What next for the PLCs?
A few weeks ago, I asked the question “What’s the point of First Group?”
Are we any closer to finding out the answer?
Well, one clue emerged recently, when First finally concluded the sale of its American businesses. Instead of being a global transport conglomerate, First has now joined Stagecoach in retreating back to the UK.
The opportunity
Even excluding walking and cycling, just 10% of journeys of 5 miles or less are currently made by bus. Local bus travel should be a major growth sector. We have a Prime Minister who has built his identity, in part, around his support for buses (we have a “Boris Bus” but even under New Labour, we never had a “Tony Tram”. Back in the 80s, of course, we absolutely should have had a “Maggie Motor”). And the need for a climate transition means the macro environment should be set fair for bus travel.
Set against that, however, are some of the many uncertainties that still exist in the National Bus Strategy. Running buses is a capital-intensive business. New buses require a stream of fares to pay for the upfront costs of new vehicles; without certainty of the future, there’s a temptation for the owning groups to delay investment, risking a vicious circle of declining quality reducing income. It wouldn’t be wise, but it would be understandable. Creating certainty around the National Bus Strategy funding as opposed to aspirations must be a key priority for the Government. Sadly, the recent guidance doesn’t do that (we’ll come back to this in a future post).
Stay close to home?
One of the themes of recent years has been the gradual retreat of Stagecoach. It has exited both the American and European bus markets and the UK rail market, and is now back to its origins as British bus company.
First is also now a much more local business; with Greyhound looking highly vulnerable to closure. Megabus in the USA was sold last year, and the school buses this year. If Greyhound could easily be sold, it would have been and First will not keep running it at a loss forever. It’s likely that First will be entirely out of the USA by the end of this year.
Go-Ahead has been focusing its overseas adventuring in Germany, having launched a new contract in Stuttgart in 2019 and taking on services in Bavaria later this year.
National Express is the only one of the major PLCs with an established and stable overseas business; indeed, the UK is only National Express’s third-largest territory after the USA and Spain.
One thing that really stands out is that very few of the owning groups have managed to make a decent fist of launching new overseas operations. The National Express overseas empire was largely built by acquisition in the late 90s and early noughties. The America business was anchored in Durham School Services, bought in 1999, and the Spanish business in Alsa, bought in 2005. In both cases, the local management teams and brands were retained, as opposed to attempting to export British management. Indeed, the Cosman family (who created Alsa) went the other way, and joined the National Express Board.
Attempts at creating new overseas entities by the other owning groups have tended to be much less successful. Stagecoach’s Megabus businesses in both the US and Europe were sold in the last five years. The US sale followed a right down of £85m while the European sale to Flixbus was for an undisclosed price. It’s highly unlikely Megabus overseas made any overall contribution to Stagecoach’s bottom line.
Go Ahead has had similar struggles in trying to expand a proven model into other territories. They’ve just written down £30m covering both its existing concession and the Bavarian concession that has not yet even started. Indeed, last year Go Ahead Germany lost £30m on revenues of £30m, as a result of late trains and having underestimated driver costs in their bid. Their smaller Norway operation also lost £2.5m last year. The only successful overseas operation is a single bus depot in Singapore, though it’s hard to know just how successful as it gets reported as part of the UK bus division.
National Express, which has grown successfully throughout Europe and America through acquisition, has also struggled to build European businesses from scratch. Its new Rhine-Rhur Express German operation lost £4.9m and was subject to a £17m impairment. This is National Express’s second attempt at the German market: it exited the operation of the Nuremberg S-Bahn in 2016 before it had even started operating the trains; while it pulled out of the coach market in 2014 just 18 months after launching a new scheduled network.
Interestingly, the consensus was that First got a better price for its American operations than was expected, suggesting multiple bidders thought they could do better than First at running its overseas business.
