Description

 Given how ugly the last two pitches in the UK have turned out (granted for the most part timing is too short to really judge but there are definitely crumpets or chucky egg on the proverbial face from those pitches) - figure this third time will be a charm, that or a hard lesson learned that Mr. Market’s wonky UK cousin is just a mean-spirited wanker.    

Summary: Trainline (“TRN LN”) is a dominant, high return business with a large, underpenetrated addressable market. We think the company will return 2.5x-3x over the next 3 years and potentially a 5x or more over the next decade, with little chance of impairment with the current valuation, balance sheet strength and market position (according to the psychology of colors green is meant to represent tranquility and good luck – a color everyone could use right about now – soak it in!).

What Does Trainline Do?:

Questions? 

For anyone not following, here are a few more details:

TRN LN is an OTA that allows consumers to buy train and bus tickets in the EU/UK. Founded in 1997 as the Thetrainline.com it was the ticketing division of Virgin Rail Group, TRN LN originally sold tickets via call centers and in 1999 started selling online (sadly Sean Parker has yet to tell Clare (TRN LN’s CEO) about the brilliance of dropping the “the” – clearly that is a value lever for TRN LN to pull later).  Stagecoach (SGC LN) bought a 49% stake in TRN LN from Virgin. TRN LN started to white label online sites in 2002 for Train Operating Companies (the companies that operate the choo-choos – for the non-technical). SGC LN sold out its stake to National Expressway and Virgin which owned 14% and 86% respectively. TRN LN was then purchased then by Exponent Private Equity in 2006. The current CEO was appointed in 2014 who accelerated growth and launched non-UK. KKR bought the business in Jan 2015, they acquired Captain Trains in 2016 for greater EU access (50mm price). During 2017, TRN LN localized the platform to add additional languages and currencies. KKR IPO’d TRN LN in June of 2019 at GBp 350 (original pricing range of 318-360).

Why is TRN LN Interesting?:

There are multiple growth drivers which will allow TRN LN to grow for a long time at high returns. The EU rail and coach (bus) market is E35.5B. The UK is a £10B+ market, with 40% of tickets currently sold online, and the overall market is growing at 4%. TRN LN has 67% online market share. The EU market is also around 40% online and growing 3% annually, TRN LN has 4% share of this market but is growing rapidly.  We view the EU as a free option and aren’t really counting on its success to drive returns. 

Online rail ticket penetration is around 40% which is low compared to other verticals: food delivery at 55%, classifieds at 70-80% and airlines at 86%. Importantly, only half of current online tickets are mobile (that means half are printed still). Current mobile tickets are only available on 63% of routes in the UK (which is going to 100%) but only represent 14% of journeys. TRN LN gets a higher margin on mobile and sees a 4.4x higher booking frequency on this customer cohort. The growth is triangulated via a 59% increase in downloads over the past year, resulting in an increasing lead on competitors. The move from offline to online is this market is highly certain (who would bet on the strength of paper tickets?) and TRN LN’s dominant market position makes it so they will get almost all the incremental volume (at very high margins).

The complex structure of the UK market is key to TRN LN’s success. There are 27,000 rail stations in the EU (compared to 400 airports), 800 rail carriers, with 55mm fare possibilities and no standard system (as opposed to flights which has a standardized global GDS). The lack of a GDS type system is very important, as companies with an offline to online aggregation platform in a market that do not have a GDS / MLS (e.g. AUTO LN, RMV LN, REA AU, which all have less than 20mm of net PP&E, > than 60% EBITDA margins and > 250mm in GP) and have achieved massively better units economics and winner take all dynamics than those were central information repositories exist (ZG, EXPE, etc. which have < 30% margins and much higher capital intensity). Trainline covers 80% of EU rail and 50% of bus supply and is going to get to 100% (or close to it). The load factor of a train is around 50% compared to 95% for flights, which means TRN LN brings significantly more value to the rails with each customer than their airline equivalents do. Additionally, the take rate on each ticket is regulated at 5% so no one can undercut on price and given the previously mentioned load factor there is no take rate pressure from operators as the incremental volume is so important.

