What’s the point of FirstGroup?
One of the interesting questions thrown up by the National Bus Strategy is the future of the major transport groups.
Arriva, Stagecoach, First and Go-Ahead are national businesses in a world that is suddenly local. Where do they fit?
Where did all the margins go?
The owning groups all started out as bus companies back in the 1980s. They grew by acquisition into national bus businesses in the 1990s, and then diversified into rail.
Arriva, before the name ‘Arriva’
Initially, the City saw rail as a significant opportunity. The downside of the bus business was that buying and owning buses consumed a lot of capital. Rail, with its capital-light structure, balanced this nicely. However, rail never lived up to its promise. During the time I worked there, National Express was the country’s biggest rail operator with nine franchises. Yet analysis afterwards suggested that the entire exercise in running trains hadn’t made any material return at all. The majority of recent franchise wins have turned sour for the winner.
Then the owning groups looked overseas. For a while, America (and, especially, school buses) was the opportunity. But margins were suppressed by the highly localised and management-inefficient nature of these operations. Then the opening up of European rail operations looked like it might be the answer. But most contracts were won by state incumbents, and the few profitable contracts won by the owning groups were hardly big enough to cover the central costs of the new bid infrastructure.
The big new growth opportunity of recent years turned out to be the liberalisation of intercity coaches in Europe, but most of the owning groups sat this one out (though Stagecoach dived into it), with venture-capital funded Flixbus using its huge cash raises to buy up routes throughout Europe (including all of Stagecoach’s). (It’s not yet certain how profitable Flixbus will be in the long term.)
So with rail franchises out of favour and overseas opportunities generally small, the owning groups are back where they started as British bus companies.
But, of course, the environment is very different.
Back in the 1990s and 2000s, most owning groups prioritised margin growth through cutting costs. Management teams were stripped back, depots closed and passenger numbers fell. As costs fell ahead of passenger numbers, so margins stayed high. Both Go Ahead and FirstGroup saw their share prices peak in 2007: today, the share price of Go Ahead is half that of the 2007 peak, and First’s is less than a fifth. In 2009, FirstGroup’s adjusted profit was £400m on turnover of £6bn; ten years later this was £300m on £7bn. More work for less reward.
First in 2002: costs fell faster than passenger numbers
In the heyday of 2007, it looked like buses would generate high margins to justify the capital cost of buses, while rail would provide lower margins but high volume cash. Finance Directors loved rail season tickets, which generated vast amounts of free cashflow; a source of finance now closed off. The National Bus Strategy appears to indicate a world in which buses have neither the margins, nor the cash.
So, what is the future?
There is now no room for owning group differentiation. I remember from various Association of Train Operating Company forums how difficult it was to move forward on ticketing and technology, as each owning group had its own technology strategy. Those days are over. Instead, ticketing and technology will be determined by local authorities, and operators will largely have to fit in. Indeed, the strategy was also explicit that the owning groups won’t even have their own brands: the names “First” and “Arriva” will vanish from the sides of buses, to be replaced by local identities. (There is an interesting question around how two different operators on the same patch will work: will we now have the “Oxford Bus Company” and the “Bus Company for Oxford”?).
In many ways, the National Bus Strategy moves us towards a world more akin to rail than recent past of bus. Decisions are likely to be centralised in Whitehall, though with a lot more mediation by local authorities.
However, there are potential upsides for operators. Rail involved vast one-off gambles that frequently turned sour. Bus companies won’t have to bid - one of the strange things about the new Enhanced Partnership model proposed is that it basically freezes the operator map as it is today. If operators play their cards right, they are likely to be permitted reasonable (though not high) margins.
In many ways, you can see a comfortable future for operators working in partnership with local authorities in an environment of growth generated by new bus priority measures. The more intelligent operators will work in partnership with local authorities to ensure that the solutions that emerge are practical and efficient, while benefiting from local authorities feeling more ‘bought in’.
However, there are two potential risks. The first is that this will require a big upskilling from the groups that have denuded their regions of management. The groups with local, empowered management teams can immediately start work with their local authorities in shaping a high growth future, built on the ambition of the strategy. But that doesn’t describe the bigger groups. Stagecoach recently announced that its Oxford business would no longer be run from Oxford. This is precisely the opposite of the direction of travel required by the strategy. This is going to be tricky for those owning groups that have stripped out all this cost, as they are faced with the choice of putting it all back in (with no guarantee of any kind of return - it will just sit as a drag on the P&L in the short term) or not putting it in, and causing the Enhanced Partnerships required by the document to fail. If they fail, they’re unlikely to be replaced by anything more advantageous to the operator.
The second risk is that even with all the required upskilling, the timescales are just too tight (I talked about this in more detail last week). As a result, any Enhanced Partnerships concluded in those parts of the country with zombie operators and hollowed out local authorities risk being either shallow or actively harmful.
If these risks can be avoided, then you can start to see a virtuous circle of passenger growth caused by bus priority driving profits driving further investment driving further growth. It is likely to be at lower margins than during the 2007 heyday but it is likely that the margins will be high enough to exceed the cost of capital, both because London sets a clear precedent and because, in practice, there is no alternative.
However, you are then left with the question of what, precisely, the owning groups are for. They will no longer have a brand, decisions will be devolved to local management and technology strategy will be set by Government. They will not be able to make their own ticking and technology questions, and their reduced size and scope limit their ability to deploy large-scale financial firepower. The Williams review will be crucial in determining what future these groups have. On the bus side, the future looks more like a lot of small, independent bus companies but with a group treasury and group procurement function attached.
FirstGroup now trades at book value (with a lot of Goodwill included), meaning that the City attributes no value to FirstGroup’s existence. Given that the value-add of owning groups can only fall, is the best answer to actually break up some of the big owning groups and see if more value can be generated by truly local, independent businesses working in partnership with their local authorities? Don’t go away… we’ll come back to this question again in a few weeks time and do a bit more speculation on what comes next.
What do you think? Is there a role for big owning groups? And what is it? Tell me on LinkedIn
FURTHER READING:
For the full Freewheeling commentary on the National Bus Strategy, click here
