How Punch fought its way back to number one place in the beerage

Giles Thorley, the chief executive of the pubs group Punch Taverns, was beaming yesterday even though he had had only one hour's sleep. The reason: his hugely acquisitive company had finally become Britain's largest pubs group. A former deal-maker at the investment bank Nomura, Mr Thorley had worked through Wednesday night to seal the £2.68bn acquisition of the privately owned Spirit Group, beating off stiff competition from the property tycoon Robert Tchenguiz.

The acquisition is the latest in the merry-go-round of pub deals, with pub companies always on the lookout for high-quality estates while trying to sell off underperforming pubs.

Under the terms of the transaction, Punch is taking on £1.25bn of Spirit's debt. "It's a good deal," Mr Thorley said. "We won an extraordinarily high-quality estate and kept a lot of options for that estate. There are some fantastic pubs in that portfolio." City analysts concurred and shares in Punch rose 3.7 per cent to 861p yesterday.

One analyst said: "They have two to three years' worth of growth in this transaction. They don't need to worry about acquisitions for a while - they've done it." Depending on how many pubs are sold on, the deal could boost Punch earnings by about 20 per cent.

Spirit's 1,832-strong estate will elevate Punch, until now the country's No 2 pubs group with 8,200 tenanted outlets, ahead of the industry leader Enterprise Inns with 8,750 pubs. At the same time, a secondary auction for some of Spirit's pubs looms, with a host of hopeful bidders including Mitchells & Butlers already lining up.

While further industry consolidation is rife as pub companies battle with rising staff and energy costs and a slowdown in consumer spending, Punch's move looks to be one of the last big deals in the sector. Pub estates have been changing hands ever since the industry was partially deregulated with the 1990 Beer Orders, which weakened the brewers' traditional hold on pubs and led to the rise of independent operators such as Punch and Enterprise. Paul Crawford, an analyst at the ratings agency Fitch, said: "There's been an awful lot of consolidation over the last few years. This is one of the last big deals ... But there seems to be more swapping of portfolios, particularly at the lower end."

Major pub groups such as Punch have been trying to improve the quality of their estates by selling off the bottom end to private-equity investors. Alongside the Spirit purchase, Punch announced yesterday that it was selling 203 pubs to Admiral Taverns, a group of property investors. It is also in the business of selling what it calls "gold bricks", pubs with a high real-estate value, for profit.

Spirit, which is behind the Chef & Brewer and John Barras chains, was until now owned by a consortium of private-equity firms comprising Texas Pacific, Blackstone Group, CVC Capital Partners and Merrill Lynch Global Private Equity. Spirit's management, led by the chief executive Karen Jones, holds a combined stake believed to be worth tens of millions of pounds.

Spirit received four bids - from Punch, Mr Tchenguiz, the former WestLB banker Robin Saunders and the Barclay brothers - but Punch's certainty of funding and speed of completion gave it the edge. Mr Thorley said: "We were consistent in our price and our ability to deliver."

Aside from its aggressive deal-making, Punch has benefited from its tenanted model of pub ownership. A key feature of the industry is the trend towards running tenanted estates to keep overhead costs down. Pub landlords such as Punch make their money from rent and selling alcohol to their tenants. Of the UK's 59,000 pubs, only 11,000 are managed and the rest are tenanted, according to the British Beer and Pub Association.

Punch will convert 750 of Spirit's managed pubs to tenanted within the next couple of years, and sell on another 82 pubs straight away. Speculation has centred on whether the Spirit estate will be broken up and how much Punch will keep, but Mr Thorley indicated he was in no rush to make a decision while acknowledging there was no shortage of interest.

The deal will reunite the managed and tenanted pubs of the original Punch Taverns, which was forged by the entrepreneur Hugh Osmond from the former Allied Domecq and Bass pub estates. Mr Osmond snatched Allied Domecq's pubs from Whitbread in 1999 after a ferocious David-and-Goliath-style battle with the then brewer. After the deal, Punch Taverns hived off its managed pubs into a separate division, Punch Retail, which was later renamed Spirit Group.

Punch Taverns floated on the stock market in May 2002 and went on to buy Pubmaster for £1.93bn in November 2003. The acquisition added 2,859 pubs to its estate, which took the total to more than 7,400 pubs and cemented Punch's position as one of the two leading pub groups in Britain. It later gobbled up the InnSpired Group and Avebury. Its shares have risen from a flotation price of 230p to yesterday's 861p, delivering good capital growth for investors.

Meanwhile, Spirit hugely expanded when it snapped up Scottish & Newcastle's 1,450-strong pub estate two years ago, beating off M&B. M&B, the operator of the All Bar One, O'Neills and Harvester chains, now wants to have a second stab at acquiring some of these pubs and has expressed interest in 300 to 400 pubs from Spirit's successful Chef & Brewer brand. Other possible bidders include Wolverhampton & Dudley Breweries and Greene King.

A key factor driving consolidation is rising costs, which stem from a surge in government regulation, higher heating and electricity bills and rising staff costs. Douglas Jack, at Panmure Gordon, concluded in a recent research report that acquisitive companies have seen the best margin performance. W&D, Enterprise Inns and Greene King have benefited most from acquisition synergies, he said.

Analysts said pub companies were battling with some 120 laws introduced by the Labour Government since coming to power - including the new 24-hour drinking laws and a smoking ban in all public places from 2007, from which pubs that do not serve food are exempt. JD Wetherspoon has already seen a sharp fall in sales after banning smoking in some pubs. With 24-hour drinking, bigger takings are largely cancelled out by higher staff costs, some operators have said.

Chronic overcapacity on the high street is another problem. This stems from an effort in the 1990s to regenerate town centres when local authorities allowed pub companies to move into cinemas and churches that had fallen into disuse. That led to new discount operators moving in. That's why the likes of Punch have focused on the "local boozer", running pubs in rural communities.

In a competitive market, size is important. As Mr Crawford explained: "When they get to critical mass, their bargaining power with the breweries increases." Beer is still by far the biggest product sold in pubs, despite a 16 per cent decline in beer sales since 1979 and an explosion in food sales, which now accounts for 40 per cent of average pub revenues.