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Published 08 May 2013 12:18, Updated 09 May 2013 09:40
“We’re not just a bunch of larrikins buying hotels on a whim”: Riversdale Group investors at the Bellevue Hotel in Paddington: Paddy Coughlan, Jack Singleton, John ‘Singo’ Singleton, Geoff Dixon and Mark Carnegie and Allan ‘Jo’ Johnston. Photo: Nic Walker
“This is a serious business, you know,” Geoff Dixon tells BRW as we sit down to talk to the former Qantas boss and his fellow investors in the Australian Pub Fund, now the owner of nine watering holes in Sydney and one in Brisbane.
“We’re not just a bunch of larrikins buying hotels on a whim. We’re doing this because we think we can add real value.” From the outside, the fund Dixon chairs looks anything but a joke. Backed by big-name private investors and the industry fund Sunsuper, it has just acquired $65 million of new capital to continue its strategy of buying under-performing or financially distressed pubs in prime locations, and renovating them to improve their food and entertainment.
Dixon has something of a knockabout image. Most people know he was the publican at Wagga Wagga’s Turvey Tops Tavern, and his on-again off-again interest in Qantas shows he likes to stir things up. However, the main reason Dixon feels he needs to downplay the larrikin tag is sitting across the table.
John Singleton is in fact a serious businessman behind his self-styled “ocker” image – the lengths to which he’s just gone to protect his racehorse interests should convince anyone of that. The ad man says he’s a major investor in the pub fund for money, not fun. However, he admits that it wouldn’t help to be a wowser.
“All of us around this table,” he says, gesturing towards Dixon, investment banker Mark Carnegie, and fellow ad-land legend Allan Johnston (the Jo in the Mojo agency who wrote I Feel Like A Tooheys on his guitar), “we all know pubs. We don’t have to hire someone to explain it to us – you know, ‘this is beer, this is what people drink’. Some of the pubs we’ve got in this fund are part of my heritage. The Vic On The Park at Enmore - that’s where we used to drink after we’d been thrown out of the Henson Park up the road.”
“Singo” and his fellow investors might seem synonymous with pubs, but there was a long period where no one involved in the fund touched a pub investment.
That says something for their acuity.
The hotel industry “jumped out of its skin” in the early 2000s and went to unprecedented values that had established pub owners shaking their heads, says pub broker Nick Tinning of Chris Tinning & Company.
“The major factor was that people thought the gaming boom would continue, that we’d always have incremental profits coming from gaming. So they were renovating these hotels and basically turning them into mini-clubs,” Tinning recalls.
Far from soaring, Tinning says the overall gaming dollar has remained static, in part thanks to regulatory intervention such as smoking bans and the cap on poker machine numbers in NSW, as well as the downcast economy.
British bank HBOS also blew plenty of hot air into the pub bubble after it took full ownership of Western Australia’s Bankwest in 2003. “They wanted to grow their business on the east coast, and the easiest way they found to do that was to lend to the pub industry,” Mark Carnegie recalls.
“Then the other banks felt that they had to compete, so you had an incredible lending bubble. Everyone was ignoring the fact that the number of poker machines in NSW was now absolutely capped, and that smoking bans were sending cash flows down 20 per cent.”
Yet the banks were pushing their loan-to-value ratios for publicans out to 80 per cent and beyond, with what Carnegie describes as a “hair trigger set of covenants that meant any cash flow trip and you were in receivership”.
Still, there was so much demand that the established pub valuers couldn’t service it all. “You had a lot of valuers that weren’t pub specialists come in, and they really rolled along with the show,” Tinning remembers.
Having been told what they wanted to hear for too long, the banks sobered up with pub lending come the GFC, and in 2013, they’ve got the shakes.
“The banks seem hesitant to pull the trigger on a lot of publican receiverships,” Tinning observes.
“They’re in a fair bit of trouble, because they’ve got customers who paid $10 million for a pub which is today valued at $5 million, and would probably fetch $3.5 million if it went to auction. Yet the banks’ loan on it would be around the $6 million mark.”
