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Hedge Closure, Strategy and Trading Update

Mitchells & Butlers announces that following a recent and rapid deterioration in the mark-to-market deficit on the hedges taken out in connection with last year's proposed property joint venture, and with no near term prospect of debt markets permitting a property-based transaction, it has closed out in cash the hedges no longer required at a cost of £274m post tax. The Board intends to conduct a strategic review for value creation in parallel with the management focus on ensuring continued operational out-performance from the integrated business to capitalise further on the Company's position of competitive strength.


  • Resilient performance in a challenging trading environment: same outlet like-for-like sales up 0.7% in first 17 weeks
  • Strong market share gains: same outlet food sales up 4.6%, drink declines limited to 1.1%
  • Continued growth in Scotland during second year of smoking ban; same outlet sales up 4.4% in first 17 weeks


Background to Hedges

Following a rigorous review of its property assets, which included extensive consultation with shareholders during the first half of 2007, Mitchells & Butlers pursued a joint venture transaction in order to liberate shareholder value. R20, an investment company owned by Robert Tchenguiz, had made the most attractive offer to participate in this OpCo/PropCo structure.

As previously announced last August, Mitchells & Butlers and R20 were in final negotiations with banks in July 2007 to put in place a financial package for the proposed joint venture, aimed at maximising shareholder returns. Putting in place hedges on interest rates and inflation rates was a fundamental requirement of the banks to underwrite the junior debt facility and to achieve the appropriate ratings from the rating agencies on the senior debt. Following receipt of written credit-approved debt terms from the banks, Mitchells & Butlers and R20 separately entered into a number of debt hedging arrangements intended to be contributed to the joint venture, to underpin the delivery of a successful transaction. The process was started in mid-July, two weeks before the planned announcement date of the transaction. This was on the banks' advice that the hedging could take some time to execute given the relatively low liquidity of the inflation swaps market.

Whilst the details of the debt package were being finalised with the banks, there was a material adverse change, with debt market conditions suddenly deteriorating in late July and the credit-approved debt terms from the banks were withdrawn. This left Mitchells & Butlers and R20 with hedge instruments in place but unable to fund the transaction.

Retention of Hedges

General expectations in the Autumn were that the disruption in the debt markets would be temporary. The Board received bank advice that an OpCo/PropCo transaction, if scaled back from the original debt levels, should be capable of execution. The evidence at the time continued to suggest that significant value could still be captured for shareholders by such a structure.

In November, Mitchells & Butlers received a proposal from R20 for a partial underwriting of a demerged REIT structure which the Board believed it should evaluate, as announced at the time of the Preliminary Results last year. However, during December, as the credit crunch worsened, it became clear that even the most modest debt package required for a REIT structure could not be secured then and the future prospects for such debt raising have deteriorated further in January.

As a result, there appears little prospect in the near term of market conditions permitting the delivery of such a structure on attractive terms that would create material value for shareholders.

Closure of Hedges

In December and early January, the mark-to-market deficit on the hedges continued to be volatile but not materially different from the post-tax loss of £180m previously reported. However, the more recent instability in the financial markets led to a further sharp deterioration in the position. In these circumstances, maintaining the hedge position to utilise in a property-based transaction, which was now highly unlikely to occur in the near future, became a risk that could no longer be justified despite the challenge of exiting in an illiquid market. As a result, the inflation hedges and the interest rate swaps no longer required have been terminated at a total cost of £274m after tax. A portion of the interest rate swaps will be retained to cover some £300m of debt outside the securitisation as this will form part of the Company's core long term debt structure. The latest mark-to-market deficit to income on these swaps was approximately £22m post tax.

The settlement of the hedges will be funded from a bank facility specifically set up for this purpose and is expected to take the Company's balance sheet gearing, on a proforma basis, to approximately 67%, compared to 61% reported at the year-end. The additional debt cost resulting from the closure of the hedges is expected to reduce post tax earnings by approximately £13m in the current financial year, of which £4m will be incurred in the first half.

