The less than glamorous domestic transport sector became the surprising sweetheart of investors this summer, helped by revenues that are indirectly tied to inflation and often backed by government contracts.
UK transport operators continue to provide rich pickings for international trade and private-equity buyers.
Coach operator Stagecoach Group PLC (LSE:SGC)'s decision to reject a planned merger with National Express Group PLC (LSE:NEX) in favour of a take-private bid from infrastructure investor DWS Infrastructure highlights the trend.
Recent bids and approaches for Sweden's Nobina, Stagecoach, FirstGroup and now Go-Ahead have “highlighted significant interest in bus (and rail) assets from PE, infrastructure and pension funds,” investment bank RBC said in a note on Tuesday.
“Even if not acquired, (or alternatively approached regarding parts of their businesses), the remaining listed operators should arguably start to trade with a scarcity premium.”
If you take a closer look at these assets, the reasons behind the unlikely courtships stem from relative insulation against, and in some cases a boon from, price rises.
Domestic transport also forms an infrastructure-like asset base which, like other public infrastructure investments, sometimes has revenues underwritten by government contracts.
Amid periods of high inflation like the current global climate, domestic transport operators can benefit from fare increases, and many are bouncing back since the pandemic now that workers are returning on a hybrid basis to the office, unlike in the ailing flight sector.
FirstGroup, which rejected a bid from the private-equity firm I Squared that valued its shares at 163.6p each, is among the latest domestic transport operators to receive takeover interest.
Having spurned I Squared's advances, the company announced today that it had won a new three-year contract with National Rail to continue servicing Great Western Railway lines that it claims represent not just a low revenue risk, but a non-existent risk.
Under the management contract, the Department for Transport “retains all revenue risk” and “substantially all cost risk”, FirstGroup said.
A spokeswoman for the company told Proactive Investors that the revenue under the contract is not directly linked to passenger fares and has no passenger volume risk.
“[National Rail contracts] have a better balance of risk and reward, with a fixed fee for service delivery and limited contingent capital risk," she said.
"It’s a concession-type structure with no passenger volume/ revenue risk. It also has performance-based fee opportunities mainly based on passenger-focused metrics.”
Under the three-year contract, FirstGroup will earn a fixed management fee of £6.9mln a year with the opportunity to earn an additional performance-based fee of up to £17.8mln a year depending on punctuality and other targets.
Elsewhere in the public infra space, there are companies such as Biffa PLC (LSE:BIFF), which recently attracted interest from private-equity firm Energy Capital Partners LLC, that offer further hedges against inflation through inflation-linked pricing structures.
“It’s easy to see why private equity would want to own Biffa," said AJ Bell investment director Russ Mould.
"Its services are in demand whatever the economic climate and a lot of inflationary pressures can be passed on to customers thanks to inflation-linked pricing structures for many of its contracts."
Already this week, the board of train and bus operator Go-Ahead Group PLC (LSE:GOG) has also recommended an all-cash takeover offer from a consortium, fighting off a rival bid from Kelsian.
The company's board recommended a bid from Gerrard Investment Bidco, set up by a consortium of investors including Antipodean bus operator Kinetic and transport infrastructure company Globalvia, of £15 per share.
Both buyers in the consortium are backed by pension funds, such as OP Trust, PGGM and USS, which often have a low appetite for risk and are partial to infra exposure.
Canadian investment bank RBC said it expects the bus operator to materially outperform the sector average over 12 months.
The deal values Go-Ahead at about £647.7mln, a 24% premium to its closing price on 10 June, but still below its value at the start of the pandemic. Go-Ahead shareholders would get £14.50 in cash per share and a 50p per-share dividend payout for the year in July.
RBC said the deal hinges largely on UK policy, highlighting the bus operator’s UK strategy and the potential to increase its market share in the UK through acquisitions.
"In our view there should be positive read across to peers from further sector M&A,” RBC said.