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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.

9th Oct 2019
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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.”

Replies (19)

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By Justin Bryant
09th Oct 2019 13:33

"Due to the fixed return and consequent lower risk, debt is normally considered cheaper than shareholders funds, Redfern said,..."

How on earth can that be the case? When do you see companies going bust for having too much issued share capital (and not enough debt)?

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Replying to Justin Bryant:
Psycho
By Wilson Philips
09th Oct 2019 15:33

Justin Bryant wrote:

"Due to the fixed return and consequent lower risk, debt is normally considered cheaper than shareholders funds, Redfern said,..."

How on earth can that be the case? When do you see companies going bust for having too much issued share capital (and not enough debt)?

Try reading a little further.

Or else stick to law and leave economics to those that know what they're talking about.

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Replying to Wilson Philips:
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By Justin Bryant
09th Oct 2019 15:55

Blimey, he's right (I misunderstood the context re borrower/lender perspective). There is a 1st time for everything!!!

As an aside, this shows the importance of clear unambiguous writing and a well written article would have made that risk point clear & unambiguous (without having to read further and work out the context).

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Replying to Justin Bryant:
By Tom Herbert
09th Oct 2019 15:57

This guy...

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By kendrylee
10th Oct 2019 10:16

I'm not an accountant, but a lawyer. As someone who specialises in IP (and consequently the value of brands, which will include goodwill - not in the footfall sense), the phrase in the article about the value of intangibles interested me. I am often amazed at the value attributed to these types of intangibles and I suppose, when the chips are down for a business which is going down the pan, the value attributed to intangibles is, well, exactly that, intangible.

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By Andrew3018
10th Oct 2019 10:32

Of whats happening, it feels like the bubble is about to burst again. Big debtors all around, too big that banks just can't let them fall so they lend more to give these companies a chance hence the pile of debt (and perhaps because there will be pile of bankers' commissions). Later on the banks will follow suit... once again and then taxpayers and pensioners will take all the hit. The banks would blame the auditors of course for not raising the going concern issues but the truth is the damage has been done long before auditors come in due to poor financial management. Perhaps its about time to regulate plc companies in terms of debt-equity management.

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By andrew1211
10th Oct 2019 10:59

Why start to blame the auditors? The first big debt repayment £465m was due (August 2021) well beyond a year after the audit report was signed (in April 2019) so no issue as such as long as the banking covenants were being hit. Operating cash flows were very healthy and still are. This is only a story now as the company is making contingencies for that debt repayment and are worried about it. They can probably do nothing and survive until August 2021 although that would obviously be foolish.

The group annual report is a ridiculous 110 pages and the P&L starts on page 60!

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Replying to andrew1211:
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By C.Y.Nical
10th Oct 2019 11:30

andrew1211 wrote:

The group annual report is a ridiculous 110 pages and the P&L starts on page 60!


Is there a market for a service that would take published accounts like this and condense them to standardized reports in accordance with traditional conventions (no IAS16 for example) without any "adjustments" or "normalisations", including a crystal-clear statement of cash flow? As an investor I would subscribe to such a service if the price was right. I find it very difficult to make use of modern company accounts because they are too long and I don't understand half of what they contain despite having been in business for 40 years and learning book-keeping from my father when I was a teenager. Such a service could be named "Old Fashioned Accounts"!
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By AmandaElliott
10th Oct 2019 13:11

‘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.’

Take away the restaurant and the serving staff and in my mind you don’t have hospitality- you are in takeaway territory.

What we as a society needs to decide is whether we all want to just sit in our houses in splendid (relative) isolation ordering in takeaway or whether we want the facility to go out and about in the wider world. The same is true of retail generally and unless we are careful we will end up living in isolation whether we want to or not.

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Replying to AmandaElliott:
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By andrew1211
10th Oct 2019 14:47

True but now you can often order in advance, have it brought to your table, pay on your phone for it so that is almost tantamount to a takeaway service too!

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Replying to andrew1211:
By k743snx
11th Oct 2019 11:09

I think Amanda's hinting we should get off our posteriors generally and get out more. That idea has wider application than what's under discussion here.
~

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By andye
10th Oct 2019 14:26

Would this not be classed as a Zombie company where its leveraged up slack accountants a board that still gets its bonuses . We have and will see this again as these companies fold.

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By Springfield
11th Oct 2019 09:44

The issue that I haven't seen addressed here is how Pizza Express came to have £1.1bn of debt on its balance sheet.

Simplistically, a restaurant should have positive cash flow - customer receipts arrive every day whereas wages are weekly or monthly, rent is monthly or quarterly, and suppliers perhaps on 30 or 60 days so, provided it is profitable, it shouldn't need borrowed money to function from day to day.

What seems to be the case though is that the annual interest cost appears to eliminate any corporation tax liability.

So maybe this story is less about the high street and our eating habits and more about modern business ownership and financing methods?

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Replying to Springfield:
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By andrew1211
11th Oct 2019 10:11

Day to day yes, but what about the massive set up costs of each restaurant? If they wait until operating cash flows delivered enough to set up a new site it would take them 100 years or more to get to the number of sites they have! Herein lies the problem...wanting to expand and to be big and too quickly and in prime expensive locations which is the failing of most of the other chains that have gone belly up to date.

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Replying to andrew1211:
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By Springfield
11th Oct 2019 10:48

£1.6m per restaurant?

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Replying to Springfield:
Hallerud at Easter
By DJKL
11th Oct 2019 23:11

I think the clue will be within this part of the article

"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"

A highly leveraged buyout is I suspect the culprit. (Though have not looked at the accounts/history so merely an educated guess)

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By Jholm
11th Oct 2019 11:29

I like pizza

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By AndrewV12
12th Oct 2019 10:11

I am surprised a Pizza based Company ran out of Dough.

Seriously what were the Auditor supposed to do, raise the white flag, announce the Company was technically insolvent and depart from the Going concern concept, the Company would have gone under with a year, a least they have a bit of a chance of survival now.

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Replying to AndrewV12:
Hallerud at Easter
By DJKL
12th Oct 2019 19:23

Maybe it was the yeast they ought to have done.

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