped when the sale process was announced. The loan to the SPV is a bet on improving EBITDA in the pub estate with the company growing into its capital structure. Our view on the overall Stonegate portfolio is no different.

- Leverage 8.3x,

- EBITDA is £77m vs. Interest £75m (SONIA 5.19% +650bp).

- LTV 76% (EV £839m/debt £638m).

Once a buyer for the equity could not be found, Stonegate needed to put as much debt in the vehicle as possible (LTV 76%).

- The EV/EBITDA valuation is 10.9x, relatively close to the 11x management had talked about as its benchmark for pub valuations.

I look forward to discussing this with you all.

Aengus