At the end of last financial year, an exceptional accounting loss of £155m post tax was booked in respect of the hedges. The above settlement of the majority of the hedges results in a further £119m post tax exceptional loss which will be taken in the current year.

Management Change

Management, supported by advisers and the Board, acted professionally and diligently in the preparation of the financial package for the proposed joint venture with R20 and the subsequent retention of the hedge, but fell victim to the global credit crunch which began in the midst of the final execution of the transaction. Nevertheless, in light of the cash loss incurred, the Finance Director, Karim Naffah, has tendered his resignation, which has been accepted. He will leave Mitchells & Butlers by mutual agreement.

The Chief Executive, Tim Clarke, also tendered his resignation, however this was declined as the Board believes it is in the best interests of the Company that he should continue to lead the operational out-performance of the business.

Jeremy Townsend, currently Deputy Finance Director, will be appointed to the Board as Finance Director.

All executive directors, including Mr Naffah, will forego their 2007 bonus awards in recognition of the large loss suffered by the Company from the hedge closure.


The Board remains committed to the goal of further developing Mitchells & Butlers as the market leader in the managed pub sector, and maximising shareholder value.

Management Focus

The pub sector is facing some of the strongest challenges it has encountered for many years. In this context, we believe the current emphasis must be on managing the business to maximise profitability and capitalise on our position of competitive strength. To that end, management will focus on the delivery of operational out-performance, through further market share gains, cost reduction and strengthening the balance sheet by disciplined cash and asset management.


The Board remains committed to value creation and would, if market conditions recovered sufficiently, seek a structure which successfully demonstrates the full value of the property whilst underpinning the robustness of the operating business.

In the interests of providing full and transparent information to investors, we believe it is appropriate to reflect more explicitly the component parts of the operating and property elements within the integrated business. Since the Preliminary Results, we have moved to regular revaluations of our property and will continue to monitor and report the open market rental levels for all of our freehold and long leasehold property.

To add to the Board's property expertise we will seek to appoint a non-executive director with specialist property knowledge.

Strategic Options

In the absence of a property transaction, the Board will undertake a review of strategic options for value creation. This will be pursued in parallel with the management focus on delivery of operational performance to capitalise further on the company's position of competitive strength.


Trading has continued to be resilient in a very challenging environment with same outlet like-for-like sales growth for the first 17 weeks up 0.7% on the comparable period last year. This reflects substantial market share gains against the background of the adverse impact of the first winter of trading since the start of the smoking ban in England and Wales. Since the update at the end of November the trading pattern was: a weak first three weeks of December; strong trading over the Christmas and New Year break; followed by a satisfactory January to date, resulting in like-for-like sales up 0.2% over the last 10 weeks.

Our Residential pubs same outlet like-for-like sales in the 17 week period were up 0.8% which includes an uplift in Vintage Inns sales as a result of the new menus and our margin reinvestment strategy. On the High Street same outlet like-for-likes were up 1.0% with Central London remaining in good growth.

Food sales have been strong with same outlet like-for-likes up 4.6% in the 17 weeks reflecting a further increase in the number of consumers being attracted by the quality and value of our pub food offers. In drinks, our market share gains have accelerated in the face of on-trade beer market volume declines of approximately 9% over the period*, with our same outlet like-for-like drink sales decline limited to 1.1%. The divergent trajectory of these product categories is in line with our experience during the first winter of the smoking ban in our Scottish pubs.

In the 30 weeks since the introduction of the smoking ban in England, same outlet like-for-like sales for our English pubs not previously converted to non-smoking have increased by 0.6%, with food sales up 4.9% and drink sales down 1.0%. The trading in our Scottish estate continues to show good growth in the second year of the ban with same outlet like-for-like sales in the first 17 weeks of this financial year up 4.4%.

