UK bus sales should be key to First’s turnaround plan

The announcement of First’s annual results on 31 May  launched an avalanche of press articles, due to the large loss and resignation of chief executive officer Tim O’Toole (‘FirstGroup’s chief steps down as annual results disappoint’ LTT 08 Jun).

I frequently find myself at odds with the usual financial analysts when results are reported as often what I think is good news they think as bad news, and vice versa. In this case my initial look at the numbers led me to think that at last some real progress had been made, albeit eight years after the real cause of the problem had left the company. For First was the creation of one man, Moir Lockhead, who wanted to be the world’s biggest transport provider, and nearly succeeded by creating an overly-centralised and disjointed monolith over two continents, weighed down by £2bn of debt. This was clearly unsustainable and was obvious to everyone, except the First board, at the time of the purchase of US firm Laidlaw in 2009. Even the low margin US school bus business, where the only real growth in margin would be achieved by cutting costs, had £1bn of goodwill allocated to it. This is the legacy that Tim O’Toole and his team had to resolve, which has overshadowed everything that has happened subsequently.

In this year’s results were three positive items. Net debt was down by 20 per cent; other debt has been refinanced at much lower rates; and UK bus margins have finally started to increase. In addition, the board has finally realised that Greyhound is doomed in its current format by writing off the goodwill on acquisition. But clearly much more has to change.

First has been living in cloud cuckoo land ever since it paid £1.9bn for Laidlaw, well over the odds. The Americans clearly saw Moir Lockhead coming.

When O’Toole and his team took over in 2010 their strategy appeared to be to try to improve margins in the US and UK bus businesses, and win more rail franchises. All logical, but whilst some underperforming operations were disposed of, nothing really moved the needle. So in 2013 there was the rescue rights issue that halved debt, but it was really more of the same and the needle still did not move. On the basis that it should be obvious after three years that a plan is succeeding or failing, the alarm button should have been pressed in 2016. But First’s board sat on their hands.

Throughout this period there were numerous good housekeeping measures, and the quality of the UK bus offering improved considerably from the Lockhead years. But the financial performance did not improve, although net asset value has doubled over the past five years. In UK Bus some operations such as Bristol began to sparkle in terms of passenger numbers, and fare cuts in Manchester also boosted passenger numbers. But in both cases the benefits to the bottom line would be five years down the road, which was not helpful to First’s weak balance sheet. The downside was that the increase in rail passenger numbers slowed, contract prices in the US continued to be competitive, and UK Bus was hit by rising costs and falling passenger numbers due to events outside its control, such as congestion and internet shopping.

In spring 2018 along comes the indicative bid from US private equity giant Apollo Management, which was rejected by the First board. This is rumoured to have been around the level of £1.10 per share. Who knows if Apollo was ever serious, as it never came back with a real bid. But this, coupled with write-off of the carrying value of Greyhound and losses at TransPennine Express has now left First in crisis mode.

What to do next? The first thing to look at is First’s board with three executive and five non-executive directors, now of course minus Tim O’Toole. It’s time to clear out anyone who has been there for more than two years. The financial meltdown seems to have come as a bit of a shock; in fact, reading the various press releases a scene of panic seems to have set in. The chairman and two of the non-executives list one of their strengths as “strategy”. Really? So you have a chairman on £600,000 and four non execs on £60,000 each who did not see this coming and clearly don’t know what to do next. There is a statement in the 2018 results that the board will decide its future strategy and then appoint a new CEO. So the new CEO has no hand in future strategy? 

First needs a CEO who actually understands transport. How about David Martin, formerly of Arriva, or Keith Ludeman, formerly of Go-Ahead? Or get both, that would certainly drive some progress.

Where to take the businesses? In the US, First Student and Transit seem to have relatively stable businesses and margins and these must remain the core of the company. Greyhound is in trouble as the long-distance market has changed, and it is time for FirstGroup to get out. Flixbus or other competitors might like to buy bits, and the city centre terminals either have value as redevelopment sites or as income-generating terminals for other operators. In either case they need selling off to cut debt.

In the UK the bus business has good and bad parts, some of which may have some goodwill value. It will be interesting to see how much goodwill Go-Ahead will pay for their next acquisition; that will be a pointer to value. Action needs to be taken with the poor performers. Has the South West operation a future? Perhaps it could be sold to a management buy-out. Go-Ahead might find the Southampton operations attractive. And what about the isolated operations in Weymouth, Slough and Worcester? Larger operations such as Essex and Glasgow need to be made to pay or hived off to others (Ipswich to Go-Ahead?). 

Unfortunately, there are two real problem areas. In Greater Manchester my suggestion would be to say to Transport for Greater Manchester, ‘you can have it to run, and simply pay us an asset utilisation fee or alternatively we will progressively shut it down’, and South Yorkshire, where in my view the only option would be to sell to Stagecoach, if it was interested. In both cases there would be all kinds of regulatory and financial issues but I think everyone needs to understand that unless there is a pragmatic way forward then both conurbations could end up with significantly fewer bus services.

On UK rail, Great Western is a management contract so low risk, and TransPennine Express is clearly a millstone, so surely this should be handed back to the DfT. All available brainpower should be concentrated on the South Western Railway to salvage as much as possible there. Given the risk to the balance sheet, First should not bid for any more rail franchises, particularly the West Coast Partnership where the risk, and presumably bidding costs, will be even higher than normal as HS2 is involved.

I must emphasise that I have no inside knowledge and all of this article is based on an outsider’s view based on published information. The hurdles that First faces are high but not insurmountable, and it is constrained by its debt and pension liabilities. But unless firm action is taken by a rejuvenated and competent board very soon, the financial position will only get worse.

The next AGM should be very interesting.