Buy City Pub Group as a takeover target

City Pub Group was set up by Clive Watson and colleagues in late 2011, and started trading in March 2012. The group raised £35m with its Alternative Investment Market (Aim) listing in November 2017. This hasn’t been its only round of fundraising. Prior to the IPO, it raised £38m under the Enterprise Investment Scheme, and in October 2018 it raised £6.2m via a share placing at 220p.

A number of the current board members, including executive chairman Clive Watson and managing directors Rupert Clark and Alex Derrick, worked together previously running Capital Pub Company. The entity was eventually floated on Aim, then sold to Greene King (GNK) for £93m shortly before the new company was founded.

Considering management’s track record, a similar exit strategy may be on the cards. One potential buyer could be Fuller, Smith & Turner (FSTA) which has just sold its beer and brewing business to Asahi for £250m. Between £55m and £69m of the £205m net proceeds will be returned to shareholders, and so the money left over could go towards a deal. Fuller’s chief executive, Simon Emeny, is keen on expansion via acquisition in the wake of the beer business sale, and City Pub’s premium, predominantly freehold estate would fit nicely alongside Fuller’s existing pubs. What's more, there should be plenty of value to extract for a larger group; Fuller's managed pubs reported an operating margin two-and-a-quarter times that achieved by City Pub Group in its first half.

In the meantime, City Pub Group’s expansion plans are well on track. When it went public in November 2017, Mr Watson said the company would double the size of its estate, then made up of 34 pubs, by 2021. At the half-year results in September 2018, Mr Watson said the group was ahead of schedule on meeting that goal, and now expects to achieve it 12 months early, by mid-2020. At the year-end, it was trading from 44 locations with four more in the pipeline. Further expansion will be funded through a combination of internal cash flow and debt.

The group is benefiting from its focus on drinks-led pubs, which have had more resilient and higher-margin sales than pub restaurants. Management avoids branding, which helps set it apart from some of the bigger chains and develop customer loyalty.

City Pubs is in the process of renegotiating its debt facilities, hoping to increase it by £10m to £40m, although its year-end net debt position is just £10.5m. Mr Watson views the current level of net debt to cash profits of about two times as reasonable given the strong backing provided by freeholds.