Revolution Bars Group (RBG)

A highly leveraged UK bars company, emerging from the pandemic, recently purchased a pub group.

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Business description

Founded in 1996, Revolutions Bars Group has 69 bars across the UK, focussed on selling vodkas and cocktails, with a Cuban and Latin American style tapas menu, with DJs and live music at the venues. In October 2022, Revolution also acquired 21 pubs, branded, ‘Peach,’ for £16.5M on a debt/cash free basis: buying £3.6M of assets in the transaction. Peach estimates for FY2023 are: £30M sales, pro forma EBITDA of £1.5M. EBITDA is forecast to rise by £1.5M in the next two years, due to cost-saving synergies the management is forecasting to make.

Revolution’s actions during the Covid pandemic:

During the Covid pandemic, Revolution’s bars were closed during the end of FY 2020 (ending Jun-20), and for much of FY2021 either closed or had restricted hours: revenues were £151M in 2019, then sank to £110M in 2020, plunged to £40M in FY2021 and recovered to £140M in FY 2022.

Before the pandemic in 2019, Revolution has 50M shares outstanding, and then it took the following actions during the pandemic:

1. In June 2020, RBG raised £15M by doing a firm placing (for institutions) and open offer (for existing shareholders) of 75M new shares at 20p/share.

2. In Nov-21, Revolution had a CVA (Company Voluntary Arrangement) approved, to close 6 bars, and change the terms of the leases for 7 more.

3. In May 2021 Revolution did another firm placing and open offer, raising £21M at 20 p/share, issuing 105M new shares in total.

The share count after this is now 230M, with pre-pandemic shareholders having been diluted by 78%. Revolution made net losses of £2.8M in 2018, £5.2M in 2019, £35.2M in 2020, £26.3M in 2021, and a net profit of £2.1M in 2022.

In the H1 23 results released on 7^th March to Dec-22, Revolution reported a £0.1M loss before taxes.

Quality

Pre-pandemic, Revolution had very stable gross margins around 76%, they dropped slightly to 73% during the pandemic. Operating margins had been fairly stable around 5% until 2019, when they dropped to a negative margin just before the pandemic. This was due to costs incurred for potential takeover approaches from two other companies, and a £6.7M ‘onerous lease provision.’ This means that the payments due under the lease exceed the benefits expected to be received from it. Since under the current accounting rules, leases are capitalised on the balance sheet, this means that when the company expects to earn less from using the lease, than they are paying for it, their value must be impaired, or written down in the income statement. Given that the company has seen problems with non-performing sites, and experienced difficulty in exiting them, due to the leases more than once, this has had a significant impact on earnings, and may happen again in the future. Therefore, earnings are not very stable.

Post-pandemic, we can look at the income statement to assess the quality of earnings. In FY2022, the first year with no Covid restrictions, revenue was £141M, gross profit was £110M, operating profit was £7.4M, and finance expense (interest on lease payments and bank debt) was £5.3M, leaving £2.1M net profit.

Lease payments (capital and interest) plus bank debt interest were a total of £9.8M. This company has high operating leverage: i.e. a small increase or decrease in revenue can lead to a bigger gain or loss in profits. Therefore, it is likely to have both unstable and unpredictable earnings, so they are of low quality in that respect. In previous press releases, e.g. the 7^th March 2023 interim results, the company has reported various factors leading to lower sales, e.g. hot weather, train strikes, lower consumer confidence due to the cost of living crisis, high energy prices etc. Earnings may be significantly affected by small shifts in sales. In this period, this led to earnings being -£0.1M.

Credit risk:

Revolution has (post acquisition of Peach pubs), a total of £46M in property, plant and equipment – almost all of which is fixtures and fittings in their leased premises, and net current liabilities of £20.4M, together with debt of £23M, and provisions of £2M, so excluding leases, it has net assets slightly less than zero. Their assets are unlikely to be able to be sold at a value close to what they cost, given that they are bars decorated in a specific style that another company would not be able to use – they would want to put their own brand on the premises. Therefore, they only have a significant value if they are owned by Revolution, and if it continues to operate: if Revolution were to be liquidated for any reason they would not have much value, and they would not have much if any resale value if Revolution exited a location. This means that Revolution has very few assets of value to sell should it need to raise capital, which in turn means that the only likely sources of additional capital are more bank debt, and also raising more money from shareholders.

Revolution has a Revolving Credit Facility of £30M, (which reduces by £1M every 6 months to Jun-24), of which £18.5M is drawn at Dec-22. The auditors noted a material uncertainty whether the company can continue to operate as a going concern in their report, due to the fluctuating earnings due to the pandemic and other factors. In this context, it is interesting that Revolution management chose to spend £16.5M buying the 21 Peach pubs.   

There is a possibility that Revolution may breach it’s banking covenants on it’s debt, if sales are lower than forecast in future. This may require renegotiation with it’s lenders, or further equity fundraisings.

Capex: Revolution has £1.4M of freehold property: £82.3M of short leasehold and £56M of fixtures and fittings. Due to the premium nature of the bars, the company has to maintain a high standard of décor in it’s premises, therefore it spends significant amounts on capex refurbishing it’s properties every year, e.g. £8.3M in 2022. It is likely that they will continue to need to spend to maintain the attractiveness of their venues to the public.

One way to predict the risk of bankruptcy is to use the Altman z-score: calculated from financial ratios of the company. This has been shown to predict bankruptcy with fairly high accuracy. Values below 1.8 indicate an increased likelihood of bankruptcy. Before the pandemic, Revolution’s Z-score ranged from 2.16 to 4.67 in the period 2012-2019. The current z-score is 0.54, indicating a high probability of bankruptcy.

Appraisal

Revolution cannot be valued on a price:book basis as it has a negative tangible book value.

On a price: earnings basis, net earnings for the H123 year are -£0.1M, so it is difficult to place a P/E multiple on the business. Pre-pandemic, average net earnings in the period 2012-2019 were £2.2M.

The current market cap is £16M, so that would make a normalised P/E ratio of 8x. However, the pre-pandemic business was not carrying the current level of £18.5M of net debt.

Bear case:

Due to the unpredictable nature of earnings, and the high operating leverage, it is quite possible that Revolution may breach it’s debt covenants if it’s sales dip for any reason. It does not have significant freehold assets that it can sell in this scenario, so it may have to dilute existing shareholders more in this case by seeking to raise capital, and there is a potential risk of insolvency, as noted by the auditors.

Bull case:

if sales increase from current levels, e.g. through the recent acquisition of Peach Pubs, it may be able to significantly improve profits and pay down its debt, causing the shares to re-rate upwards. In order for this to happen, management will have to deliver on the projected cost savings by integrating the acquired business. Revolution may be able to generate significant cash flow to pay down it’s debt, and control capex spending to deleverage, reducing risk of bankruptcy. In this case, the shares may re-rate upwards as profits increase.

Conclusion:

The unpredictable earnings and high operating leverage, combined with the credit risk due to high debt levels, means that Revolution Bars Group (RBG) is a pass for me.

This is not investment advice. Please refer to the full terms and conditions on the Real Worth Stocks website. Real Worth Stocks does not hold any position in Revolution Bars Group at the time of writing in March 2023.