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2013

2014 FEBRUARY

STATE OF THE NATION: HOSPITALITY

CONTENTS

Section Page

WELCOME 3

1 KEY ISSUES: Our ringside perspective 4

2 A ROUND OF DRINKS: Developments around the country 6

3 TECHNOLOGY: Are you wired for success? 7

4 RAISING THE BAR: Precinct profiles 9

5 IT’S A JUNGLE OUT THERE: The competitive landscape 10

6 BEHAVING RESPONSIBLY: Legislative pressures, compliance and costs 13

7 2013 DEAL REVIEW: Consolidation, market sentiment and float 19

8 OUTLOOK FOR 2014 22

9 CONTACTS 23

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WELCOME

February 2014 Welcome to Ferrier Hodgson’s 2014 Hospitality State of the Nation report, detailing our analysis of the key developments and events of 2013, and the outlook for 2014. The hospitality sector has been the focus of significant media coverage over the last 12 months. Enormous political and social pressure to reform gaming was significantly diluted by the wider gambling industry issues, and then relegated to the backburner following the election. After a series of tragic events in the Sydney Kings Cross late-night precinct, alcohol-related violence drew the attention of the public and the media and NSW Premier O’Farrell’s tough response is likely to create some structural shifts in the NSW hospitality sector. Despite these challenges, the sector remains dynamic and thriving. Social media and a focus on the customer experience continue to raise the bar for quality and service, which is good news for consumers. The rise and rise of small bars and greater expectations of customers demand a higher standard from hospitality-sector participants which continues to emphasise the gap between the successful operations and the less successful. During 2013, Ferrier Hodgson’s Hospitality Team managed a number of high profile and challenging hospitality sector matters, including the Annandale Hotel and the Heritage Group. We also hosted many of our clients at popular pop-up bar events, providing an opportunity to network with industry participants and players, brokers, valuers and financiers. We look forward to seeing you at our next event. No doubt the year ahead will continue to be interesting, and as always there will be winners and losers as businesses respond to the rapidly changing landscape. The Ferrier Hodgson Hospitality Team is ready to assist you in navigating this challenging environment. I hope you find this publication useful and informative. Best regards,

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Morgan Kelly National Hospitality Practice Leader

1. KEY ISSUES Our ringside perspective

We have spoken with key industry contacts on a selection of big picture themes including the dual effects of rising costs and increasing competition, and the intensifying pressure from anti-social-behaviour legislation. With the sector as a whole continuing to experience limited revenue growth and declining alcoholic beverage volumes expected over the next 12-18 months, competition for consumer discretionary dollars is intensifying. The Ashes tests are over and the next Lions rugby tour will be in 12 years, so we won’t see the Barmy Army coming to the rescue in 2014.

Given the flat revenues and increased levels of competition expected in the sector, holding market share will require a renewed focus on the key areas of product offering, customer service and cost control.

The need to innovate and the ability to adapt to changing market conditions is what separates progressive operators with growth prospects from traditional operators whose only route to improved financial performance is through cost reduction.

The lower Australian dollar is expected to provide some relief for the sector, driving an increase in inbound tourism and a rebound in domestic leisure spending as overseas holidays become more expensive. The sector should see a corresponding rise in economic sentiment as consumer confidence returns and drives increased visitation and spending.

Transactional activity, which rose in 2013, is expected to continue to improve as access to funding is facilitated by lenders competing for market share and the cost of debt remains relatively low. However, the market is likely to be affected by lock-out laws in Sydney and Adelaide which may subdue transaction activity as exposed operators and lenders adopt a ‘wait and see’ approach. A number of opportunistic vendors are repositioning their portfolios and we expect to see distressed assets continue to be brought to market, particularly in regional areas

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*Hipster culture – Urban cheesemongers and mustachioed greengrocers, with their organic fruit and vegetable smoothies, making creative waves and setting trends.

Source: Huffington Post

Key issues for 2014 are: • A number of major transactions and strategic moves

are being executed; in particular, we have seen the exit of Coles from the NSW pub market at the same time Woolworths has doubled its holdings. We look at the significant transactions for the year in Section 7 of the report.

• Liquor act reviews are being conducted across the country, and the recent tragedies in key hot spots have seen on-premise venues under intense scrutiny from governments, media and public interest groups. Lock-outs, service restrictions and identification scanners are being imposed or proposed in high-risk precincts across the country. These changes threaten to have a significant impact on revenue and profitability, particularly for late-night gaming venues. We anticipate revenue declines of up to 30 per cent across affected areas. We address the implications of these legislative changes in Section 6 of this report.