British PLCs struggle to make money on overseas contracts. In part, I suspect, there is the problem of margin discipline. Understandably, the PLCs operate to minimum margin targets. Unfortunately, there are always other bidders hungrier and willing to sacrifice margins. These include ComfortDelGro, who are on a major expansion spree and bidding for many of the same contracts. It includes the French firms Transdev and RATP Dev, both of whom have track records of winning overseas bids on multiple occasions. And, of course, it includes the many state railways that dip in and out of overseas competitions. Given the PLCs’ deliberate margin discipline and the roster of other firms keen to take market share, it means that the British PLCs almost only ever win an overseas competition if they’ve got the numbers wrong - as with Go Ahead in Germany.
It’s a bit like the famous quote by Groucho Marx: “I wouldn’t want to belong to any club that will accept me as a member.” In the PLCs’ case it is: “I woudn’t want to execute any contract that I am able to win”.
Of course, the absurdity of this situation is that it works for no-one. Margin ill-discipline from the state railways has resulted in TrenItalia making big losses on c2c, while write-offs contributed to a £64.5 million loss for Abellio at Scotrail last year.
But despite this, it’s notable that overseas adventuring is identified by Stagecoach as a key opportunity area for growth. They talk about bidding for two contracts in Dubai and five in Sweden. This is despite consolidating operating regions in the UK and scaling down management teams.
Sensibly, Go Ahead and National Express plan to steer clear of significant attempts at overseas organic growth; with Go Ahead dismantling its German bid infrastructure.
Other than NX, the only British PLC to have successfully built an overseas empire was Arriva, prior to its acquisition by DB. David Martin, like Phil White at National Express back in the days of the Alsa acquisition, was a dealmaker not an operator. He’s now Chairman at First and will have slightly more capital to play with following the American exit (though most of the proceeds will go to pay down debt), so it may be that First may start to grow through overseas acquisition in future.
Trains
There’s a famous quote that goes “How do you make a small fortune in [insert business sector]? Start with a large fortune”.
I’ve heard it applied to wine-making, owning football teams, aviation, owning racehorses and being Donald Trump.
It could also apply to running rail franchises.
When I joined National Express as a graduate trainee, they were the largest train company in Britain. They employed 25,000 people, operated nine rail franchises and it was possible to travel from Southend to Holyhead or from Penzance to Wick entirely on NX trains, with just a brief gap between Leeds and Carlisle. Yet when they finally exited the UK rail division someone (and I’m really sorry, I can’t remember who) did a study and found that, actually, they’d made absolutely no money whatsoever from all that effort.
A National Express-operated train in Penzance
And those were the days when some rail franchises at least made money. This was the era in which every PLC was comfortably in the FTSE 250 and First was briefly in the FTSE 100. Today, only NX’s position in the FTSE 250 is comfortable.
As with the overseas adventurism, the PLCs have been squeezed out of rail by the fact there’s always someone willing to put in a stupid bid. The most recent example was Abellio in Scotland, who reported £56m of losses last month. But similar disastrous wins recently included Britain’s all three of Britain’s largest franchises (by the three ways you can define largest): South Western Railway (First), GTR (Go-Ahead) and Northern (Arriva). First got out of TransPennine with smaller losses than expected (but losses, nonetheless) while Serco has lost £20m with the Caledonian Sleeper.
I remember a very senior person in a bid team (I won’t say which one) telling me that they always tried to come second in any competition. That way, you came out looking good but all the crazy assumptions wouldn’t be exposed.
However, after a pretty hostile decade to private capital in rail (in contrast to the widespread popular perception that rail companies are leaching vast profits), the Williams Review may be changing the environment.
In future, all contracts will be purely operating concessions like the London Overground, with no revenue risk. The first National Rail Contracts to be issued suggest a margin of 1.5%. Based on the margin discipline applied to overseas bidding, no PLC would ever bid for a rail contract on this basis. On the other hand, while the upside is heavily capped, so is the downside. Virtually no capital is being put at risk and the PLCs have a lot of knowledge of the UK rail market locked up in their management teams - unlike with their overseas adventuring.
