Private Equity Makes a Brave Move With Jeremy Corbyn In View

(Bloomberg Gadfly) -- Britain's politicians are still smarting about the hostile takeover and probable breakup of engineering firm GKN Plc. Now another struggling domestic company -- train and bus operator FirstGroup Plc -- has received a proposal from what those of a left-wing persuasion might call an American asset-stripper. Politics permitting, the outcome is likely to be similar.

FirstGroup, owner of British rail and bus franchises, plus U.S. yellow school buses and the Greyhound bus network, says U.S. private equity group Apollo has made a preliminary cash offer. Without revealing details, FirstGroup said it rejected an "opportunistic" and "highly conditional" bid that "fundamentally undervalues the company."

To be frank, that's not going to cut it. Bid speculation has driven FirstGroup shares up 30 percent since the start of April. That suggests investors expect the group will be sold for a decent premium, or management will finally take action to unlock value from its portfolio.

Private Equity Makes a Brave Move With Jeremy Corbyn In View

As with GKN -- which should have separated its autos and aerospace businesses long before Melrose Industries Plc tabled an offer -- FirstGroup is guilty of not doing enough to revive its flagging share price. Even today, it trades on just 9 times estimated earnings, a big discount to rival National Express Group Plc.

The stock has stagnated since a 2013 rights issue, when the company scrapped its dividend but rejected calls from activist Sandell Asset Management to break itself up and sell Greyhound.

In fairness, FirstGroup needs lots of capital and labor. It owns more than 50,000 vehicles and employs more than 100,000 people. Hence there's a lot that can, and has, gone wrong.

The U.S. bus business is struggling with driver shortages and Greyhound faces competition from budget airlines, while cheap gasoline encourages people to drive themselves. In the U.K., rival rail operators have put in aggressive bids to win tenders so profit margins are pretty low. The British bus business is challenged by the decline of high street shopping. Brexit doesn't help.

The company doesn't generate much free cash flow, which doesn't help when you have 1.25 billion pounds of net debt and a 340 million pound pension deficit.

In view of the weak balance sheet and the political and economic climate in the U.K., Apollo's bid is certainly ballsy. The opposition Labor party would doubtless be furious if driver jobs were threatened. Plus, if Labour leader Jeremy Corbyn wins the next election, he says he'll renationalize the railways. FirstGroup operates three big franchises.

It's plausible that Apollo could try to cut FirstGroup's high interest expenses by refinancing some of that debt. Presumably, it would seek too to unlock value from FirstGroup's portfolio. Even if Greyhound isn't sold -- it might struggle to fetch a decent price in the current environment -- it looks ripe for restructuring . It's probably also sitting on some valuable real estate. In 2016, FirstGroup sold a bus terminal in San Jose for more than 20 million pounds.

It wouldn't be surprising if Apollo hoped to try the well-tested activist idea of splitting the U.K. and U.S. arms. The U.S. school bus business has decent margins and might fetch a higher multiple, and could take on more debt. 

For now, this is speculation. Even so, it seems unlikely that FirstGroup investors will let executives simply reject Apollo's bid without further ado. Either FirstGroup considers radical action, including a breakup, or someone might do it for them. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

To contact the author of this story: Chris Bryant in Berlin at cbryant32@bloomberg.net.

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