• Technology and social media continue to have a growing influence on the sector. While venues exist as places for social interaction, it is becoming increasingly important for venues to interact with their guests online.

• Up, up and up – Rising costs across the key expense areas of wages, rent and cost of goods sold (COGS) are being compounded with new costs including the carbon tax and additional compliance requirements. In the face of flat revenue growth forecasts across the sector and intensifying competition, it is becoming increasingly difficult for operators to maintain profitability. Progressive operators are now competing to retain the best staff and ensure they do not carry expensive ‘dead wood’ on their teams.

• Small bars continue to grow, particularly in NSW, WA and SA. Hipster culture* is now influencing the broader sector as operators of boutique bars, generally attracted by cash-flow and lower entry costs, take advantage of consumer trends towards customisation and premium service offerings.

1. KEY ISSUES Our ringside perspective

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2. A ROUND OF DRINKS Developments around the country

• CBD precinct enforced lock-outs and closing times with the real threat of state-wide implementation

• Three-strikes legislation • Small bar proliferation

NSW

• Gaming operators now control their own gaming performance destiny, leading to further consolidation

• Changes to the gaming tax rates in 2014

VIC

• Government alcohol management plan - March 2014

• Ban on motorcycle gang colours • Changes to allow $50 and $100

notes for pokies entry

QLD

• Retail liquor sales restrictions to reduce indigenous drinking issues

• Banning of motorcycle gang colours

NT

• Liquor Act review findings handed down in 2014

• Slowing of economic growth with mining boom moving to production phase

• Small bar proliferation

WA

• Adelaide - enforced lock-outs and closing times

• Small bar proliferation • $250 ATM withdrawal

maximums

SA

• Recovery plans for operators after changes to gaming promotions saw lower revenues in 2013

TAS

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3. TECHNOLOGY Are you wired for success?

Key segments of the population will now investigate bars and restaurants on Google, read blogs and online reviews and ask their online networks, friends and peers for informed advice.

Whilst connecting with new and existing customers is great news, it is pointless without controls in place. Of vital importance to every business is an integrated point of sale (POS) and inventory-management system enabling tight cost controls, margin analysis and profit maximisation. Combining rostering and time-and-attendance systems with effective gaming, POS and inventory management programming allows business management to be fact-based rather than relying on gut feel.

Dash is a payment app for bars and restaurants, linked directly to a venue’s POS.

Customers who download the mobile app can settle their restaurant and bar tabs, even before they’ve been handed the bill. Customers “open a tab” when they arrive at the business, and they can pay with their phones whenever they’re “ready to dash”. Faster service and payments with no cash changing hands, tips calculated, bills split and regular customer information stored. Although presently only available in the US, we expect to see similar apps appearing in Australia soon.

Whilst consumers cannot dine or sleep online, they can research, book, pay for and share their experience with others via a smartphone, tablet or computer. They can also have a full gaming experience with online poker, gaming and sports betting services. In the accommodation sector, online bookings now account for over 70 per cent of all reservations, and increasingly consumers are making decisions about what venue to visit via online research.

Successful operators are adapting to this and employing engaging and creative marketing techniques to expand their client-base, increase market-share and grow turnover.

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How fast is your Wi-Fi? With connectivity rating as a key feature for the 18-25 year old market, and the potential for online gambling to grow significantly over the next five years, a fast and reliable connection to the internet will be vital for progressive operators. For accommodation providers, the speed and coverage of a hotel’s internet is a key influencer for repeat visitation.

Reservations made online, via sites such as Dimmi, currently only account for two per cent of all Australian bookings. In San Francisco this figure is now 50 per cent of all bookings. More than 30 per cent of these are made from mobile phones and nearly 50 per cent less than six hours before seating.

Source: Dimmi bookings analysis

Social media and online review sites allow for excellent marketing and customer engagement opportunities, however, they can also be destructive. Sites such as www.urbanspoon.com.au can make or break a venue, and management responses to criticism are vital. An integrated technology strategy requires a focus on engaging with consumers and tailoring your product offering. Social media is a key component in achieving this. We are seeing quality operators take market share from those without a forward-thinking plan.

A number of different cloud-based management tools can assist you to better manage your business, including scheduling, time and attendance, communications, point of sale, financial accounting, invoicing and inventory management.

The outlook Venue presentation, product offering and service will never lose relevance and will ultimately drive repeat business and improve the underlying asset value. However, increasing competition and changing consumer tastes mean that every business needs to clearly communicate its value proposition to ensure repeat visitation from regulars and attract new customers.

