First Group suitor Apollo ‘must have pension plan’
A private equity firm’s approach for the bus and train operator FirstGroup may create a political head of steam, finds Bradley Gerrard
THE pensions watchdog has warned a US private equity firm that its planned takeover of the rail operator First Group will face scrutiny over the company’s £350m retirement fund deficit.
First Group revealed it had rejected an “opportunistic” approach at an undisclosed price from Apollo Management on Wednesday night. Yesterday the private equity firm was already attracting political and regulatory fire.
The Pensions Regulator (TPR) said it would “expect any business planning a major corporate transaction, such as a takeover, to identify if there is potential material detriment to a pension scheme and explain how they will mitigate against that detriment”.
First Group’s pension deficit has been a financial millstone for the firm but any attempt by Apollo to shirk responsibility for its 50,000 defined benefit members would spark political fury.
The regulatory clearance process is voluntary but TPR said it was important to secure its approval because, without it, the body could turn to its anti-avoidance powers to force Apollo to close the deficit. TPR can look back six years to identify actions taken by management that might have been detrimental to its pension schemes. Shadow transport secretary Andy McDonald said: “Labour will be seeking urgent assurances from the Government that this deal protects employees and their pension schemes. If such guarantees cannot be provided, we will be calling on the Government to block the deal.”
John Ralfe, a pension consultant, said the recent bid by Melrose for GKN had shown how important pensions are in acquisitions.
Apollo is yet to comment on its plans for First Group.
The surprise bid for one of Britain’s largest bus and rail companies by an American private equity firm looks set to intensify the debate about ownership of the railways and UK plc more generally. New York-based Apollo Management has been rebuffed by the Aberdeen-based transport group but the private equity firm now has until May 9 to make a formal offer.
A formal bid threatens to raise the already high temperature in the rail industry. Apollo has no prior experience of running a franchise and brings with it all the political baggage of a major buyout firm.
FirstGroup, which was founded in 1986 as Grampian Regional Transport, floated on the London Stock Exchange in 1994 with a £57m valuation on the back of a raft of bus acquisitions.
It is now a £1.2bn FTSE 250 company with control of Britain’s third and fourth largest rail franchises by ticket revenue. It runs South Western Railway from London Waterloo and the Great Western Railway via Paddington.
Apollo’s approach means yet another operator would end up in the hands of a foreign owner. Already, just six out of 18 firms eligible to bid for control of UK rail franchises are British companies.
Gerald Khoo, transport analyst at Liberum, said: “The acquisition of a large UK employer providing essential services to the public by a foreign private equity fund seems unlikely to be welcomed in the current political environment.
“Even before that private equity ownership of rail franchises seems unlikely to be acceptable.”
The Government has always sought out operators that can demonstrate both operational expertise in rail and a long-term commitment to the industry. Ministers are likely to want a say in any change of control of any rail franchise.
Apollo, founded in 1990, was launched from the ashes of the investment bank Drexel Burnham Lambert, which collapsed after a junk bonds scandal. Leon Black, the former head of Drexel’s mergers and acquisitions department, launched the firm with various former Drexel colleagues, and invests money on behalf of some of the world’s largest pension funds.
Some of its recent big purchases include Harrah’s Entertainment, a leading US gaming and casino company; Norwegian Cruise Line, the cruise line operator; and one that is perhaps more familiar with British consumers, Claire’s, the retailer of costume jewellery.
Transport has not been an investment focus, however.
Luke Pollard, Labour MP for Plymouth, said its approach for FirstGroup raised “serious political questions”.
He said: “Private equity firms are famous for asset stripping and profit maximisation and I don’t know if that’s the type of business we want running our railway.
“The takeovers of British businesses in the past few months is a concern because they are being lost and it seems to me we don’t have a government that is standing up for such companies.”
Yet FirstGroup is in some ways easy prey. Amid a malaise of several years, it has been under particular pressure in recent months. Its shares fell nearly two-fifths to 82p at the end of March after it cut its earnings expectations.
The company runs roughly a fifth of the nation’s buses but has found conditions across the UK extremely tough. It has been forced to relinquish swathes of business to rival Go-Ahead.
It has also been hit by poor weather in the US, which has hit its Student Bus division, and the rise of low-cost airlines in the US has put pressure on its coach business Greyhound.
There’s also the issue of the transport firm’s gaping pensions black hole. FirstGroup was named as the company most under pressure due to its pension liabilities in a 2017 study by JLT Employee Benefits because of the £4.9bn liability compared to its stock market value, then £1.3bn.
The company sponsors 12 funded final salary schemes across its non-rail operations, covering approximately 50,000 former and current employees. Apollo’s plans for the deficit will attract close scrutiny.
The pensions lifeboat the Pension Protection Fund has already been forced to rescue the schemes of BHS and British Steel, which could make ministers wary of a US private equity firm owning a company with so many workers’ retirements at stake.
John Ralfe, an independent pensions expert, said FirstGroup clearly had a “very large underlying pension liability given the size of the company”.
He said that the importance of pensions in a bid process were recently highlighted by Melrose’s hostile takeover bid for engineer GKN.
“FirstGroup’s pensions are huge in relation to its market cap of £1.3bn, with a £350m deficit at March 2017. How Apollo will handle pensions is a major issue, especially if the bid is debt financed, but so far it has said nothing.”
Little is known of Apollo’s plans to turn FirstGroup around. A break up is possible. The buyout firm could be simply seeking to secure First Group’s US businesses and then sell off the UK ones, thus avoiding the political strife that a potential purchase would bring.
FirstGroup’s Student Bus group, corporate-focused transit division and Greyhound account for roughly 60pc of revenues at the group, which stood at £2.77bn at its most recent half-year results. This only included four weeks of the South Western franchise it took over from Stagecoach last year, so a more equal balance between the UK and US might be achieved in the coming years.
One of FirstGroup’s biggest investors, who did not want to be identified, acknowledged the company was “undervalued” and said it will hold on to its shares while monitoring Apollo’s next move.
Analysts expect full-year pre-tax profits of £200m for the year to end-March, slightly below the £207m achieved in the prior year. This could mean FirstGroup needs to surprise on the upside to fight off the transatlantic approach. That could be extremely challenging given the harsh weather conditions across the UK this winter.
‘The acquisition of a large UK employer providing essential services to the public by a foreign private equity fund seems unlikely to be welcomed in the current political climate’
Passengers stand on the roadside during a Greyhound bus layover in Wyoming. Buyout firm Apollo’s bid for the transport group may see it target the US division, while hiving off its UK operations