These factors result in TRN LN being able to increase take rate by adding additional services and booking fees (take rate up 60bps in the UK and 130bps in the EU YoY, booking fees are 12% of revenue). App download data suggest that TRN LN’s lead is expanding

As mentioned TRN LN also provides white label websites to the rails (TRN LN runs sites for 8 of the top 20 UK train operating companies), which means that in 2019, 28% of all UK train ticket sales and 67% of online sales went through the TRN LN system, in addition to capturing 96% of all third party UK consumer ticket sales.

Low Take Rate + Significant Complexity + High TRN LN Brand Awareness = Significant Barrier to Entry.

This is triangulated with multiple cases of failed entry, including Skyscanner, Expedia, Ctrip, Klook, Omio and Loco2 among others, along with primary research conversations which made it clear that taking enough volume away from TRN LN in this low take rate market to be viable was almost impossible.

Not surprisingly the barrier to entry has led to impressive economics. The UK consumer business grew 25% in 1H20 (FYE Feb) with flat year over year marketing spend as 80% of customers come from free channels in the UK. Sales from repeat customers increased from 80% to 85%. As a customer acquisition cost business, controlling their channel of acquisition is incredibly important and rare.  More importantly what this means is Google does not dictate their future which has been an anchor around a number of other online booking mediums.

In 1H20, ticket sales were up 20%, revenue up 29%, gross profit up 37% and EBITDA up 99%. In FY20 (pre the preliminary trading report) ticket sales were up 17% and revenue was up 24%.   For FY20 management expects EBITDA of 82M-86M ahead of their expectations at IPO. Overall ticket sales were in-line and revenue and EBITDA were above IPO expectations. They are not offering FY21 guidance yet – their FY20 earnings call is on May 7th.  They did however reiterate their medium-term guidance of high-teens growth in net ticket sales and revenue.

Free cash flow conversion is great due to negative net working capital and very little PP&E (TRN LN has negative invested capital). Over the past 3 years, UK consumer revenue is up 87% while marketing spend is flat. Additionally, the current income statement is suppressed by the spend to get the EU platform up to speed and acquire customers. Based on the structure of the EU market and numerous primary research conversations, we think it is unlikely TRN LN will replicate their success in the UK in the short term (but could over the longer term due to EU mandated competition). In the UK, EBITDA margins are 57% but they are losing 18mm in EBITDA on 14.5mm of revenue in the EU putting them at 28% overall.

Why Does the Opportunity Exist?

Pretty simply this is a new IPO with lower volume so its off most people’s radars.  More importantly though CV has decimated anything and everything travel and taken TRN LN below its IPO price.  This seems like a classic case of the baby being thrown out with the virus infected bathwater. 

What Can you Make?

Companies similar to TRN LN typically trade for 20x forward FCF with lower growth.  If you take out the EU losses and put a 20x multiple on the UK only business (assuming 35mm to 40mm of corporate costs are for the UK) it is worth 590p on trailing numbers given considerable valuation support (that is 85% upside on UK business alone today). 

We think the right long-term way to value the company is on FCF.  As TRN LN normalizes (FY21 will be messy) we think they can get to 375mm in FY23 revenue (assumes slightly down FY21 and in-line with medium-term guidance growth in FY22 & FY23).  Assuming the low-end of what we thinks is possible on EBITDA margins (40%) that implies 150mm in FY23 EBITDA. Netting out say 35mm for CapEx (negative working capital is offset by taxes) results in FCF of 115mm on a 1,584mm TEV (TEV is actually lower presently as it ignores 2H’20 FCF generation which hasn’t been reported yet).  Incremental EBITDA margins are in the 80% neighborhood even if they are growing at a LDD rate – that still implies 20s+ FCF growth. 

