City focus: M&B's bad bet hits home
It was supposed to be a clever device to save cash. But it ended up as one of the worst pieces of financial engineering in recent history. A disastrous gamble on interest rates has now left the pubs group Mitchells & Butlers with £500m of losses.
Barring a disaster: But pub owner M&B did lose out in a gamble on climbing interest rates
And yesterday, the failed wager - a device to hedge the risk of interest rate movements - claimed its biggest scalp: Tim Clarke, M&B chief executive. Chairman Roger Carr and finance director Karim Naffah have already stepped down. Clarke goes after six years at the helm and after delivering a set of poor results.
Investors were already braced for the 48% fall in profit. But they were unaware of the extra £96m hit from the interest rate hedge. It was the final undoing of Clarke.
It was an ill-judged decision to take out the insurance policy which was meant to negate the risks of a sharp rise in borrowing costs. But they don't always work - as Clarke has found to his cost.
Investors had already stomached a £390m loss at the hands of the hedge last year and hoped that was an end to the matter.
But the unexpected hit was the tipping point for Clarke, in charge of a chain of 2,000 pubs including the Harvester and All Bar One chains spun out of Six Continents in 2003.
He had already offered to resign last year, but was asked to stay on in his £573,000 a year job by the board. But his position was 'clearly untenable' after the latest disaster, said one insider.
'In the light of the crystallisation of the swap loss, Tim Clarke has tendered his resignation, which has been accepted,' the firm said adding that he 'will leave by mutual agreement'. Adam Fowle, currently chief operating officer will become acting chief executive as the company seeks a replacement.
The arch-conservative Clarke took out the hedge as an insurance policy because he thought interest rates were on the up.
But it all went wrong following the collapse of a property joint venture with Iranian tycoon and investor Robert Tchenguiz at the beginning of last year. The plan was that M&B would put the majority of its pubs into a separate investment vehicle that would be jointly owned by Tchenguiz.
The pubs boss took out an insurance policy to cover interest rates movement on debt he was raising to fund the aborted deal. His mistake was not closing off the hedge earlier as it rang up the giant losses.
New chairman Drummond Hall said that while the latest cost arising from the hedge was a slightly different issue, Clarke felt he had to go. 'Tim is a man of huge integrity and honour,' said Hall. 'He felt it was a real body blow last time and this time he felt strongly that he should go. He consulted with large shareholders over the last week and they did agree with Tim that his position was untenable.
'Tim felt he could now go with honour. He has left the business in good shape. Debt is under control and financially we are very strong.'
The half year figures tend to bear this out, even though profits for the six months to April fell 48% to £44m.
Much of this was due to the hedge hit and a reduction in the value of its property. Underlying sales actually rose 1.5%, suggesting the business itself is in reasonable health.
In fact analysts say M&B is one of the best performing pubs groups in a sector strewn with heavily indebted firms hit hard by the recession.
But the broader problem striking fear into the heart of the City is the other firms, yet to surface, caught out by the sudden plunge in interest rates over the last six months. Collapsed New Star lost £17.2m on an interest rate hedge, and in March Big Yellow paid £15.2m to end hedges. Private equity firms loaded themselves up with debt during the boom times and a bad bet could push some businesses over the edge.
NCP Carparks, in which 3i is an investor, was hit by £2.9m of hedge costs and Trader Media, backed by Apax and Guardian Media Group, still has a £441m hedge.
This looks like the end of the hedge debacle for M&B. But it could be just the beginning for others.
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