Share price £ 1.15
Shares outstanding 1,213
Market Cap £ 1,395
Capital Leases 105
|Enterprise Value £ 2,570
|EBITDA £ 690
Peer Median First Group
Abra399, in his/her writeup on March 19, 2018 has thoroughly depicted the 5 operating divisions of this company, and the fact that FGP is currently an orphaned stock: a UK listed company with 70% of the operating income generated in North America. In that March 2018 analysis, Abra399 believes the equity upside to be 158p (+40% from the current price) using what we believe to be very conservative assumptions – namely TTM EBITDA for First Student which we expect to have higher growth rates, a 4x multiple for the market leading US transit business (whose less attractive peers have been sold for at least 7x), a 4x multiple for the UK bus business (analysts say 6x-7x), and excludes any potential uplift from hidden assets which could be worth multiples of the current market cap, as discussed below. By way of background, we have spent over two years studying this company along with leading CEO’s and experts in the industry, have developed a detailed operational turn-around plan and value creation plan for the company (which we will disclose over www.savefirstgroup.co.uk). In short, we believe that the stock is worth 250p to 300p+ per share, and presents well over 150% upside potential from here.
FirstGroup, despite its world class assets, has been very poorly managed under a defunct and inexperienced board and top management team that are based in the UK and have micro-managed very local businesses in the US. As a result, the different divisions are performing well below their potential, and the company has under-performed its only true peer, National Express, by nearly 400% on a dividend adjusted basis over the past 9 years. To note, we believe that the company has notable margin improvement potential in 4 of its 5 businesses (First Student, Greyhound, First Bus and Rail) but has no board member with surface transport or turn-around experience, and a CEO who was previously a low level executive with a gambling and chemicals background. Coast Capital, an activist fund based in New York, has recently identified a world appointed board which includes leading CEO’s and operators from the space, and developed a detailed operational turn-around plan, which investors will vote on at an EGM that is to be scheduled by the company in coming weeks (Coast Capital has built a 9.8% position, and requisitioned an EGM calling for the removal of 6 under-performing board members and their replacement with 7 experienced and pedigreed independent directors. We believe that for the first time in a decade, FGP investors are about to be presented with numerous value creative events.
A Misunderstood Business on the Brink of Revaluation
FirstGroup owns some of the most valuable assets in the public transport sector
· First Student - Owns and operates the largest fleet of school buses. A well managed student bus operator generates 20-25% EBITDA margins, spends 7-10% of revenues on capex, and operates on the basis of 4 year contracts with 90% contract renewal rates. This is basically a great infrastructure asset.
· First Transit - Operates largest fleet of transit and paratransit vehicles. Low capital employed, 6 to 8% EBIT margins, over 20% ROC.
· Greyhound - Owns and operates the largest fleet of inter-city buses (very asset rich operation)
· First Bus - Owns and operates the second largest fleet of buses in the UK (when well managed, UK bus operations generate well over 20% EBITDA margins with 7-10% of revenues going to capex)
· First Rail - Operates a suite of rail contracts across UK (for the record, we ascribe zero value to this historically CF generative business).
Great company, poor structure
· FGP is the largest or second largest operator in each of its respective markets, and enjoys economies of scale unavailable to peers
· High barriers to entry / Attractive cash flows
· Great revenue visibility: 4-year contacts / 90% renewal
· Dis-jointed structure creates opportunity: US company (70% of EBIT from North America), yet quoted in the UK, does not pay a dividend (which UK institutions look for)
· The US student bus business is a gem in the transportation sector. This business operates on 4-year contracts with 90% renewal rates, and EBITDA margins from 20% to 25% when well managed (currently 19%) and 7-10% capex to sales. As local municipalities continue to outsource their operations, the industry stands to triple in size. Meanwhile, there are innumerable mom and pop operations to acquire and streamline. Currently, the company owns and operates 42,000 school buses, most of which could be sold and leased back (releasing approx. $3 billion potentially). While Caisse des Depots acquired FGP’s smaller, less profitable peer Student Transport Inc for 12.5x EBITDA in 2018, at which valuation this division alone is worth well over 3 times the current share price.
· The company also has 400m GBP of real estate on its books which consists of depots and parking lots around city centers in the UK and US. These properties were acquired in the 70’s/80’s and have been fully depreciated. If the real estate is only worth 3x it’s book value, then you have the entire market cap. Recent transactions have transpired at up to and over 20 times BV.
· FirstGroup is the only company in the sector to own nearly all of their operating assets. There are nearly 3 billion GBP of operating assets and real estate on balance sheet against an EV of just 2.5 billion GBP. They could easily lease 30% - 40% of these operating assets and release the entire market cap in value back to investors.
· FirstGroup can support and needs to pay a proper dividend. Despite a leverage ratio in line with peers (2.7x Net Debt/EBITDA ex Rail), and positive cash generation, the company has thus far refused to pay a dividend. Given the yield seeking nature of UK institutions, we would target a share price of 150 (30% upside) just based on the reinstatement of dividends.
