The U.K. pub industry faced several regulatory upheavals in 2004, yet with two deals already priced this year, things are looking up. Industry sources expect a better year for the sector, and maintain that the effects of the new regulations may not be as dire as some have anticipated.

One key issue is the partial smoking ban on British pubs expected to take effect in late 2008. The ban would apply to all bar areas as well as licensed premises that serve food.

The smoking ban is already in place in parts of Ireland, and Scotland plans to implement a smoking ban in all public places. Wales has not yet indicated whether it will adopt a no-smoking policy, but analysts expect the country to implement rules similar to either the Scottish or English policy.

England is drafting a plan that would give non-food serving pubs a choice in implementing the smoking ban.

"Proposals for a smoking ban in England were contained in the Health White Paper published on 15 November, last year," explained Royal Bank of Scotland structured finance analyst Michael Cox in his report on the industry.

"The paper only sets out the broad themes, and does not define exactly how a ban would be implemented; leaving a lot of questions unanswered, and therefore presumably open to consultation."

Under the White Paper proposal for the English ban on smoking, all restaurants would be smoke-free; pubs and bars preparing and serving food would be smoke-free; non-food serving pubs would be allowed to choose whether to allow smoking or to be smoke-free; and smoking in bars would be prohibited everywhere. The deadline for implementation of this regime is 2008, and roughly 10% to 30% of these pubs could fall into the "do not prepare food" category.

It's difficult to predict what immediate impact this ban could have on pub revenues, industry sources said. Conflicts of opinion have arisen in various reports out in the market. "As analysts have sought to gain an understanding of the likely impact of such a ban on England's licensed trade, many have drawn conclusions based on the experiences of other countries," explained analysts at Fitch Ratings.

"However, we have avoided this route for several reasons: unbiased reports are hard to come by; the drinking culture in England differs substantially from that of other nations - the obvious exception being Ireland; the pub industry in Ireland is very different from that in England; and the implementation of the Irish ban followed a much shorter notice period, which gave the industry little time to adapt to the changes."

Scotland announced its smoking ban shortly before the White Paper on the ban in English pubs was announced. Even Scotland's total smoking ban should have little impact on the performance of pub securitizations, as none of the estates included in existing securitizations have Scotland exposure greater than 8%. "The impact of the Scottish ban on pub securitizations will be limited because only a small proportion of each estate is located north of the border," explained RBS' Cox.

"Arguably, one benefit of the ban in Scotland is that it will be across the board. There is therefore less potential for the impact to differ between pubs, which should result in less disruption overall."

Because the ban is partial in England, it could selectively disrupt sales figures for those pubcos that are required to implement the full ban.

"Drinkers wishing to smoke, who are willing to go to a pub that does not serve food, will go to smoking pubs; however, anyone wishing to eat (whether a smoker or a non-smoker) will have to go to a pub that, by definition, will be non-smoking," added Cox. "This adds a complication that will not be seen north of the border."

Pubs that are not distinctly a food or a drink venue stand to bear the brunt of the new rules, said Cox. These pubs can vary from food-led to drink-led depending on the day of the week - and the time of day - and risk losing food revenue by forgoing the ban, or alienating their core evening and weekend drinkers.

Among the names that come up are Yates' Wine Lodges, the local offering from managed pubcos Mitchells & Butlers (Arena, Ember) and Spirit (Barras), and many leased or tenanted pubs. "Given that this type of pub is found in every portfolio, and is probably the most common type of pub in the U.K., it is difficult to determine which pubcos are most exposed," said Cox.

The drop in cashflows expected during the first year the ban is in place should be fully recovered in the two years that follow, Standard & Poor's analysts said.

Therefore, pubcos should be able to pay the securitization debt backed by their operating businesses, analysts added. The expectation is that any fall in revenues will be softened by various factors, notably that the pubcos - especially those that have already introduced a voluntary ban - have a long lead-time to take mitigating actions.

However, the slowdown that is likely to follow the implementation of the partial ban in England could leave the sector more open to consumer spending vulnerabilities.

"With the current plans for a smoking ban likely to polarize the market into pubs that do not serve food but do allow smoking, and those that serve food and do not allow smoking, we believe the former to be more vulnerable to recession than previously assumed, particularly as they will be unable to draw in customers with a value for-money food offer," said Cox.

"In the event of a slowdown in consumer spending, we would feel less comfortable with pub exposure than ever before."

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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