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Pizza prospects
(28 April 2003 12:39)

This time last year, PizzaExpress was a stock market darling. For nearly 10 years it had been the exception to the rule that restaurant groups make lousy investments. But today, shareholders have seen the value of their investment drop to less than half of its peak. And only circling bidders are preventing the share price falling further.

It was not a fundamental flaw in the business that drove the fall from grace. Rather, a series of events conspired to create problems for the chain's management, who are also seen as culpable for taking their eye off the ball.

"The original strength of the brand has turned into a hostage to fortune," says Peter Antenen from consultancy consortium Salon. "The purity of the original format that made it easy to expand is looking thin by comparison with other emerging rivals."

The terminology is particularly apt, since the original success of PizzaExpress was based on introducing the British public to an authentic, thin pizza style rather than the deep-pan version that chains such as Pizza Hut were offering. It was more than just product that led to its success. The skill of Pizza Express was in becoming the restaurant of choice for the British middle class. It provided a close to fine-dining experience at a reasonable price and customers grew to love it.

Like most great business ideas, the PizzaExpress concept was straightforward. The skill was in the execution - consistently providing a good product in pleasant surroundings. "It was a grown-up offer. The lighting was particularly good and it was always reliable in a sea of sometimes dodgy independents," says Antenen.

The decade of dominance, however, has caused the management to lose its grip, with Antenen likening the situation to that of British retailing icon, Marks & Spencer. "Competitors were entering the market to make the PizzaExpress offer look narrow. This put too much burden on the product, the pizza," he says.

And so the great shrinking pizza debate was started. PizzaExpress firmly denies that it ever reduced the size of its pizzas, but the public perception - perhaps because of the larger sizes provided by rivals - was that the pizzas were getting smaller. Whatever the truth, it was the perception that mattered, and it damaged the PizzaExpress reputation.

Of all the young bloods giving PizzaExpress problems, Ask Central has become the biggest threat. The company has grown from one outlet, bought by brothers Sam and Adam Kaye in 1993, to nearly 150. The chain today is split between its original Ask brand and the newer Zizzi, and the latter in particular is exposing some of PizzaExpress's shortcomings. "Zizzi has far warmer interiors and offers wood-burning ovens, but is much more than just pizza," says Antenen.

The City has been quick to switch its affections. Analysts believe that Ask is likely to benefit if, as seems likely, PizzaExpress is taken private and loses its stock-market listing. Douglas Jack at WestLB Panmure says that Ask offers the best returns in the licensed retail sector. He is forecasting a compound annual growth rate of 15% over the next three years.

Ask's rollout began in earnest in the late 1990s. It breached the 100-outlet mark in 2000 and is scheduled to have more than 170 restaurants by the end of this year. It puts it hot on the heels of PizzaExpress, which operates 300 restaurants in the UK.

Duncan Lillie, a partner at property adviser Shelley Sandzer, says Ask has benefited from PizzaExpress blazing a trail - a kind of first-mover disadvantage. "Where PizzaExpress is successful, Ask has gone in nearby. Where a PizzaExpress has struggled, Ask knows to avoid the location," he explains.

Even Ask, though, has endured some hostility from investors. When the founding Kaye brothers sold £5m worth of shares at the end of last year, sentiment towards the company became less friendly. But a good set of financial results in March helped to reassure, and contrasted markedly with PizzaExpress.

Fears confirmed
The woes of PizzaExpress began last spring, when Andrew Saunders, an analyst at Numis Securities, downgraded the stock. The following working day, CSFB, the broker to PizzaExpress, also downgraded, saying it expected trading in London to be weak.

The fears were confirmed in June, when the company said like-for-like sales for the second half of its financial year would fall by 1%. The falling numbers of tourists and declining economy were cited as the main reasons. And things just became worse from there, with an admission in October that the three months to the end of September had seen like-for-likes slump 4.4%.