One hates to think how many pub group receiverships there would have been by now if the banks weren’t holding fire.
The latest in a string of groups to have been taken over by receivers is the J & J O’Brien Group, from whom the Australian Pub Fund snapped up the Marlborough Hotel in Newtown late last year (another Singo “heritage” pub, it’s the spiritual home of his beloved Newtown Jets rugby league club).
However, it was a different struggling pub family, the McHughs, who gave the team behind the fund its best deal.
It was early 2009 when Carnegie took a meeting with Patrick “Paddy” Coughlan and Robert “Ned” Kelly, two boys from Bowral who’d done the hard yards as lessees of Sydney pubs before buying one of the roughest, the Grosvenor at Redfern, and turning it around.
“When it came to pub investments, I’d had my cue in the rack for 20 years when Paddy came along and said, ‘seems like there’s a storm coming here, mate’,” remembers Carnegie, who was then still in partnership with the Lazard investment bank. “But he said it was nothing you’d want to do yet - I’ll call you when there is.”
A handshake deal was done to put pub investments identified by Coughlan and Kelly’s Riversdale Group into a new fund, of which Lazard Carnegie Wylie’s private equity fund would be the seed investor. Then, 11 months of silence.
“Paddy showed his maturity by waiting those 11 months. Most people, you give them some money, they’ll spend it for you tomorrow, so that showed a level of discipline,” Carnegie says. Finally, Coughlan got back in touch to say he’d just seen pubs trade in Newcastle and Wollongong at prices that suggested a bottoming of the market. A couple of months later, the Kinselas hotel at Sydney’s Taylor Square went on the block. “Suddenly, people who’d been saying pubs are worth a 3 per cent yield are saying there’s no price too low for Kinselas,” Carnegie recalls. “It was one where trailing EBITDA was $1.6 million and we knew it was going down.
They’d spent $3 million to buy a block of land next door that was going to be their smoking solution, and they had the development approval for that which had taken them a tonne of time.
“We ended up buying the whole thing for $12 million. If you assume the $3 million they dusted is worth $2 million, we paid $10 million for $1.6 million of income.” At a time when private equity deals were regularly trading at 11 to 14 times EBITDA, these upstarts had just bought freehold real estate on exclusive Taylor Square for six times.
“And Paddy had a plan for how the hotel would do better,” Carnegie adds.
Coughlan says the pub industry “assumed we just got lucky” with the Kinselas deal. But he says patience – and rejecting nine out of 10 hotels that come up for sale – have allowed the pub fund to amass $40 million of EBIT to date at “something like” six times. “We think we can get them trading at 11 to 13 times, and that’s going to give investors an unleveraged asset return of 15 per cent, in a world where you’re getting 3.5 per cent at the bank,” says Carnegie.
The strategy to get those returns is a reversal of the mentality that ruled pub investing for a decade. The Australian Pub Fund wants only one-third of its revenue to come from gaming.
Gaming is an “easy target” for revenue-hungry governments, according to Coughlan, who has been careful not to overemphasise it in the portfolio. Dixon vouches for the strategy where food, beverage and gaming contribute roughly one-third of revenue each.
“I’ve got nothing against gambling – how could I? I’m a director of [casino operator] Crown,” Dixon says. “But with the regulatory uncertainty around poker machines, I think it’s dangerous to make it the be all and end all of your pub. We make sure we have a good range of wine, good food, entertainment.”
Pubs have taken over from what the old clubs used to provide, back when pubs were considered downmarket.”
Tinning says the Australian Pub Fund is one example of owner-operators returning to the pub market, after a long period of domination by the tenant-landlord model.
One thing the owner-operators have going for them is alignment of interest, and according to Singo, there is plenty of that in play for the Riversdale boys.
“Paddy and Ned have got their lives on the line, their careers on the line with this,” he says of his pub operators Coughlan and Kelly, who are also major investors alongside him.