The Acquired Sites conversion programme has been rapidly executed and will be completed by the half-year with 181 pubs now converted to our brands and formats. In the more difficult consumer environment, average weekly sales uplifts on these converted sites are running at approximately 17% above the levels at which the pubs were acquired and we will continue to develop the trading performance of these pubs to deliver our year three target of 30% sales uplifts in the 2009 financial year.

We remain cautious on the outlook for consumer spending and in particular, the near term prospects for the on-trade beer market. Against that background our strong food sales growth and substantial drinks market share gains reflect our competitive focus on amenity, service and value. However, the smoking ban has accelerated the shift in the sales mix to food which is having an adverse impact on gross margins. In addition, rising food inflation continues to put upward pressure on costs. To offset the impact of these pressures, strong management action is being taken to reduce both fixed and variable operating costs by some £20m although even with the implementation of these plans it will be challenging to maintain fully net Retail margins for the year, particularly in the first half.

The evidence from Scotland was that the first winter of the smoking ban in our business saw the bulk of the loss in beer and machines sales, followed by sustained growth in sales of food, soft drinks and wine.

The quality of our estate, the competitive strengths of our brands and formats, our leading position in the eating out market and our value for money offers are generating substantial market out-performance and we expect continuing strong market share gains with improved prospects after the 1 July anniversary of the smoking ban.

As a result of the actions being taken to drive sales and reduce costs, we expect a resilient Retail operating performance for the year as a whole against trading conditions which are set to remain highly challenging. Whilst the cash loss from the hedges, which the Board very much regrets, will impact earnings in the current year, the competitive operational out-performance of the business continues to strengthen.

This announcement is Mitchells & Butlers' Interim Management Statement for the 17 week trading period to 26 January 2008. We will announce Interim Results for the 28 weeks to 12 April 2008 on 20 May.

* Industry data for October to December

There will be a conference call for analysts and investors at 9.00am; please dial +44(0) 207 162 0025. The replay will be available until 5 February 2008 on +44(0) 207 031 4064, passcode 782762.

Appendix: Like-for-like sales

17 weeks ended 26 January 2008

Same outlet like-for-like sales growth

Uninvested like-for-like sales growth




High Street






Note: These results include the Acquired Sites

For further information please contact:

Investor Relations:


Erik Castenskiold

0121 498 6513



Kathryn Holland

0121 498 4526

James Murgatroyd (Finsbury Group)

0207 251 3801

Notes for editors:

  • Mitchells & Butlers owns and operates around 2,000 high quality pubs in prime locations nationwide. The Group's predominantly freehold, managed estate is biased towards large pubs in residential locations. With around 3% of the pubs in the UK, Mitchells & Butlers has 10% of industry sales and average weekly sales per pub over three times greater than that of the average UK pub.
  • Mitchells & Butlers' leading portfolio of brands and formats includes Ember Inns, Harvester, Sizzling Pub Co., Toby Carvery, Vintage Inns, All Bar One, O'Neill's, Nicholson's and Browns. In addition, Mitchells & Butlers operates a large number of individual city centre and residential pubs.
  • Jeremy Townsend joined the Company in June 2005 as Deputy Finance Director. He was previously employed by J Sainsbury plc where he held various finance roles including Group Financial Controller, Corporate Finance Director and Strategy Director. Prior to Sainsbury's, he was employed by Ernst & Young working in audit and corporate finance. Jeremy is a Fellow of the Institute of Chartered Accountants of England and Wales.
  • The "Acquired Sites" are the pub restaurant sites purchased from Whitbread plc in July 2006.
  • Same outlet like-for-like sales include the sales performance for the comparable period in the prior year of all managed pubs that were trading for the two periods being compared. For the 17 weeks to 26 January 92% of the estate is included in this measure.
  • Uninvested like-for-like sales include the sales performance for the comparable period in the prior year of those managed pubs that have not received expansionary investment of more than £30,000 in the two periods being compared. For the 26 weeks to 26 January 82% of the estate is included in this measure.

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