Will the new contracting arrangements will be enough to tempt the PLCs back into the water? I suspect so, but it’s probably too early to say.
What next?
A reminder that the local travel market is one in which buses have just 10% market share. And in which the Government is explicitly supportive. And in which there is now a defined strategy - but not yet too much clarity funding.
The PLCs can either take the Stagecoach approach of putting more overhead into the bid costs of expensive foreign adventuring, while thinning out the management overhead of the existing UK operation. Or they can do the reverse.
My hunch is that the reverse might be the best idea.
At the most basic level, the PLCs need to earn a decent margin to fund capital investment into buses. “Decent” will vary by group, but the days of 20% margins at Travel West Midlands in the early noughties (achieved by driving costs into the ground at the expense of customer satisfaction and future revenue) are gone. That will come as a particular shock for businesses like Stagecoach who’ve seen margins as high as 17% in Manchester (with similar margins in Newcastle) within the last decade but which are never going to be repeated in the new world of the National Bus Strategy.
London operators typically earn more like 7%, which still feeds the investment beast nicely. The margins on offer from the new Enhanced Partnerships are going to be a matter of negotiation but may be lower. But going into that negotiation, the PLCs have some significant advantages.
One of the weirdnesses of the Enhanced Partnership regime is that it, effectively, freezes the market shares of the various operators as it exists today. Yes, theoretically, new entrants are entitled to come in and competition law still applies. But in practice, the rules of the game are going to be drawn up by the founding members. An Enhanced Partnership is a bit like a local European Super League; with both promotion and relegation hard to achieve.
That means that the PLCs don’t have to worry about the Comfort DelGros, Abellios (or, indeed, the Sercos) nearly as much as they would under a bid process. The challenge, however, is in negotiating a proper margin. The obvious way to do this is to show a local authority what it’s buying. To do that, an operator needs to have something to sell (beyond what it’s doing already).
An operator that is able to demonstrate, through its local Bus Improvement Plan, that a local area will get a well-thought-through network, really high-quality information provision, friendly drivers, punctual services and great quality marketing will be in a much stronger position to argue that all this needs paying for. As we’ve discussed previously, there’s a purely commercial case for these things anyway but they require upfront investment and investment requires margin.
Even if conversations with local authorities don’t take this rationalistic form (and they probably won’t), there’s a simple logic that most people are willing to pay something for something and no-one likes being taken for a mug.
A bit like First York in offering up £20k as a downpayment on future relationships, now’s the time for the PLCs to be investing in local management teams and central innovation in order to be able to come to local authorities with a really high quality offer. National Express in the West Midlands are a larger scale version of the same dynamic; the local love-in with Mayor Andy Street is highly likely to prove advantageous in the new world of Enhanced Partnerships.
Realistically, operators are probably going to be starting at margins of around 3-4% at the start, which is barely enough to cover cost of capital. But the bus industry needs around £800m per year just to keep the existing show on the road and the much-vaunted £3 billion isn’t going to go very far. The trick is going to be to work in partnership to kickstart the engine of growth (with the bus priority measures on offer) and use that to build up both revenues and margins.
The operators with established local relationships will have a big advantage in this; others will need to build them quickly. Go-Ahead and Transdev, who have maintained local management teams and prioritised local relationships, have been on the right side of history, and may now stand to gain a reward.
Of the ‘big five’, Go Ahead looks in the strongest position, with a modern fleet and strong management teams in place, they will not have to sacrifice too much margin to get to the position they need to be in to ‘earn’ their margins in the new world. Go Ahead also has the advantage of having experience of the challenges of a zero revenue risk franchise at scale with its scarring experience at GTR. Stagecoach and others will have little option but to catch up on both fronts.
Or, alternatively, I heard there’s a really good contract coming up in Turkmenistan?…
