Pizza Express calls in advisers as debt mismanagement criticisms mount
Pizza Express faces wipe-out under crippling debt repayments that could rob the high street of another familiar name. AccountingWEB spoke with business experts to find out what went wrong to leave the dining business staring at oblivion, despite turning an operating profit.
Popular high street chain Pizza Express has served a slice of Italy to British diners since 1965 when it first opened in Soho, London. However, the chain has called in advisers ahead of talks with creditors as falling sales have left one of the country’s favourite franchise restaurants struggling to pay off its loans.
The business employs more than 14,000 people in more than 600 kitchens around the world but is now saddled with debts that average around £1.6m per restaurant, following a buyout in 2014 from Chinese private equity firm Hony Capital.
In difficult trading conditions, Pizza Express reported a 0.2% rise in like-for-like sales in the first half of 2019 but also posted a 7.7% fall in underlying earnings for that period.
The 54-year-old company has until August 2022 to repay £655.6m of its total £1.1bn debt and is now enduring the same woes as fellow chain restaurant casualties Jamie’s Italian, Byron and Strada.
“Pizza Express ran an operating profit, which on the face of it does seem like the company should be in a reasonable situation despite the falling sales over the last few years,” said Rick Smith, managing director of turnaround and restructuring experts Forbes Burton. “However, operating profit is calculated before debt repayments. Once the debt repayments had been factored in, this wiped out any profit and showed losses.”
Despite recording sales of £543m in 2018, the interest on the debt alone is costing the company around £93m a year, said Smith, leading to the loss of £55m per year.
Questions for the auditor
“The company accounts were signed off by its auditors last year even though its debts outweighed its assets,” said Smith. “This would normally be a red flag as technically the company is insolvent at this point. However, because the company was pulling in plenty of cash, the auditors concluded it was a viable going concern.”
Smith believes the role of the auditors should be closely scrutinised. PwC signed off Pizza Express’s most recent accounts but declined to offer comment for this article.
“How was the situation able to move beyond when they did the accounts? Shouldn’t action have been taken earlier on?” Smith said. “Measures should be in place to make sure that if auditors are not working responsibly, then they need to be accountable.”
The £900m of intangible assets, primarily goodwill and brand value, represent the directors and, as a result of their audit opinion, PwC’s judgment on the value of future cash flows, said the Forbes Burton expert.
“The EBITDA (earnings before interest tax depreciation and amortisation) has been falling over the last couple of years, suggesting these budgets must have an amazing hockey stick to support this valuation,” he said.
A ‘hockey stick projection’ refers to flat results on a chart that soar upwards dramatically for future years, in the shape of a hockey stick blade.
Ian Smith, general manager and finance director at document management specialists Invu, is in agreement and said these issues appear to have been buried deep in the financial reports.
“The current trajectory on cash flow suggests that the debt due to be repaid in August 2021 and August 2022 would have to be refinanced. This is a clear assumption in the December 31, 2018 accounts,” the Invu director said. “You have to ask why the Pizza Express balance sheet is like a thin crust pizza base (equity) that has become all toppings because it is overburdened with debt.”
The pair said they were hopeful a solution could be found, as the business was doing well, albeit in need of at least £100m in capital funding.
High-risk strategy, high street slump
The restaurant chain has hired Houlian Lokey, a financial adviser, to help it work through the difficulties. However the general economic slump impacting Britain’s mid-tier restaurant chains may make turnaround difficult, said Nic Redfern, finance director at KnowYourMoney.co.uk.
“Businesses loaded with debt are described as highly geared,” Redfern said. “That means that less shareholder funds are used for growth as more third party borrowing is used.”
Debt has a fixed return, payable as interest, whereas shareholders funds have no fixed return, although shareholders do expect a return via dividends.
Due to the fixed return and consequent lower risk, debt is normally considered cheaper than shareholders funds, Redfern said, and so using debt allows greater investment in growth allowing businesses to grow rapidly with lower levels of shareholder investment.
“This is great when businesses are growing, but as the high-interest cost is fixed it makes the business more sensitive to downturns in performance as the business is unable to meet its interest liabilities,” Redfern said. “If the financing was by shareholders funds, the company would not be obliged to pay dividends. Most businesses use a mixture of debt and shareholders funds to provide a balance of risk and cost.”
Neil Robertson, executive chairman of budgeting software company Compleat, added that Pizza Express has ultimately fallen victim to changing business models which meant online delivery services could offer the same service at a much cheaper cost.
“For the hospitality sector, removing all of the serving staff and physical space for customers and focusing on just production and distribution delivers the disruptive model that is killing the old restaurant industry and Pizza Express is just the latest, not the last,” said Robertson. “No surprise, as the same is true for every sector (whether B2B or B2C) where you can remove every unnecessary aspect of the cost (including accounting for it) and make higher margins than legacy businesses, whilst selling at a lower cost.”
Can it be rescued?
Lessons to be learned include making sure that a company’s debt never outweighs its assets, experts agree.
“The solution may prove to be a bit like scraping too much cheese off the toppings on your pizza,” Smith of Invu said.
It is likely that many of the chain’s stores will be sold, and staff redundancies are inevitable to make inroads into the debts, they said, as the firm considers other ways of restructuring.
“Pizza Express may be able to be saved, but they are still going to have to weather the ongoing changes to the high street,” said Smith of Forbes Burton. “The same changes that have claimed many big names recently. “The only good news is that recognition of the situation seems to have come about a bit earlier than it did for the likes of Carillion and Thomas Cook.”