Assuming a high-teens potentially low 20s topline grower with 40% EBITDA margins and 30% FCF margins can trade at 25x (4% implied FCF yield) that would imply a little more than a 2x from today. If TRN LN doesn’t start aggressively buying back stock or paying a massive dividend by FY23 they will have ~35% of their market cap in cash.  This likely makes it in the 2.5x-3x return range – but who knows maybe they royally mess up capital allocation.

Longer-term we think this has massive potential – if you do TAM math the UK market is €11.1B and the European market is €23B (both growing at 3%) so the right question is what portion of tickets will be mobile in 5-10 years?  If you think mobile and physical ticketing will go down – TRN LN is your short! If however you think digital will eventually be 100% and mobile will go from 19% (in the UK for example) to some higher number then TRN LN will do VERY well.

Given their dominant positioning with amazing incremental and current FCF margins we could easily see this being a 5x+ return over the next decade.

Risks:

There are three “risks” here. 

1)      In the near-term its obviously Covid-19 (an obscure virus out of Wuhan that may have some global implications – TBD). 

2)      Regulatory action.

3)      New competitive entrants.

On #1 – eventually we will get through this and people will go back to work and commute again.  This doesn’t feel like an absurd statement. The company has ~36M in net debt and the debt is not due until 2024.  If we want to do extreme math and pretend all commuter revenue drops to zero (which it won’t) but let’s be extreme. As of 8/31/19 TRN LN had 165mm in cash. Today it is likely closer to at least 180mm, potentially 190mm. If revenue went to zero, they would have a working capital unwind that is likely a one-time 50-70mm drain. Total fixed costs are 70mm, marketing is likely already at zero with is the remainder of the costs. They also have about 50mm of excess revolver capacity which was recently refinanced and not due until 2024.  So all this means TRN LN could exist for more than 2 years without any revenue assuming no cuts to OpEx (which is a silly bold assumption IMO). Also all this above ignores the massive UK government stimulus which TRN LN could likely tap into if needed. Long story short a CV shut-down induced BK seems silly to spend this much time arguing why it won’t happen.

On #2 – the longer-term bear case is regulatory action. The UK is undergoing a Williams Rail Review, one aim of which is to make pricing less complex which might make their product less attractive. The FT has written that “Trainline is a highly profitable business that leeches off an industry requiring £4.3bn in government subsidies last year”, the Williams Review “plans to simplify fares by replacing the “outdated” Ticketing and Settlement Agreement, which is the framework both for Trainline’s retail license and its data feeds” and that “simplifications could erode Trainline’s technical advantage, since baffling complexity was what it was built to navigate”. From our calls, it is possible that the Train Operating Companies might try to lower commission rates but they are contractual through 2023, overall take rate has been growing as train operating companies move away from franchises towards contractual arrangements where they get fixed fees, this reduces the need for them to push for lower take rates. Given the popularity of TRN LN’s product with consumers there is very little chance the government will try to eliminate or significantly hurt them, but they could try.  Williams has been positive on TRN LN as the FT noted: “Mr. Williams seems to view Trainline as a benefit to travelers, saying last year that the company was among those “demonstrating that innovation is possible for rail”. That would make it hard to imagine a situation where the economics are massively impaired. There has been little to no competitive switching so far. We think its much more likely that TRN LN comes out of this stronger with expanded take rates given their essential function to the rail operators (similar to how BKNG expanded its take rates in the GFC).

On #3 there have been competitive entries in the past and they have universally flopped.  It is highly unlikely someone like BKNG or GOOG would enter the market given UK TAM and take rates.  Long-term TRN LN could very well be acquired by someone seeking to roll up dominant bookings platforms but it unlikely they see additional competition.  Many of the recent failed entrants were VC backed companies and its unlikely we are going to see a large influx of VC money into the travel bookings space anytime soon.  If anything TRN LN may extend their already large lead. 

Catalyst

Three likely catalysts:

1) CV fears subsiding and life as we know it resuming

2) Williams Review coming out without nuking the UK rail industry

3) TRN LN continues to beat expectations