The London Tunnels — Hidden reserves

London Tunnels is newly established to seize an opportunity to acquire an exceptional asset in terms of its history (World War 2 location of the Special Operations Executive and considered inspiration for James Bond’s ‘Q Branch’) and likely visitor appeal as both a heritage and cultural destination. Management is confident that it can develop Kingsway Exchange Tunnels in central London either independently or with partner operators (eg content owners and theme parks) into a ’must-see’ visitor attraction on a par with the London Eye, the city’s most recent such addition and evidently successful (3.5 million visitors pa in 2018 before COVID-19). The site is extensive with a series of tunnels over a mile long in total, 30 metres deep and up to 7.6 metres in diameter, allowing clear scope for revitalisation by way of heritage and cultural experiences, facilitated by digital displays. As its first step in implementing its strategy, London Tunnels will purchase Kingsway Exchange Tunnels on a 100-year leasehold basis and surface-level properties, including 39 Furnival Street and 31-33 High Holborn, for c £20m.

From the spectre of vast, deep underground shelters to the enduring resonance of wartime London and Cold War James Bond associations, the Tunnels have broad appeal even before the projected development. They comprise two parallel tubes, each about 1,200 feet long, with a diameter substantially greater than that of a typical London Underground tunnel, supplemented by four shorter tunnels at right angles and three deep access shafts. As a measure, the main twin tunnels were built to provide emergency accommodation during air raids for 8,000 people on two levels, albeit never used for this as the Blitz campaign had tempered by their completion in March 1942. The lateral tunnels date from the early 1950s as extra space for the site’s post-war use as a long-distance public telephone exchange until 1980 as well as a secure government communications centre. Since 1990 the site has been maintained and managed by British Telecom wholly for storage; there is continued connection to mains power, water and sewerage. Total floor space is of the order of 8,300 square metres.

With effectively a blank canvas on an epic scale, management has evolved a twin-pronged strategy to make the best of its unique asset. Heritage and culture are its drivers for redevelopment of the tunnels with a celebration of their significance to the history of the UK combined with the supply of a matchless space for digital exhibitions:

Arguably less glamorous but still of considerable significance to the nation was the Tunnels’ use for civil defence and Port of London Authority staff towards the end of World War 2, as a repository for the Public Record Office (until 1951) and from 1954 as Kingsway Trunk Exchange, handling 15% of London’s long-distance telephone traffic, according to Subterranea Britannica. With over 200 Post Office staff, this was effectively ‘a city under a city.’

As an illustration, the opening in June 2023 by Warner Bros. of Studio Tour Tokyo – The Making of Harry Potter, its largest such indoor attraction and the first in Asia, shows the willingness of content owners to invest ($280m). The longevity of a successful franchise’s appeal is endorsed by the popularity of Studio Tour London 12 years after its opening and indeed after the release of the final film, ‘Deathly Hallows – Part 2’, ie ‘continued strong attendance’ per Warner Bros. Discovery’s Q323 earnings release and over 17 million visitors to date. On a broader front, the opportunity to exploit its intellectual property is manifest across the Warner Bros. estate, with parks in Abu Dhabi (the world’s biggest indoor theme park), Gold Coast, Australia and Madrid. Merlin Entertainments has been similarly active using intellectual property as a central element of its attractions. In April 2022 it opened ‘JUMANJI – The Adventure’ at Gardaland Resort in Italy, the first ride to be opened as part of a multi-territory exclusivity agreement with Sony Pictures Entertainment, to develop and operate attractions, rides, lands, retail outlets and themed hotel rooms based on the studio’s ‘Jumanji’ film franchise. This was followed at Merlin’s Chessington World of Adventures Resort in May 2023.

As for digital art exhibitions, ‘Van Gogh Exhibit: The Immersive Experience’ typifies their growing appeal and scope. Since 2017 there have been more than five million visitors to this touring exhibition, which is currently at about 20 locations worldwide including a key site in London. Its counterpart for Monet is similarly popular with very positive reviews in London since its opening there in September 2023. The company is pleased to have newly established a relationship with Refik Anadol, who is widely recognised for his innovative media works and large-scale public installations. He was the first artist to project his works on the Sphere in Las Vegas and his first major solo exhibition in the UK opens in February at the Serpentine North Gallery.

With the full commercial launch not expected until 2027 the above is necessarily work in progress and subject of course to funding.

Explorer Tours as an imminent taster

Reflecting the innate lure of a leading historic site, the company is soon to launch guided Explorer Tours, which will allow visitors to experience the Tunnels in their unrestored state, along with original artefacts. Obvious comparisons are the Paris Catacombs, which attract 550,000 visitors annually to a 1.5km tour of its 11,000 square metre site, and London Transport Museum’s tours of ‘forgotten’ historical Underground stations. Maybe as a fitting counterpart, the Berlin Underworlds Association has been organising tours of its WW2 and Cold War shelters for the past 25 years.

Notwithstanding the variables inherent in such an undertaking, London Tunnels has a clearly defined development schedule, marked by potential stumbling blocks, such as planning approval and funding. A planning application has been submitted (November 2023) with the outcome due at a London Borough of Camden committee meeting on 11 July. Management is hopeful as approval was recently given by the City of London Corporation. However, before that is known, a placing is planned for up to 90 days after the Listing to raise £30m, which should allow continued progress over the next year at least until much more significant funding (the company estimates c £120m) for construction.