Reasons for the Current Low Valuation
There are numerous reasons for the current, extraordinary undervaluation, namely:
· Value-destructive, in-experienced board & a history of governance failures
Ø Which we believe Coast Capital is well placed and certainly intent to change
· History of over-promising and under-delivering (promised turnaround in 2013 and failed to deliver on all key metrics committed to)
Ø The Coast board has a long history of effecting business transformation and operational turn-arounds
· CEO: No experience in the surface transport industry, and has spent the bulk of his career in the chemicals industry and at a gambling company
Ø Coast Capital has identified a detailed operational turn-around, and numerous CEO candidates who will happily join the company under new board leadership
· Centralized business model leads to poor decisions and destructive capital allocation
Ø Key operating metric to be changed under new leadershp
· Refuses to reinstate dividend even though net debt in line with peers ex. Rail
Ø Will re-instate dividend in light of CF generation and debt declines
· Mismatched balance sheet: 70% of EBIT in USD, 80% of debt in GBP; only operator to own rather than lease assets
Ø To be addressed by new board and management
· Greyhound & First Rail are distractions: Negative PR, heavy capex with limited upside
Ø Will be exited or disposed of, we expect a commitment to either eventuality within months
· US & UK assets don’t belong together: Negative synergies, US peer STB recently sold for 12.5x EBITDA
Ø Consensus perspective among investors means either board will change or status quo will be broken (likely both)
· The board has claimed that a breakup of the US & UK assets could crystalize pension obligations of potentially £800 million (misleading statement without having first discussed with pension trustees – leading consultant believe could be solved through a restructuring and as little as £75 million)
Ø Coast capital has worked with leading pension fund consultants in UK and drawn a credible, expert led pension restructuring plan which suggests that a separation of businesses can be accommodated with a top up payment would be less than 10% of the above amount
Paths to Value Creation:
A. Operational Turn-around can lead to over 30% EBITDA increase
· Current Board members and management have presided over massive business under-performance
· Our proposed diverse, independent board members are leading operators with inspiring track records and intimate understanding of the industry
· Coast has developed a detailed operational turn-around plan for the company, details on www.savefirstgroup.co.uk
Separate US and UK assets
· End a 10-year history of negative synergies
· US assets have much higher independent valuation, could fetch up to 10 times EBITDA (ex Greyhound)
· Generates £3+ billion in capital used for reinvestment, debt reduction, pension top ups, dividends and buybacks
C. Optimize Pension Plan, Pay Down Debt
· Coast has worked with one of the best UK pension consultants to develop plans to restructure debt
· Reduce gross debt by up to £1 billion
âD. Dividend & Buyback
· FirstGroup is FCF positive, and given above levers can pay dividend, conduct a buy back and invest in growing operations
· UK investors are dividend seeking in nature
· Can buy back over half of outstanding stock in event of monetization of even part of US operations
E. Asset Sale & Leasebacks
· Optimize balance sheet and capital allocation plan through leasebacks
Operational Improvement Potential
Coast Capital’s value creation plan has been developed by leading sector CEO’s under the leadership of the same individual who drew up National Express’ operational turn-around plan (which helped that company to out-perform FGP by over 400% over 9 years). Other consultants to Coast Capital include:
Advisor to the UK Department of Transport
Prior minister for Transport in UK and chairman of FGP’s London Bus company
Former Senior Executives at First Student, First Transit, Greyhound
Founders of one of the fastest growing and most profitable North American Student Transport Business
Our detailed 3-year turnaround plan (an 85-page deck not shared publicly) envisions the following improvements in each division:
· Resource re-allocation from underperforming markets to high-growth, high-margin markets
· Revenue growth rates of ~4% p.a. with improving EBITDA margins to 22%/23% from 19% today.
· NB National Express, #2 operator is growing revenues at 7%, best in class operators generate margins upwards of 25%
· Revenue growth rate of 5% p.a. (in-line with historical growth rates)
· EBITDA margins in line with historical figures: 9%
· Bus re-allocation to profitable routes, implementation of dynamic pricing systems, provision of food on board and outdoor advertising would materially improve profitability
· We assume no net revenue growth and only slight margin improvement from described initiatives
· Margins already improving due to the closure of loss making Canadian operations
· Margins are currently half of peers, because 1/3rd of routes are loss making
· Shrink to grow: Business should be a smaller, more efficient and profitable business with generating EBITDA margins of >16%+
A well-managed FirstGroup should generate £800 million in EBITDA (vs. today’s depressed EBITDA of ~£700 million). With a better board and management team, we believe 2021/22 EBITDA could be £850 million. At National Express’ 8x multiple, that equates to an EV of nearly £7 billion, or c. 460p per share (>300% upside).
If FirstGroup was valued in line with its closest peer National Express, valuation would be:
· EV/EBITDA basis: £3.50 / share (NEX: 7.8x)
· EV/EBITA basis: £2.25 / share (NEX: 12.2x)
· P/BV basis: £2.50 / share (NEX: 1.8x)
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
1. Change in board / management
2. Implementation of Coast Capital’s value creation plan (please visit www.savefirstgroup.com)
3. Disposal of non-core assets