The U.K. transport operator FirstGroup (OTCPK:FGROF)(OTCPK:FGROY) may be able to rejig its asset base, which along with some government help could help ensure its survival. Although there are too many moving parts here for my own tastes, for those interested in a special situation like FirstGroup, I think the recent news stream is positive for the company’s chances of survival.
FirstGroup: In the Middle of an Existential Crisis
FirstGroup is a U.K.-based bus and train operator. Despite its U.K. base and listing, a large part of its operations is in the U.S., where it operates under the Greyhound brand, amongst others.
It has had a torrid year, announcing in July concerns about its ability to remain as a going concern. The shares fell, although they had already had a large downward slide due to the demand slide caused by the COVID-19 pandemic and lockdowns.
Source: Google Finance
However, the past few days have seen some good news for FirstGroup which increases its chance of remaining as a going concern.
The U.S. Operations May Have a Buyer
The U.K. press is reporting that buyers have been sounded out in recent months about a possible sale of its U.S. operations, and there are a number of interested buyers. The company has not yet issued an announcement to the market confirming these rumors, but the press reports seem credible.
I don’t regard the prospect of such a sale as a surprise. Operations like school buses and, indeed, intercity bus routes are bound to start service again at some point, if they haven’t already: Greyhound services continue to operate in many U.S. cities. School buses are facing a difficult restart (as per this New York Times article) but are beginning to resume. While ridership may take time to recover, for the most part I expect it to recover.
So if a cash rich buyer is able to buy the business and cover its operating losses until business gets back to normal, likely in a matter of months or perhaps one or two years, it would be able to pick up what should be a profitable business. Doing so now would allow it to acquire the assets on the cheap – in the current situation, FirstGroup looks like a distressed seller, so if someone comes along and offers it the dual benefits of a pile of cash, and no longer needing to worry about the U.S. operations bleeding, I expect the company would take it rather than hang on for a possible future price recovery in the value of the asset.
The press reports refer to the company’s U.S. business. It also has a fairly small business in Canada, but for now it is unclear whether that will stay or go as part of any sale. The big headache is the U.S. business.
Yes, it may be a fire sale, but if a fire sale raises funds which allow a company to keep going with its other operations, it can be a bitter pill worth swallowing. Stagecoach (OTCPK:SAGKF)(OTC:SAGKY) took a massive loss when it exited the U.S., as I outlined in Stagecoach Is Not FirstGroup: An Attractive Entry Point. I expect the same to be true for FirstGroup. But, a non-cash balance sheet writedown, accompanied by a cash injection from a sale even at a low price, would help the company’s long-term survival prospects.
The Company’s Train Operations Will Receive a Funding Extension
The company’s train operation GWR has been benefiting from government money during the pandemic. The U.K. transport department waives revenue, cost and contingent capital risk. GWR receives a fixed management fee with the potential for a small performance-based fee. In other words, even if passenger numbers do not recover, heads GWR wins, tails GWR doesn’t lose. I think there is a lot wrong with the way risks and rewards are distributed in the U.K. railway as it is currently configurated, and this sort of agreement is very poor value for passengers and taxpayers in my view. However, it is a boon for GWR and FirstGroup, as it provides more clarity on revenue and helps to derisk a decline in passenger numbers, which nationally are currently running at only a third or so of their pre-pandemic level.
It was announced last week that the “emergency measures agreement” under which this funding is being provided will be extended until at least 26 June, almost a year from now.
There is both a short- and long-term benefit for FirstGroup here. In the short term, it gets revenue even if passengers stay away. Longer term, I think these sorts of arrangements will lead to a reevaluation of how the rail network and services are run. Government is looking to take closer control. That is risible – it was government-owned British Rail that ran such poor services before privatization, and it was the government’s insistence on an unworkable structure and division of responsibilities that led to the current shambles, versus returning to something akin to the proven Big Four private model used before Mr. Atlee’s socialist government nationalized the railways in 1948. However, if it does happen, it will likely mean the government will need to sweeten operators like GWR for changing contract terms. So, any move for further nationalization could be accompanied by some financial benefits for incumbent operators. I certainly wouldn’t count on that for now, but it is a possibility.
A U.S. Sale will Strengthen the Currently Frail FirstGroup
I don’t much like FirstGroup at this point – it’s in the middle of a large reduction in transport demand of uncertain duration, and its problematic U.S. business is a distraction. In the U.K., the company’s bus passenger volumes last month were still reported at only around 40% of normal. Train passenger volumes are slightly worse, as discussed above. Clearly, FirstGroup is not a standard investment choice right now and I do not think anyone should consider it who is not willing to accept the risk, albeit now reduced in my opinion, that its shares could still go to zero.
However, if it can sell the U.S. business even at a bad price, the cash will somewhat help its balance sheet and it can focus on its U.K. business. With the government more or less funding the train business, and heavily supporting the bus business, that should provide the company with an opportunity to restructure its debt and find a viable path to long-term financial health.
As at the end of June 2020, the Group’s undrawn committed headroom under its revolving credit facility and free cash (before ringfenced cash) was c. £850m, per its annual report. However, it continues to have heavy liabilities.
Source: company annual report (figures in £m)
A U.S. sale was mooted last year at around £3 billion. I think that was ambitious, which is why it didn’t materialize, and it is now a buyers’ market, so even if it is hotly contested, estimating pricing is a crapshoot. But clearly, even if it can only raise half a billion or a billion pounds, that would still improve the company’s balance sheet. It won’t transform it, but it will improve it.
Putting a valuation on the company’s shares at this point is very tricky. Almost every part of its business lacks a transparent outlook. We don’t know how fast and to what level demand will pick up on buses, we don’t know that for trains, and we don’t know what price the U.S. business will fetch. The whole thing is too messy for me to consider investing. However, while the company for now remains on life support, the recent news stream shows that it has a path back which, if it materializes, could allow it to improve its balance sheet and focus longer term on its cash generative U.K. business.
Improved Prospects Should Lead to a Share Price Recovery to Some Extent
If the group is seen as able to survive, it will lead to a reevaluation of its beaten down shares, whose fall from grace has been long and severe and far predates 2020’s challenges.
Source: Google Finance
On Monday, following the weekend news about the possible sale, shares were up 25%, suggesting that the market likes the news and also considers it to increase the likelihood of FirstGroup continuing as a going concern.
While the company ended 2019 at 130p, for much of the past five years it has traded around 100p or less. So, after Monday’s rally, the shares have already recovered a considerable part of their recent lost ground. There may be further upside from here, albeit with risks, but the market is already starting to price in an improving albeit uncertain prospect of recovery.
Conclusion: A Step in the Right Direction
The possible U.S. sale is a much needed shot in the arm for the company’s finances, if it materializes. That is so not only for the cash input, but also because it removes the risk of negative cash flow in coming months if the company restores services, but ridership is low.
The key thing to look out for here is whether a credible bid is tabled, when and at what price. If it does, at anything other than a total bargain basement price, there may be further upside in the shares. However, significant risk remains for the company and at this point I continue to regard them as a punt, not an investment.
Disclosure: I am/we are long SAGKF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.