As a lad, over 18 of course, I can remember sitting in a big, dank pub somewhere in the Midlands, drinking fizzy brown beer. This pub was owned by Bass a brewer of some note who was later taken over by Mitchell & Butlers.
Mitchell & Butlers, now owners of All Bar One and Harvester Inns, decided, like several other major British brewers, that it was best to leave the actual brewing to Johnny Foreigner and much better returns were to be had from rolling out trendy pub and ‘leisure’ formats, and try and make money out of property and derivatives.
In 2007 they decided you didn’t need to be a giant multinational bank to make a giant loss trading in obscure instruments that your director doesn’t understand. This was the ‘90s. In the 21st century, even dull old pub companies with flat beer and flat profits that want to turn themselves into hot young pub companies with whizzing shareholder returns can do it. In M&B’s case, they did it in bucket loads.
What better way to generate profits than to embark on a sale-and-leaseback joint-venture with a property tycoon involving some 1,300 of their pub properties? M&B were persuaded by their City advisers, Citigroup and Royal Bank of Scotland, to take out huge future hedging contracts against the risk of rising interest rates and future trends in pub rents. But the pub-property deal never went ahead, leaving the hedging contracts as an open one-way bet, which is of course the very opposite of a hedge. As Bank of England interest rates started to fall and rents started to move the wrong way, M&B’s position looked worse and worse. Finally, M&B’s board decided to close out the hedge contracts, crystallise the loss at £274 million, part company with finance director, and in an exquisitely rare act of corporate penitence, cancel their own annual bonuses.
Remember if you are not careful hedges do have a downside risk if they do not match an underlying transaction.
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