Online gaming The Federal Government has banned online gambling for money, however, major gaming operators and the club sector face very real competition from international gambling sites. Guidance from the government indicates there will be no change to legislation in the immediate future, however, with access to international sites very difficult to control, we anticipate changes will need to be made in the not-too-distant future. The trend in Las Vegas is for casinos to offer online gaming where credits earned are redeemable for services in the venue. The Australian gaming sector needs to prepare for similar trends.

3. TECHNOLOGY Are you wired for success?

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http://www.urbanspoon.com.au/

4. RAISING THE BAR: Precinct profiles

According to surveyors of cool, new hospitality trends generally start in the Sydney/ Melbourne CBDs and spread from there. Urban and regional centres are delivering a growing mass of consumers keen to experience the latest hospitality trends. As a result, certain precincts are emerging with significant influence on local and national consumer trends. While Australia lacks the population of the US and the close-knit geography of the UK, we are witnessing the aggregation of venues and operators into distinct “go-to” locations.

Opportunities Pressures

Parochial regular clientele looking for quality contemporary offerings

Declining population

Access to local suppliers to deliver quality regional produce

Intensifying competition from clubs, licensed restaurants and small bars

Entry into distressed assets with significant upside for astute operators in select regional locations

Coles and Woolworths big box retail outlets (the “Dan Murphy’s Effect”)

Limited demand for assets means exit is often not an option as vendor expectations do not align with market pricing

Regional Australia is also feeling the precinct effect as city trends migrate and are adopted by non-metro centres. For regional pub operators struggling to adapt, this increasing competition is squeezing them out of the market. In country venues, upgrades can prove costly due to legacy designs requiring significant building works and the possible historic listing of older buildings. During 2013 we saw the sale of a number of distressed regional assets, often at or below break-up value.

However, in regional centres with sustainable populations, diverse industry growth and no oversupply of pubs, opportunities continue to exist.

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These precincts are driving a proliferation of venues, establishing trends and setting operational benchmarks for the rest of the industry. Traditional areas such as Sydney’s Kings Cross, Brisbane's Fortitude Valley, Melbourne’s Southbank, Perth’s Northbridge and Adelaide’s West End are widely known, however, newer or revitalised CBD-fringe areas and residential growth corridors are also asserting an influence. The quality of venue fit-out, product offering, service levels and marketing innovation in these precincts is delivering consumer experiences which are being embraced by the wider market.

Increased licencing restrictions and compliance costs in traditional high-risk precincts are motivating top operators to seek new markets. In Sydney we have seen leading CBD operators Merivale, Keystone and Solotel move to areas including the Manly and Newtown precincts to gain a foothold in these areas, increasingly drawing patrons away from more traditional locations.

Regional venues

We have seen a proliferation of stylised design set to a carefully chosen theme in 2013. These tailored small bar venues provide female-friendly drinking establishments that are changing the broader sector by:

• Raising consumer expectations regarding customer service levels, fit-out and quality of product offering.

• Providing extensive venue choice for consumers and dramatically increasing competition for food and beverage spend. This can also impact other revenue streams including gaming, as consumers stay out of traditional pubs and spend more on premium products rather than mainstream draft beer and the pokies.

• Driving competition for the best staff. Opportunities including improved training, workplace environment and tips that are often superior to traditional hotels.

The pub sector is highly regulated, very competitive and operationally intensive. Experience and the ability to reinvent and reposition the standard offering are needed to survive.

When we look at the revenue streams available to the traditional publican, specialist players have a significant advantage. In this environment of intense competition, it is important for operators to understand their customer base and focus on one or two revenue streams – diversity in income should only be sought as a complement to unquestioned leadership in a chosen offering.

The lines between bars, clubs, cafes, restaurants, pubs and accommodation hotels is blurring across the sector. In 2013 we saw a proliferation of small bar licenses in the NSW market whilst in SA there was a mini bar-boom, with 11 venues established since the new laws were enacted six months ago. A further 22 venues are due to open in the Adelaide CBD in coming months.

Simplified application processes, reduced fees, low-cost fit-outs, food offerings and a focus on product and customer service have meant that CBD and inner-city suburbs are being scoured by prospective operators for rooftops, laneways, basements and any other potential small bar perch.

5. IT’S A JUNGLE OUT THERE The competitive landscape

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Progressive hoteliers need to understand the core competencies of their operations and focus on being a market leader in one or two of these offerings. The challenge is to find a balance between each revenue stream. We have seen operators of strong gaming venues have their gaming revenue decline when food is emphasised and the venue isolates its core gaming clientele.

