December 12, 2013 1:14 am

FirstGroup deflects spin-off call

By Jane Wild

FirstGroup’s rejection of break-up proposals from an activist shareholder has received widespread support from analysts.

Sandell Asset Management, a US hedge fund set up by billionaire Tom Sandell, called on Monday for FirstGroup to spin off its US student and contract businesses and sell Greyhound, the US intercity coach business.

It wants proceeds to go towards repaying the debt of the UK-listed transport group and to be reinvested in its UK bus and rail businesses, allowing it to boost returns to shareholders.

But analysts have questioned the proposals from Sandell, which has been building a position in FirstGroup since the summer and currently holds a 3.1 per cent stake.

“It’s difficult to understand why paying down more debt in a standalone Firstgroup UK business is the right thing to do. And actually finding natural buyers for the US businesses may prove more challenging than Sandell anticipate,” says Anand Date, a transport analyst at Deutsche Bank.

Damian Brewer, at RBC Europe, says that there was the risk that any cash value created would leak back to resolving First’s substantial pension deficits, rather than going to shareholders.

Analysts have valued Greyhound at eight to 10 times operating profit of £60m in year to March 2014, putting it at £480m-£600m.

Sandell’s intervention appears timed to coincide with the appointment of a new chairman, John McFarlane, who faces a baptism of fire. His appointment and Sandell’s move have led some analysts to privately question Tim O’Toole’s position as chief executive.

FirstGroup holds a capital markets day in January, when a more detailed picture of their response will be delivered.

Although FirstGroup appears to have the support of most analysts in rejecting Sandell’s proposals, management face the tricky task of keeping investors on board, given that the turnround plan is expected to take several years.

It must first improve the operational performance of its two biggest profit drivers, the UK bus and US school bus operations, with the aim of generating free cash that can then be used to pay down debt.

One of the main challenges management faces in the UK is that it needs to invest to renew its bus fleet in the hope of attracting more passengers, at a time when its fares are already high.

Some of the funds raised from its £615m rights issue this May – which sent the share price plummeting – will be used to finance a £1.6bn investment plan, largely aimed at renewing the bus fleet.

“The management of FirstGroup are trying to execute on a turnround plan at the moment. But this is more of a slow-burn process than a quick fix and could take up to three years,” says Mark Manduca, analyst at Bank of America Merrill Lynch.

Mr Sandell, chief executive of Sandell Asset Management, dismissed FirstGroup’s rejection.

He says: “They don’t understand it yet and are making up excuses as to why the plan wouldn’t work.”

Fellow investors supported the move, he says, adding that he had taken multiple calls from both private equity and strategic buyers expressing an interest.

Other top 10 FirstGroup shareholders, including Majedie Asset Management and Legal & General, declined to comment.

Josh Black, an analyst at the data provider Activist Insight, said the small size of Sandell’s stake would not prevent them from pursuing their objectives. “What’s important is whether they can convince other shareholders.”

He adds: “If Sandell want to take this campaign forward they will have to up the ante a bit, it’s harder in the UK to unseat a board.”