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Does Pizza Express have enough dough?

Alastair Barlow examines the fallout from Pizza Express's debt restructuring exercise and considers whether the high street chain will befall the same fate as Jamie's Italian.

23rd Oct 2019
Founder & Chief Dreamer flinder
Columnist
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I’m guessing most readers have either visited or at least have heard of Pizza Express. After all, they are on pretty much every high street across the country.

Pizza Express was founded in 1965 when founder Peter Boizot shipped an authentic pizza oven from Naples, sourced real mozzarella from the only producer in London and started selling squares of pizza at Wardour Street for 10p a slice. The chain has since grown to over 620 restaurants globally.

However, Pizza Express suddenly hit the headlines earlier this month with reports that they've hired a firm to help restructure their rather large debt, which is due to for repayment by 2021.

So, the big question is, will Pizza Express follow the same fate Jamie’s Italian did earlier this year? I don’t think so, certainly not to the same extent. Here’s my rationale for this, but also some lessons for anyone considering a leveraged buyout.

Background

Back in 2014, Hony Capital took over Pizza Express in a leveraged buyout that put in £900m of debt into the group. A leveraged buyout is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.

So, rather than pumping funds in as equity, they put it in the form of debt. And, as we all know, debt attracts interest rather than dividends which would ordinarily be the case for an equity deal. The latter is also only distributable where there are sufficient profits available.

Here are some relevant facts:

  • The chain operates over 620 restaurants across 12 territories and employs 14,000 people
  • It achieved Superbrand status in 2018 (awarded for quality, reliability and distinction)
  • Last audited financials for December 2018 show group revenues of £543m
  • In 2014, current owners Hony Capital completed a leveraged buyout and put in £900m debt into the business
  • There is currently £1.1bn of debt in the group
  • Total financing interest repayments were £93m (a whacking 17% of revenue!)
  • The interest repayments turned the £38m operating profit into a £55m loss before tax
  • Most importantly, £465m of senior debt matures in August 2021

Experience and information

If you were to design the blueprint for the CFO of Pizza Express right now it would probably be pretty similar to Andy Pellington. He has a wealth of experience in the industry and has been at Pizza Express for almost six years: the whole time Hony has been involved.

While he’s had a couple of stints outside hospitality, his main experience aside from Pizza Express is some 17 years, in aggregate, at Whitbread.

Let’s just say he’s got the t-shirt on this one, contrary perhaps to Kraft CFO David Knopf who was just 29 years old when he took the title of its youngest ever CFO: that is before he exited quickly following a 28% one-day share price drop.

Pizza Express financial statements cite ‘senior management teams of each business unit review detailed weekly and periodic information on performance that covers a wide range of financial and non-financial measures to drive performance against key targets.’ This is music to my ears: being on the pulse with financial and operational metrics and KPIs is fundamental to understanding the business and making timely, proactive decisions. Especially important in a consumer business where the market is changing so rapidly.

Business model: Relevance and profitability

The high street is an ever-changing environment with more and more disruption from players like JustEat, UberEats and Deliveroo transforming the way in which consumers are dining.

Consumers dining at home means the group is losing out on high-margin drink sales, which is cutting into overall margins. EBITDA margins at Pizza Express have eroded significantly over the past years (2018: 14.8% compared to 2015: 21.8%) but interestingly they are still higher than Jamie’s Italian had ever been (in 2014 and 2015 a peak of 11.4%).

Just like Jamie’s Italian, Pizza Express operates both an equity and franchise restaurant model. However, Pizza Express has done well to maintain relevance and diversify its distribution model.

In the UK they teamed up with Deliveroo in 2018 and Welcome Break. Not only are they adapting to the changing landscape but they are also diversified through their retail operation too (they sold 32 million fresh and frozen pizzas in 2018 through their supermarket channel).

The market for Pizza Express is far wider than Jamie’s Italian was, given the average cover price. It’s much more accessible and they are experiencing significant growth in China, a key growth market for them.

Overall, Pizza Express know their market and it’s much wider than it was for Jamie’s. You can walk into any Pizza Express and get a consistent experience with a known quality level.

Debt, cash and the parent company

The combination of a heavily leveraged buyout and chasing aggressive growth in China has put a burden of debt on the business. Both the debt (£1.1bn) and interest (£93m) numbers are alarming relative to revenues (£543m), profit and net assets.

The big issue is that £465m of senior secured debt is traded on the Irish Stock Exchange and matures in August 2021. Another £200m is unsecured and matures in August 2022.

The secured debt is trading at 85% face value, but the unsecured debt is trading at 25% face value, implying the market thinks the bondholders could gain control of the company and the unsecured holders could lose out.

However, if you dig a little deeper, a good proportion of this is payable to the parent. The parent company debt is £307m with an additional £159m of interest rolled up into it.

In fact, the parent loan interest (£42m this year) is being rolled up into the capital and so the group cashflows actually had a net cash inflow in the last annual accounts. It could be argued that the parent loan interest is akin to a dividend.

Conclusion

Pizza Express clearly needs to work through the huge debt which is due for repayment in August 2021 but there are options and they are being responsible about focusing on it now. They can either restructure the debt, convert the secured debt into equity or sell, close or franchise restaurants. Or Hony can put in more cash, in the form of equity!

I could be wrong, but to me this high street pizzeria certainly has a lot going for it. Margins may be eroding but they have a healthy-ish EBITDA margin, a wide target market at a reasonably accessible price point, a consistent brand experience, a diversified distribution model and both an appetite and ability to evolve with market changes.

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By johnhemming
23rd Oct 2019 18:24

I would tend to agree. The underlying business is ok and a lot of the debt is to the parent.

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