Whilst consolidation in the sector has put significant pressure on stand-alone operators, it is not all bad news. The best venues are typically run by specialist operators catering to their local market, which leaves opportunities for those able to adapt and take market share from corporate-controlled venues.

Successful venues are those that position themselves as a community asset. For both standalone and group operators, this means creating a family-friendly environment, with a quality food offering and diverse revenue streams.

The national retailers and big box format stores like Dan Murphy’s and First Choice Liquor, have done more than simply take market share from hotel retail liquor sales. They have also influenced the trend towards at-home consumption, with improved access to discounted alcohol and active encouragement of bulk-buying. This trend is expected to continue over the next five years.

Alcohol consumption volume is falling, decreasing by an annualised 0.7 per cent over the five years to 2013-14. Overall, the liquor industry is worth $28.1 billion to the Australian economy, with on-premise accounting for $10.4 billion. Total category spend is forecast to grow 13.8 per cent by 2016/17, while volume growth is set to remain flat for the same period. This is being driven by the move towards premium imported and craft beer, high-end wine and a boom in cider consumption.

Pub sector ownership

Pub entertainment and live music venues continue to struggle because the 18-25 year old age bracket has grown up with unprecedented access to low-cost music, computer gaming and regular music festivals. The majority of touring acts now choose to appear at dedicated music venues where the venue and promoters bear the risk of ensuring ticket sales. The closure and sale of Sydney’s iconic Annandale Hotel in 2013 followed the closure of many small live music pubs due to rising compliance costs, noise complaints and changing consumer habits.

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In Queensland, bottle shops must be attached to a hotel liquor licence. ALH and Coles therefore have high penetration in the Queensland market.

Large-scale suburban pubs are now rarely owned by standalone operators as they cannot compete with the economies of scale of multi-site corporatised operations. The ALH effect is resulting in heavy discounting as smaller operators try to compete with the big players.

Businesses unable to engage with consumers as they shift to the consumption of premium products will be competing for share in the rapidly declining traditional market. As we see increased competition for contracting volumes, those that accept the status quo will be going backwards.

The importance of food as a complement to this trend should not be understated. The ability to increase spend per head through sales of premium beer and wine is often determined by the quality of the food offering. While food has traditionally been seen as a loss-making service line, progressive operators are realising that a quality food offering can not only be a market differentiator, but also a large revenue and profit-generating component of a successful business.

Case Study 1: Home-grown advantage

The award-winning Willow Tree Inn, in the upper reaches of the NSW Hunter Valley, uses vertical integration: family owned cattle for its award-winning steaks and local Hunter Valley wines. Quality local food, wine and beer is a great differentiator which helps deliver 150-200 people for lunch every Saturday and Sunday, with the restaurant and accommodation booked out for up to six to eight weeks in advance.

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6. BEHAVING RESPONSIBLY Legislative pressures, compliance and costs

Alcohol-related anti-social behaviour On-premise liquor licensing has come under the spotlight in the wake of a series of tragic, alcohol-fuelled acts of violence. As a result of pressure from community interest groups and governments, licensed outlets are being forced to respond to legislative changes introduced in an effort to reduce alcohol-related anti-social behaviour. For some hospitality operators, these changes are likely to have significant impact on turnover and margins.

For operators across the country the prospect of additional compliance costs is significant, including:

• Administrative, operational and security staffing expenses.

• Compliance upgrades to systems including facial-recognition-capable cameras and software.

• Risk of significant fines for non-compliance. For example Queensland venues face fines of $11,000 for allowing gang colours to be worn on-premise and in NSW the three-strikes legislation could result in venues losing the ability to trade, as well as significant legal costs involved with defending any alleged breach.

Following the perceived success of Newcastle CBD lock-outs, the NSW government announced game-changing liquor regulation reforms. On 24 February 2014, NSW’s newly defined Sydney CBD Entertainment Precinct legislation was enacted.

Key points to consider are:

• 1.30am lock-outs and 3am compulsory end to service of alcohol effective from 24 February 2014.

• A freeze on new liquor licences and approvals for existing licences across the Sydney CBD Entertainment Precinct.

• $11,000 fine and/or imprisonment of up to 12 month for breaches.

• Breaches can also incur a strike against the venue’s licence.

• Exemptions for small bars, restaurants, accommodation venues and the casino.

• Yields may soften by between 0.25 per cent and 1.5 per cent depending on venue revenue distribution.

The effects of these changes on revenue and profitability are yet to be determined, however, the following case study highlights the potential asset-impairment effects.

