Greene King may sweeten Spirit offer a tad

Spirit Pub Company, the operator of managed pubs and restaurant chains received a tentative offer from its larger peer Greene King, sending Spirit’s stock up 19%.

Greene King said it approached the board of Spirit about a potential takeover, reported to be worth more than £700m.

Spirit, which runs chains like Chef & Brewer, Fayre & Square and Flaming Grill, confirmed this evening it received a “possible offer” from Punch of 100p per share.

However “there can be no certainty that any offer will be made nor as to terms of any offer”, it added.

Spirit has over 1,200 pubs nationwide, 750 managed and 450 leased, having been spun out of Punch Taverns in August 2011. It reported net income of £54.3m in its 2013 full year, on revenue of £758.2m.

Greene King has an estate of 1,900 establishments including Hungry Horse, Old English Inns and Loch Fyne Restaurants.

Offer price unconfirmed but deal has merits for both

It has not disclosed any further information beyond the talks but the Financial Times reported the firm offered Spirit around 110p following the rejection by Spirit of an 100p offer.

Greene King was not prepared to comment further.

In any case, under the normal process of takeover rules, Greene King now has until 4PM GMT on 21st October to announce a firm intention to make an offer for or walk away.

Having recently sold dozens of tenanted and leased pubs for £75.6m and later pulled out of talks to buy most of the pubs owned by rival Orchid Group, Greene King is increasing focus on its own-managed retail business, comprising restaurants, hotels and pubs.

It’s trying to advance in the broad dining market, identified as a growth business whilst at the same time trying to reduce its low-margin tenanted and leased estate.

As with many businesses like Greene King’s, success can often largely be a matter of scale.

Greene King‘s interest in Spirit comes after the latter reported increasing visibility and efficiency in its fourth-quarter results, earlier this month.

Spirit displayed enhanced like-for-like profit growth with improved cash returns to shareholders, faster expansion and growing cash reserves, despite its management bemoaning “more or less overall flat” growth in restaurants and perhaps “very slight growth” in pubs.

Spirit warrants improved offer though shares look rich

Even if reports of an improved offer of 110p per share are correct, Greene King may have to pony up more cash (and no doubt realises this.)

A company with a market value of £496.45m and no debt, like Spirit, ought to be worth more than the circa 1.45 times value of common equity, implied by a Greene King offer of 110p/share.

However, even after today’s Spirit share price jump of 17.5%, the closing price of 84.5p suggests shareholders are collectively unconvinced by the news of a possible offer.

Additionally, today’s close takes the small-cap stock to its highest level on a closing basis since Spirit listed on the market in 2011.

A further sticking point for Greene King might well be the weaker condition of Spirit’s business before it emerged from a period of reorganisation with firm full-year results in 2013.

During this transitional phase, Spirit’s growth lagged peers and it posted four years of annual net losses on a normalised basis.

One compromise might be to employ a calculation using the current price/earnings ratio applied to forecast earnings for the fiscal year after next (when Spirit ought to be fully back on its feet.)

This gives a target of about 91p/share, 7.8% above the preliminary settlement price of Spirit stock on Monday at 84.56p, with some goodwill implied too.