Nightcap — A heady cocktail

Nightcap is newly established to take advantage of significant changes taking place in the premium bars segment and more generally in UK hospitality. Management is confident that it can seize an exceptional opportunity to acquire and grow ‘drinks-led’ hospitality concepts focused on the social experience of consumers. As its first step in implementing its strategy Nightcap will acquire LCC.

‘Behind the iconic red LCC door is a light beckoning you down to the party below! Here’s our bar inspired by our appreciation of trendy tattoo parlours and influenced by our love of rum. Sip delicious award-winning cocktails among walls adorned with colourful contemporary artwork & shelves decked in all the eclectic rum antiques! This basement bar is an after work, hair-down, ties-off celebration of consequence-free drinking for an “up for it” crowd. The soundtrack of your youth echoes loudly through the speaker, so don’t be surprised to find yourself singing along!’

The LCC website introduction to its bar in Shaftesbury Avenue, which opened in 2012, epitomises the experiential destination-led offering that Nightcap is targeting. It is the antithesis of mass-produced hospitality with its emphasis on price as favoured by the likes of Revolution Bars and Wetherspoons, and is instead in tune with a shift in consumer taste towards a more discerning, personalised proposition. Indeed, each of LCC’s 10 bars, even in relatively close proximity (seven are in central London), is styled individually, multiplying the opportunity for social experience and interaction sought by its focus market, (mainly female) millennials.

However, a common theme is an intimate, basement location (capacity of up to c 120) with no outside distraction, ie daylight, to encourage dwell time. While peak trading is from 7pm to 10pm, the challenge, evidently addressed by LCC, is to retain the guest who would otherwise move on to a night club (in normal conditions its venues are open broadly until 2am). Happy Hour of 4pm to 7pm with 2–4–1 cocktails for £12 compounds this goal, as does an all-day menu, which drives efficiencies.

The experiential offering and branding are expanded through masterclass courses (£40 per person) on signature company cocktails with the provision of an LCC certificate and a kitchen cocktails book (quarantinis) and ‘LCC’ radio to allow the re-creation at home of the company’s experience.

The growing significance of branding, for example in terms of drinks and music, was recognised early by LCC’s co-founder and creative director, JJ Goodman, who is credited with revolutionising London’s cocktail scene over the past decade or more. Regarded as one of the leading mixologists and bartenders (a former world champion, no less), importantly, he remains at the heart of LCC under Nightcap as LCC’s Head Bartender.

Nightcap is confident that LCC’s proven 10-year record across London and, since 2018, provincially (Bristol) and the simplicity of its model (small, low-profile sites) should allow rapid and efficient expansion. With an average site cost of £339,000 and having consistently achieved bumper returns on investment (75% at site EBITDA level after three years), the company’s medium-term aim of 40 outlets in major UK cities looks reasonable. Thereafter, up to 120 LCC sites may be on the cards.

Notwithstanding execution risk, the opportunity for expansion appears unusually favourable, ironically as a consequence of the longstanding severity of trading conditions, which were compounded by the advent of COVID-19. Structural difficulties had long bedevilled UK hospitality as a result of excess capacity, the frequency of ‘me too’ product, rising costs and narrow margins. Economic and political uncertainty following the result of the EU referendum in 2016 only made matters worse as the erosion of consumer confidence led to an increase in vacant retail space being rented out to restaurant and bar operators on historically cheap debt finance. Stagnation in sales and inflationary pressures (notably, business rates, the National Living Wage and food imports thanks to sterling weakness) have proved an especially sorry mix for restaurant groups, which were already highly indebted. High-profile chains entering administration or credit agreements in 2018 and 2019 included Jamie’s Italian, Carluccio’s, Gaucho and Gourmet Burger Kitchen.

Happily for a well-funded operator such as Nightcap with cash and tradeable equity, this sorry tale appears to have led to a rather more benign environment which its management believes is likely to continue for a number of years:

Notwithstanding continued uncertainty about the timing of a return to trading normality, the promising news of the development of vaccines should accelerate the reopening of UK hospitality and in particular, LCC’s intended rollout.

Expansion aside, organic growth prospects for LCC appear very positive in view of the popularity of its core ingredient. Cocktails have long been the star of the drinks on-trade with the industry association CGA reporting last year that cocktails ‘continue to go from strength to strength’ and specifically up 6% y-o-y in Q120. According to Diageo, in 2019 spirits were growing ahead of beer and wine, accounting for almost one in three of total alcohol market serves.