As per Exhibit 1, the largest budgeted expense over the next year or so is the balance of payment for the leasehold titles to the Tunnels (£9.5m) by the end of June 2025 and capex of £7.9m for an additional surface-level property in order to create a larger visitor entrance. Further extensive preparatory work to validate the project is expected to cost c £5m this year, assuming the receipt of planning permission and placing proceeds. Additional income should come from the start soon of the aforementioned Explorer Tours at up to £60 for an adult as well as useful promotion. These will continue until stripping out gets underway next year.

Subject to further funding estimated at c £120m and to be received periodically from 2025, full redevelopment of the Tunnels should then proceed in earnest, as detailed in Exhibit 1. A key variable in costing is the extent to which the venture is developed independently by the company, since over 50% of estimated costs concern fitting out and installing technology for the provision of content. The technology is intended to be leased.

In its current form, the company has understandably minimal employees. As the project develops, it will recruit experience in developing, launching and operating a large-scale visitor attraction. The extent depends on whether the Tunnels are operated by the company or by partners.

Given the absence of a trading record and the period of construction, we highlight in Exhibit 2 the potential returns in the first full year of commercial operation (2028) with three attendance scenarios and if the business were in the hands of an owner/operator of intellectual property or theme parks. Notwithstanding a venue design capacity of three million visitors annually, management is targeting 1.72 million to ensure a quality experience and to avoid overcrowding. Assuming 1.89 million visitors pa, the leverage of 10% higher footfall predictably converts into a markedly higher EBITDA margin. By contrast, while three million visitors would materially enhance the top line, management thinks that a hike in operating costs would stymie margin gain.

Ancillary income, notably retail and F&B, is also of course a determinant but management focus looks to be on ensuring optimum ticket pricing.

Comfortably the leading city tourism destination in Europe by way of bed nights, the world’s most visited city by digital nomads and the third most popular destination on TikTok are diffuse testimony to London’s appeal, both globally and domestically. While not downplaying the timeless draw of landmark sites, innovation and diversity, as famously displayed in the 2012 Olympics, have ensured a stream of new attractions, which of course foster repeat custom. The proposed offering of the Tunnels, as described, plays into this. A target of 1.72 million annual visitors sits happily with established, successful paid London attractions such as the Tower of London (2.9 million visitors a year), Madame Tussauds (2.5m), The Making of Harry Potter studio tour (2m) and most notably the London Eye (3.5m). We note also that in the decade before the pandemic, visits to the City of London’s Attractions, which include St Paul’s, the Tower of London, Tower Bridge Museum and the Barbican, increased by over 40% to 7.4m pa. Significantly, although close to key source markets in the West End, South Bank and the British Museum, there is no large attraction near the Tunnels.

As for ticketing, notwithstanding the impact of inflation indexation by 2028, a notional price of £30 also looks reasonable in the context of competing attractions, for example, the Tower of London at £35 and the London Eye and Madame Tussauds at £29. Enriching the content in the Tunnels by way of digital art exhibitions should allow for a meaningful rise in pricing, as appropriate.

Our EBITDA margin assumptions are taken from the accounts of attraction and theme park operators, with 45% as a base on the target 1.72 million attendance. While the likes of Midway Attractions may benefit from scale (116 sites worldwide in 2019, which we have used as latest not distorted by the pandemic) and are not directly comparable (principally SEA LIFE, Madame Tussauds, LEGOLAND, Dungeons, Eye), the company can operate with minimal employees, hence our use of an EBITDA margin premium. It is reasonable to note that the London Eye alone reportedly achieved a 52% profit margin in 2012.

To reflect operational gearing and for the sake of prudence, we have shown how a shortfall of, say, 25% in target attendance (ie 1.29 million visitors), however unlikely, might affect EBITDA.

In the shaded column in Exhibit 2, we indicate the potential value of the business to a content owner/operator, such as Warner Bros., which could likely price significantly higher (we show £40) by filling the Tunnels with their own established IP such as Harry Potter and other studios’ material. The benefit of the expected material lucrative incremental revenue would be enhanced by not having to pay licensing fees, as is the case with the site run independently, and scope for considerably higher merchandise across that group’s franchises.

The unique aspect of the Tunnels project does not make for easy comparison with listed companies. Apart from the lack of direct peers, there is the protracted phase of construction with attendant risks of execution and funding.

We have therefore looked at the prospective/year 1 EV/EBITDA multiples of certain companies with similar businesses to apply to the respective attendance scenarios. The estimated £120m debt during initial commercial operation and planned £30m equity placing are deducted to derive an equity value. For our valuation, we have chosen the 2019 exit multiple (12x) of Merlin as the operator of London Eye and thus arguably the nearest equivalent to London Tunnels.

The terminal value even to an IP owner/operator, as indicated, is dwarfed by a high-level estimate, provided to the company, of c £1bn for current day replacement construction costs and fees etc excluding land purchase and VAT.

We emphasise that these equity values are undiscounted, therefore not taking account of the time to completion nor the aforementioned risks.