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Points for lenders to consider:

• Understanding the revenue breakdown by hour for late-night trading venues will provide a clearer picture of the potential trading impact of the new legislation.

• Operators need to adapt their business models, with an eye to diversification of revenue streams to minimise the negative impacts of the changes.

Case Study 2: Late-night lockout In our view, gaming revenues in late-night trading venues are likely to be negatively affected as a result of the reduction in trading hours and corresponding decreased visitation to the precinct.

Late-trading venues within the precinct need to proactively revise:

• Forecasting and budgets

• Compliance requirements

• Long-term viability of existing operating models

Any potential softening of yields for venues in the CBD precinct will reflect the perceived level of risk. This will be highest for late-night gaming venues.

In our experience, a 2am lockout in a late-night gaming venue will result in a reduction in gaming revenue. In the hypothetical example below, the impact on asset value is material:

Before lockout During lockout

EBITDA $2.40m $1.68m

Theoretical yield 10.5% 10.5%

Value $22.8m $16.0m

Theoretical LVR 70% 100%


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The lockout will impact different venues in different ways

• Fringe late trading hotels

• Suburban gaming hotels

• Alternative entertainment precincts

• The casino

• Large capacity establishments

• Gaming venues in Chinatown and Kings Cross

• Clubs with extended trading hours

• Smaller late night entertainment venues

• Venues with poor management (threat of strike)

Winners Losers As with the introduction of smoking bans in 2007, we may see 2014 as a tipping point for highly leveraged operators in NSW who are unable to adapt and comply with the new legislation.

Three-strikes legislation remains a serious concern for the industry. With a strike valid for three years against the licence – not the licensee or operating entity – it is a serious concern for landlords and investors as well as lenders and operators. The effect of a strike against a licence remains untested, with few such venues offered to the market.

As a result of this uncertainty, valuers may be reluctant to provide valuations on impacted venues.

Quality operators with a well-documented management plan are able to challenge any alleged infringement where all reasonable measures have been undertaken to comply with licensing requirements.

It is anticipated that any breach of lock-out or 3am alcohol service restrictions will result in heavy fines and potential strikes against a venue’s licence.

Additional risks:

• The Kings Cross precinct is awaiting final approval of the identification-scanning solution for high-risk venues (capacity > 120, trade later than 12am). The loss of anonymity for privacy-conscious gamers could further impact gaming revenues.

• Advocate groups are proposing the legislation be expanded to include Byron Bay and Parramatta CBD.

• The state-wide implementation of lock-out enforcements was a recommendation from the review of the NSW Liquor Act 2007 and the NSW Gaming and Liquor Administration Act 2007, delivered in November 2013.

• The 1.30am lock-outs and 3am cessation of alcohol service could lead to adjustments in revenue, profit and asset valuations.

• Poker machine entitlement (PME) valuations could decrease. This is often a major security consideration for lenders and may alter a lender’s security position.


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State developments

Description

Queensland

• In Queensland, the state government has been dealing with anti-social behaviour, particularly in the Brisbane and Gold Coast region. A hardened approach to policing liquor licensing laws has coincided with tough new outlaw motorcycle gang legislation in the state:

• Banning the wearing of outlaw motorcycle colours in any licensed venues. • The moratorium on applications to extend trading hours beyond midnight, due to

expire on 31 December 2013, has now been extended for three months to allow the government time to finalise its approach to Queensland Liquor Act reforms.

The government will announce a new strategy in March 2014. Recommendations include: • State-wide 3am shutdown for all licensed venues • Compulsory ID scanning in select precincts • State-wide banning of violent drunk offenders from venues

Victoria

• The Victorian government has discussed 1am lock-outs as part of a series of measures contemplated to curb violence. The current star-rating system was introduced in 2012, and provides discounts to licensing fees for good operators. This works in conjunction with the compliance history risk fee where venues incur fees based on non-compliance with the Liquor Act.

• We note that lock-outs and amended closing hours are unlikely in Victoria at this stage following the unsuccessful three-month trial of lock-outs in 2008.

Western Australia

A far-reaching review of the Western Australian Liquor Act is underway, with its findings and recommendations yet to be released. With a stated goal to streamline the management of the Liquor Licence Act there is potential for increased institutional investment into the WA market, particularly from Wesfarmers and Woolworths as they seek retail market share via large-format hotel acquisitions.

South Australia

South Australia has seen the introduction of a new Late Night Trading Code of Practice from 1 October 2013 which includes: • Lock-outs after 3am. Prominent West End operators claim they will lose millions of

dollars because of the restrictions and are testing the legislation before the full Supreme Court.