Cocktails also enjoy:

LCC trade has continued to show its mettle despite continuing coronavirus restrictions. In August and September following the phased re-opening in July, LLC reports like-for-like sales up 8% y-o-y.. This is impressive as it is in the face of the Rule of Six and the start of the 10pm curfew and of course was not flattered by the government’s Eat Out to Help Out scheme throughout August which did not apply to alcohol. A high spend per head was still achieved with a simplified menu delivered via table service. LCC’s demographic remained enthusiastic about social engagement in a safe setting, while arguably feeling more confident about COVID-19 than other groups in society. On reopening on 2 December after the second national lockdown, LCC’s London venues are offering a substantial meal to accompany alcoholic drinks in accordance with COVID restrictions.

A by-product of restrictions has been a material paring of costs including supplier prices through bulk ordering for a simplified menu, a move from monthly to hourly pay, the renegotiation of property leases and at head office.

Nightcap has stated its ambition to acquire, re-capitalise and develop or re-position drinks-led concepts across the UK. We may assume these to have similar characteristics to the LCC model, as described, and the potential for economies of scale in terms of increased purchasing power and other operational and head office synergies.

The company’s senior management (see below) is backed by the highly experienced operational management of LCC. Overall, the team has been involved in the opening and operation of over a hundred bars and restaurants and achieved a number of successful exits of hospitality companies for investors.

While the impact of expansion in FY19 and then of COVID-19 in FY20 is clearly evident in the periods’ contrasting fortunes, Nightcap believes that historical financials for LCC, shown above in Exhibit 2, are unrepresentative of the underlying business. Consequently, it has prepared a pro forma pre IFRS 16 EBITDA (Exhibit 3), which assumes trading at FY19 levels ie excluding COVID-19, with a substantial uplift for operational efficiencies. These include reducing the size of the cocktail menu, improved purchasing as a result of discontinuing legacy contracts with certain spirits brands, and a streamlined wage structure. The three openings since the start of FY19 are shown for the full period, based on their performance in the eight months to February 2020 before COVID-19 took hold. There is also an adjustment for the expected benefit of maturity of these sites in line with that of other LCC bars.

There is a bridge from site to company EBITDA with the deduction of central costs adjusted for one-off items, head office efficiencies and a discontinued business (pre-made cocktails).

The resultant figure of £1.8m for pro forma normalised EBITDA compares with adjusted reported figures for FY19 and FY20 respectively of £0.9m and £0.1m.

The lack of direct, listed peers and the trading aberration caused by COVID-19 do not make for easy comparison of Nightcap in terms of rating and profit forecasts. Therefore, we look at City Pub Group which is arguably the closest to Nightcap in view of its portfolio of 48 drinks-led pubs, of which a third are in London. While its current emphasis on outdoor seating areas and lack of reliance on surrounding offices (in contrast to LCC’s city-centre, basement premises) is understandable because of COVID-19 restrictions, our assessment assumes a resumption of trading in hopefully normalised conditions. Nonetheless, there is encouragement for LCC that its 8% like-for-like y-o-y sales gain in August and September compares with a Q3 decline of 20% in those pubs (77% of the estate) that City Pub Group had reopened. Its decision not to reopen sites deemed unlikely to trade well during COVID-19 only enhances LCC’s outperformance.

In terms of valuation, it appears helpful to base it on the pre-pandemic (2019) performance and also to use pre IFRS 16 numbers. With a current market cap of £93m and bank net debt of £13m at June 2020 following a £22m equity raise, City Pub Group’s EV is £106m and is trading on an EV/EBITDA multiple of 11.6x on application of its 2019 EBITDA. By comparison, LCC looks to have been acquired by Nightcap at just 4.2x, given an acquisition consideration of £7.5m (£2.2m cash, £3.5m shares and £1.7m debt) applied to £1.8m pro forma EBITDA.

This agreement by the vendors to take the majority of the consideration in terms of shares should also be a positive for the valuation, given its support for Nightcap’s strategy and confidence in its prospects.

Peer comparison aside, in its own right LCC should be recognised for the transparency of its business model (selling premium drinks from very small premises) and consequent high returns, eg a return on investment of 75% after three years, historical site EBITDA margins of 33% and average site capex of c £339,000.