Already rumours were growing that this former star of the stock market would attract a bid, and the share price reached a low of 245p, almost a quarter of where it had been six months previously. At the start of November the company admitted the bid rumours were true.

Hugh Osmond, who with Luke Johnson had started the company's dash for growth in the early 1990s, was behind this first approach. He had formed a vehicle called Twigway to mount the bid, teaming up with the owner of the Nando's chicken chain, Capricorn Ventures International, and Sun Capital Partners.

Osmond and Johnson were former City analysts who had decided to get their hands dirty and actually run companies. They brought PizzaExpress to the stock market in 1993 by reversing it into Star Computers, a shell company that had a stock-market listing. The pair are well placed to judge the opportunity represented by the falling share price of PizzaExpress. Osmond walked away from the deal by late November after being refused full access to the PizzaExpress books and being turned down on his requests for a £1.25m break fee if his bid was unsuccessful.

A month after Osmond's bid, it was admitted there were other approaches, including one from PizzaExpress's executive directors. Chief executive David Page was understood to have teamed up with French finance house PAI.

But it took Luke Johnson to table a formal bid at the end of February. His vehicle, Venice Bidder, is backed by ABN Amro and Hawkpoint, and he has former PizzaExpress director Ian Eldridge on board as well. The offer was priced at 367p, valuing the company at £263m. Ironically, he was able to secure a £2.6m break fee if his deal lapses or he is outbid. CVI has now teamed up with TDR Capital and last week launched a 387p bid using a vehicle called GondolaExpress.

While the bids have pushed the share price back towards £4, not all investors are happy. Mark Wallace, of Analyst Investment Management, estimates the company is worth at least £6 a share. "Our preferred option is a share buy-back. We would be disappointed to see the company go," he says.

He points out that the management have begun to make significant changes already: a new menu and larger pizzas; no price increases since June 2001; dropping the £1.2m advertising campaign launched in 2002; reorganising operational management; accelerating the capital investment in the 140 restaurants that are more than five years old.

Despite the woes, PizzaExpress is far from finished. At the year-end it had no debt and nearly £18m cash in the bank. Wallace points out that although profits after tax were down last year, they were still £25.6m, representing an adjusted return of 16% on shareholders' funds. Ian Neill, boss of Wagamama who was a PizzaExpress franchisee until 1996, says: "The company has still got tremendous legs. The management ought to be trading it rather than it be taken private."

Even if the company does change hands, there is no certainty of success. Nigel Popham, an analyst at investment bank Teather & Greenwood, says the history of brands being rebuilt is not good, but admits: "In the private sector there is a better chance. The stock market in the next two to three years will be a jungle."

The consensus view is that the company will be taken private and eventually, in some form or another, will probably come back to the stock market. But few believe it can ever repeat the soaraway success of the 1990s. The reputation of the former darling is too damaged.

Rise and fall of a star

1965 First PizzaExpress opened by Peter Boizot in London's Soho.

1993 Luke Johnson and Hugh Osmond reverse company into shell to obtain stock-market listing. Start of rapid growth, with share price climbing to more than 900p.

April 2002 House broker CSFB downgrades, share price starts rapid descent.

June 2002 Company warns sales will be down 1% year-on-year for second half.

September 2002 Press speculation about a bid denied.

October 2002 Releases update reporting that there is no improvement in trading.

Early November 2002 Company admits receiving a bid approach in 330p to 350p range.

Late November 2002 Hugh Osmond bid via Twigway collapses, and rumours of a Luke Johnson bid emerge.

December 2002 Approaches by others, including executive directors, revealed.

February 2003 Interim results statement says outlook remains uncertain.

27 February 2003 Venice Bidder, vehicle created by Johnson and Ian Eldridge, makes recommended cash offer of 367p valuing group at £263m.

17 March Capricorn Ventures International, owner of Nando's, and TDR Capital, says it's looking at bid.

27 March Venice claims 14.4% of company.

3 April GondolaExpress, CVI and TDR's vehicle, makes 387p a share offer.