• Mandatory use of metal detectors and CCTV for CBD venues. • Glassware ban after 4am and beverage service restrictions including maximum 30ml

spirits, no shots and no liquor-consumption promotions.


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Gaming certainty in an uncertain world

Hoteliers across Australia breathed a collective sigh of relief following the 2013 federal election and the end of the minority government. The incoming government has removed the major threats to gaming in the hospitality sector, and committed to:

• No mandatory pre-commitment, with voluntary pre-commitment adopted and monitoring and other fees abolished.

• No trial of technology in the ACT as mandated by the Gillard administration.

• No ATM withdrawal limits.

• Continuation of the prohibition of online gambling under the Interactive Gambling Act.

• Reviewing sports betting advertising and regulation of online wagering services.


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State Description

NSW

The implementation of amendments to the existing smoking legislation is scheduled for 6 July 2015, focussing on smoking in dining areas and at entry points to venues. This has the potential to make some venues’ outdoor gaming solutions non-compliant and could have revenue implications. Operators and investors should review how the changes could affect their venue, and where necessary address the issue prior to the 2015 deadline. Financiers should ensure their customers are aware of these amendments and have planned for them.

QLD

The state government has made friends in the pub and club sector by: • Allowing the input of $50 and $100 notes into gaming machines, removing the previous maximum of

$20.

• Proposing to increase the single bet limit from $5 to $10.

• Removal of the ATM withdrawal limit.

VIC

The 2012 legislative changes to the Tatts/Tabcorp gaming duopoly have filtered through the industry. We have seen: • Gaming revenue flat across the state, with savvy operators taking revenue from those unable to

efficiently manage their own gaming operations following years of Tatts/Tabcorp management provision.

• Increased gaming tax rates for the top two revenue tiers scheduled for April 2014.

SA

Legislative amendments in 2013 were introduced to improve responsible gambling measures and to reduce red tape. Some of the major changes include: • The Adelaide Casino can now participate in trading rounds for gaming machine entitlements (the

relative new trading scheme round #5 closes 3 March 2014) as the Casino has received approval from the government for 500 new pokies as part of its $350m expansion. This demand for entitlements may raise the selling price (to the vendor) which was $40,625 in round #4.

• $250-per-day limit on ATM withdrawals (from 1 February 2014) in line with the Commonwealth’s recommendation.

• Machines will be limited to a $5 maximum single bet (currently $10) from 1 January 2017.

TAS Implemented changes to gaming promotions in September 2014, which also included ATM withdrawal restrictions. The Federal Group-operated pokies monopoly in the state reported revenues down 14 per cent in 2013, how this recovers in 2014 will significantly impact venue performance.


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7. 2013 DEAL REVIEW Consolidation, market sentiment and float

The Queensland market in particular saw increased transaction volume and value as new entrants and experienced operators took advantage of favourable market conditions. Purchasers included experienced hoteliers such as Arthur Laundy, as well as private equity and institutional money including the John Singleton/ Mark Carnegie-led Australian Pub Fund.

A-grade assets are in demand, but transaction frequency is low because they are owned by quality operators who don’t want to part with them. B-grade assets are in high demand by good operators who are attracted by the affordable entry price and recognise an opportunity to improve performance.

As a result, a two-speed pub economy is emerging. The gap is widening between experienced operators with prime assets in key locations and those operators with sub-prime assets, lower cash flow, high debt and less ability to cope with the changing competitive landscape.

The Australian pub market saw a number of significant transactions in 2013 as well-funded players sought to consolidate their operations and/or grow market share.

Date State Venue/ Company Purchaser Vendor Deal value

$ M

May NSW Annandale Hotel Oscars Group Canangles Creek (Ferrier Hodgson)

1.7

July NSW Cat & Fiddle Hotel APF Laundy Hotels 4.25

Sept NSW Jacksons on George Lend Lease JJ O’Brien 22 Sept NSW Plumpton Hotel Laundy Hotels Hilrok Hotels 20

Dec NSW The Palms Chullora Iris Group Coles Hotels 25 Apr QLD Elephant Arms APF IPG 27

Aug QLD Exchange Hotel APF IPG 35

Dec QLD/ SA Hotel Property Investments IPO

ASX listing Redcape 485

Sep SA Flagstaff Hotel Matthews Hotels Reserve Group 12

Mar VIC Berwich Springs Hotel Zagames Dominion 27

May VIC Croydon Hotel Melbourne Racing Club

Dominion 18

Oct VIC Daisy’s Hotel Costello ALH 20

Jun WA Geraldton Hotel Golden Hotels Prodale (Ferrier Hodgson)

n/a

While the size of the consumer spend hasn’t changed, a growing allocation of that spend is finding its way into new and revitalised venues.

