Last week's long-awaited parliamentary decision in favor of a blanket smoking ban in U.K. pubs left the establishments with their most favorable scenario.

The concern had been that while pubs and restaurants would face the ban, private members' clubs might be exempted (ASR, 1/16/06). According to the British Beer & Pub Association, more than 20,000 private clubs are registered in England and Wales. Implementing a partial ban that excluded these clubs would have created an uneven playing field and could have caused a loss of business for pubs to the private clubs.

"The blanket ban allows pub companies to compete on an even footing with private members' clubs and negates pub landlords' fears that smokers would desert their establishments in favor of venues where smoking was allowed," said Paul Crawford, a director at Fitch Ratings. "An exemption for private clubs would have presented a competitive challenge to landlords, although it is questionable that such a ruling would have led to a wholesale change in where people drink.

"Members' clubs already offer a different drinking experience, and if people aren't using them now, it seems unlikely that large numbers would have joined such clubs solely to smoke."

In line with Scotland, Northern Ireland

The outright ban puts England in line with Scotland, which will implement its ban at the end of March, and Northern Ireland, which implemented its policy last year. Fitch analysts said a number of the pub companies behind pub whole business securitization transactions have exposure in Scotland, and can use their experience there as a learning tool for what awaits deals with exposure to pubs in England.

Capital expenditure requirements are expected to increase as pubs adapt to the new environment. Crawford said Northern Ireland pubs are spending more money improving outside areas and the same is likely to be seen in England.

The timetable for implementing the ban in England has not been finalized, but it is widely expected to be the summer of 2007.

"How much of a risk the ban poses really depends on how quickly the legislation is put through," Crawford said. "The pub industry is set to lobby hard to make sure that deadline gets put back as far as possible."

With many pubs looking to make up to 70% of their space available to nonsmokers, extending the ban would give these establishments time to feel out the impact of converting the space to being 100% smoke free.

A REIT possibility?

Mitchells & Butlers, an operator of managed pubs in the U.K., may be considering selling the bulk of its estate into a real estate investment trust. Karim Naffah, the finance director at Mitchells & Butlers, told Finance Week that the REIT option would be considered to the extent that it would result in enhanced value for the company's shareholders. According to Deutsche Bank, any proposed sale would allow management to focus purely on managing the pubs, with the underlying premises being leased from the REIT.

Under the preliminary proposals for U.K. REITs, Mitchells & Butlers would be able to hold a maximum 10% stake in the underlying REIT.

"The sale of the company's pub estate is likely to constitute a change of control from the securitization perspective, though there is nothing in the terms of the deal language that would restrict this, with trustee consent only being required," said Deutsche Bank in its European Asset-Backed Barometer.

But a spokesperson at the pub company said selling its estate into a REIT is not an option that works at the moment. To do so, the company would have to spin the REIT into a separate business.

"The leverage restrictions in the current proposals suggest that REITs and pub securitizations are unlikely to work effectively together," said Michael Cox at the Royal Bank of Scotland.

Crawford said some pub companies already use sale and lease-backed transactions. The Spirit Group completed two such transactions in 2002.

"Using REITs is a relatively new concept in the U.K.," Crawford said. "I imagine the motivation for doing such transactions would be whether there is an arbitrage between the debt quantum that could be raised via a whole business transaction versus a property transaction."

Mitchells & Butlers Finance has GBP1.84 billion in outstanding securitized bonds.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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