Lehman Brothers slashed its target price for Mitchells & Butlers to 235 pence from 450, causing an almost 17% drop in the company's value.

While the situation might spell trouble for shareholders, analysts said that the results on the company's hedge positions sit outside the securitization structure and will therefore not affect the bondholders.

Mitchells & Butlers closed its hedge position earlier this year, resulting in a total post-tax loss of GBP274 million ($547 million). The pub operator took out inflation hedges and interest rate swaps in the summer of last year, ahead of a planned GBP4.5 billion property joint venture with investor Robert Tchenguiz.

The restricted dividend payments from the pub operator's whole business securitization leave the parent company short of cash following the closing of its hedge position. Mitchells & Butlers' ability to pay dividends out of the securitization company, Mitchells & Butlers Retail, is primarily governed by the ratio of free cashflow to debt service cover. This ratio must be at or above 1.3 times for dividends to be payable to Mitchells & Butlers by Mitchells & Butlers Retail.

"A dip in performance could affect the dividend stream, but we are not seeing that at the moment," said Guillaume Langellier, director of global infrastructure and project finance at Fitch Ratings. He added that securitization structures have restrictive payment conditions that hinder cash flows from leaking out of the structures and funding dividend payments. "These dividend tests ultimately protect bondholders - it's a standard mechanism in whole business securitizations," he said.

Lehman said that Mitchells & Butlers could possibly find that its capital investment must be cut to retain the dividend payment and that it might need a capital injection. At the end of last financial year, Mitchells & Butlers booked an accounting loss of GBP155 million post-tax resulting from the hedges. The company is expected to take a further GBP119 million post-tax hit in the current financial year, with the settlement of the hedges funded by a special bank facility. Mitchells & Butlers is required to maintain at the end of each financial year aggregate net assets equal to or greater than GBP500 million under the terms of its securitization deal.

The smoking ban is the largest single factor impacting the firm's performance, although it remains cautious on the outlook for consumer spending.

Langellier added that, in the short term, the potential dip in consumer confidence and the creeping inflation costs are probably more of a concern for pub operators. However, most transactions have shown good resilience so far, but performance could worsen for the weaker or less profitable estates. Fitch said it is also possible that lower profitability and valuations could make some of the estates more vulnerable to M&A activity, which should not affect the securitizations except for the normal effects of change in management on medium-term asset performance.

"It is a challenging environment for all pub operators, but you have to bear in mind that the assets in securitizations are at the top quartile in terms of quality and their ratings are currently not challenged," Langellier said. "We are looking at deals on a case-by-case basis, and where there is difficulty it's usually on a specific transaction basis and we do not foresee an industry-wide rebasing."

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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