At the other end of the scale there has been little demand for country hotels, with limited buyer interest and a perception that vendors have been unwilling to meet market price expectations. Distressed assets with limited or no trading figures and declining revenues continue to be sold for at or below break-up value, or for alternate use.

See the pricing in the following table for the iconic Sydney live music venue, the Annandale Hotel, which sold for land value only.

It is not all doom and gloom, as we are beginning to see signs of a recovery in the regional sector as investors attempt to get ahead of the curve. As demand and prices for metropolitan assets continue to recover, a number of groups are attempting to purchase distressed freehold country assets before the city-led recovery filters into country hotel prices.

Source: Published sales and trade discussion prices 19

National indicative sales

Overall we saw increased confidence in trading potential of freehold assets in 2013, and this was reflected by an increase in sales volume reported by brokers, particularly in NSW and Queensland.

The leasehold market continued to be difficult in 2013, with a very limited market and difficulties in securing funding for stand-alone operators. Increased flexibility from landlords for quality tenants and better quality venues coming to market will result in increased demand in most areas in 2014. This will be most noticeable in metropolitan areas where freehold pub supply is at its lowest and market confidence strongest.

In regional areas, the continued supply of low-cost freeholds and distressed sales has delayed any recovery, and the leasehold market in particular has continued to suffer for all but the best assets.

Coles

With Australia’s second-largest stable of pubs, the Wesfarmers entity continues to divest its hotel asset holdings outside of the key Queensland market, where liquor laws link ownership of two off-site retail liquor outlets to the ownership of a hotel licence. As the major tenant of the recently-listed HPI property fund, the future of Coles in Queensland looks assured. What it will do in the remainder of the country is still a question the retail giant appears to be grappling with.

Laundy Hotels

Having missed out on acquiring Redcape in 2011/12, Laundy capitalised on Woolworths’ ambitions for the NSW market, and is actively looking at potential acquisitions. The partnership with leading Sydney operator Fraser Short has successfully rejuvenated the iconic Watsons Bay Hotel, and provides contemporary style to the traditional operator.

Redcape

With 75 assets, over half of which are tenanted by Coles Hotels, growing its core operational business was not the only area of focus in 2013. Redcape has invested heavily in a group structure which focuses on operational performance improvements to deliver sustainable growth, rather than acting as a landlord reliant on rental increases. As a result, Redcape’s private equity partners have taken the opportunity to realise a return on its investment through the successful listing of its portfolio of 41 tenanted hotels for an estimated $500m (listed 13 December 2013).

Woolworths

Cemented ALH as the number-one pub operator in the country. Having more than doubled the size of its NSW holdings in 2012 (adding 32 pubs in a single deal) it has spent 2013 digesting the purchase and fine tuning its business, including maximising gaming-asset holdings and standardising operations.

Hotel Property Investments (HPI)

Tapping into market sentiment with respect to the security of Wesfarmers/ Coles as tenants with long-term leases and secure four per cent rental growth, the HPI entity mirrors the ALE property fund tenanted by Woolworths’ ALH joint venture. The 41 pub assets in HPI are located in Queensland and South Australia. The listing on 13 December 2013 was over-subscribed.

Australian Pub Fund (APF)

12 venues and growing. APF successfully purchased a number of distressed assets at discounted prices and soft yields, however, the value of recent purchases in the Queensland market has been questioned by local operators. The business model is driven by the M.H. Carnegie & Co. private equity fund and private investor John Singleton. The bulk of the group’s assets are located in metropolitan Sydney, NSW. We note the two major Queensland acquisitions for APF in 2013 were both secured from South Australia’s Independent Pub Group (IPG). 20



For operators with significant exposure to the NSW market, the appetite of investors for any prospective IPO will be tempered by the uncertainty associated with the present three-strikes legislation, the new precinct-based trading restrictions and the exposure to added operational risks for cash-flow and asset value.

Gaming asset prices have experienced mixed sentiment. In NSW, the value of poker machine entitlements (PMEs) was driven by the ALH purchase of 31 venues and moves to maximise PME holdings in each of these venues.

Lenders with exposure to gaming assets should pay particular attention to: • The value assigned to PMEs should be agreed

between the lender and owner. • Ownership of PMEs should remain in the hands of the

landlord. In leasehold arrangements this should be clearly stipulated.

• With different legislative environments in each state, cross-border lenders need to be aware of asset values, trading conditions and tax regimes.

State 2013 gaming price range Comments

NSW $180k - $240k per block of 3 PMEs Purchaser forfeits one PME per block acquired for metropolitan transfers.

Victoria

$30k average per PME in 2012 auction, which was considerably lower than expectations of $150k per PME

10 years lease amortisation affects asset values. Auction process to be repeated in 2022.

Queensland

$91,160 – Sth East (up 18%)

$59,051 – Coastal (up 14%)

$45,481 – Western (up 1%)

Government tender #25 closed on 13 November 2013. Increases are in comparison to July 2013 tender.

South Australia $40,625 in 2013 round #4

Entry of the Casino into the trading system for the first time may help to drive up the value of PMEs which have dropped 25 per cent since the scheme was introduced in 2012 (round #5 closes 3 March 2014).

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8. OUTLOOK FOR 2014

For lenders to the sector, staying abreast of changes which might influence the value of assets or the strength of their security position is a key component in minimising exposure in these uncertain times.

We expect to see continued growth in the volume of freehold transactions in 2014, as confidence returns to the sector and access to both well-priced debt and equity finance improves. For operators, investors and financiers looking to pursue an exit strategy this could represent an opportunity to realise their position with a proactive managed sales process, where the gap between vendor and market expectations is narrowing.

For A-grade assets, particularly those with strong gaming performance, truly diverse revenue streams or irreplaceable footprints, demand from institutional investors and experienced publicans will remain high and impact the market.

In NSW we have revised our forecast to reflect the anticipated subdued market for the first half of 2014 as the sector integrates the implementation of the lock-out legislation and lenders avoid exposure to high-risk venues. Gaming venues will be particularly impacted. This has the potential to affect the sector as a whole as investor demand increasingly shifts towards assets with truly diverse product offerings, revenue streams and lower operational risk profiles.

Outside of the major cities, top venues in economically sound regional hubs, where there is no oversupply of pubs, will lead the way. However, lender appetite and/or exit strategies for vendors of country pubs will continue to be mixed, with first-time operators and leasehold purchasers continuing to find access to finance difficult. Buyers are exercising caution in areas exposed to the downturn in the mining industry, particularly those hotels reliant on accommodation.

The sector will face ongoing headwinds from government, media and social groups calling for tougher restrictions on the sale and service of alcohol. For the majority of well-run venues with appropriate operational management plans and trained staff this will not represent an immediate threat, however, operators should be mindful of the cost associated with compliance, and the significant penalties which can potentially be imposed on a business should it fail to comply. The exception to this will be in late-night trading venues in high-risk precincts, identified by respective state governments in the Sydney and Adelaide CBDs. In these precincts, late-night operators will need be innovative and look to make quick changes to their business models to stay ahead of the game.

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Morgan Kelly Partner Hospitality Practice Leader Sydney T 61 2 9286 9874 E [email protected]

Phil Quinlan Director Sydney T 61 2 9286 9991 E [email protected]

Tim Michael Partner Brisbane T 61 7 3834 9228 E [email protected] John Lindholm Partner Melbourne T 61 3 9604 5106 E [email protected]

David Kidman Partner Adelaide T 61 8 8100 7675 E [email protected]

A selection of transactions from 2013

National Hospitality Practice Team

Patrick Maher Hospitality Specialist Sydney T 61 2 9286 9992 E [email protected]

Darren Weaver Partner Perth T 61 8 9214 1407 E [email protected]

9. CONTACTS

Ferrier Hodgson has worked in partnership with financiers and operators in the hospitality industry for more than two decades and is a market leader in this field, having reviewed more than 200 venues and managed over 70 venues in the last four years alone.

The firm specialises in providing management, workout and insolvency skills to financially troubled hotels, resorts, clubs and other liquor-related businesses. Our Hospitality Team has a wide range of experience and an excellent understanding of the practical issues that can affect the viability of businesses operating within the industry.

We have completed numerous advisory roles and receiverships and accumulated extensive experience providing advice to secured creditors on how to manage their exposure as well as in the hands-on running of venues from individual establishments to large groups of hotels.

Our Hospitality Team is well placed to advise on issues and take control of assets ranging from single establishments to large national portfolios. We provide an unrivalled level of industry experience and intelligence, operational knowledge and industry contacts to deliver our clients commercial and cost-effective solutions.

If you would like to talk about the impact of recent changes or broader sector trends, Ferrier Hodgson’s Hospitality team would be pleased to hear from you.

23 www.ferrierhodgson.com

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