National Express featured among the top risers on Monday after the bus and rail operator confirmed press reports that it had rejected an unsolicited bid from mid-cap peer FirstGroup.
In midday deals, National Express shares were 12.5p or 4.5% higher at 288.25p, while FirstGroup slipped 4.25p or 1.2% lower to 366.5p. The FTSE 250 index edged up 0.6% with a gain of 45.8 points to 7,432.0.
Noting recent press speculation, National Express said in a statement this morning that it received a “highly preliminary approach regarding a potential share for share merger on unspecified terms from FirstGroup.” The company said it is currently focused on implementing “a number of initiatives to strengthen the Group and does not consider it appropriate to enter into discussions.”
Commenting on the news, Panmure Gordon analyst Gert Zonneveld said FirstGroup’s bid is “clearly opportunistic” and that, with the exception of its rail business, National Express’s assets are quite attractive. Zonneveld noted, however, that a tie-up could present some competition issues in North America and possibly in the UK.
National Express’s problems are well known, Zonneveld pointed out in a note this morning, highlighting that its East Coast franchise is heading for massive losses, is heavily indebted, and is in fact in danger of breaching its banking covenants. The Department for Transport is unlikely to renegotiate the terms and conditions of East Coast and the company may choose to hand back the franchise, Zonneveld wrote.
If National Express is to remain independent, Panmure Gordon believes it will need to raise a significant amount of new equity: “Given the current market cap of £417 million, a 1.6 for 1 rights issue at a discount of 40% would raise around £400 million.” For now, the broker sees no reason to change its Hold recommendation on the stock and also maintained its 265p price target.
Also reacting to the M&A news, Arbuthnot Securities analyst Gerald Khoo said he presumes FirstGroup’s approach was in some way contingent upon there being a solution that caps the future losses at National Express' East Coast rail franchise.
Writing ahead of National Express’s confirmation of the approach, Khoo said: “In our view, FirstGroup is in no better a position to deal with or absorb the losses at the franchise than National Express.” The analyst added that if National Express were able to find a solution to its East Coast rail problem, such as surrendering the franchise even at the risk of cross-defaulting on its other franchises, then he believes the group would be able to refinance and launch a rights issue to reinforce the balance sheet, thereby removing the need for a rescue from FirstGroup. But Khoo warned: “It is important to remember that there are worse scenarios than the one we have assumed for our 260p target price.”
Ahead of National Express’s trading statement this coming Wednesday, July 1, Khoo believes the group’s ability to meet its banking covenant is “too close to call and too close for comfort” and thinks radical management action is required to address this.
In summary, Arbuthnot remains of the view that a takeover of National Express does not, in the absence of other measures, provide a solution to the group's main problem of its East Coast franchise. The broker has a Reduce recommendation and 260p price target on National Express, and a Strong Buy and 470p target on FirstGroup. Khoo said in a separate note to clients that the 260p target on National Express assumes the group will surrender all its rail franchises in order to give greater certainty on the earnings and cash flow outlook as a prelude to a refinancing and a highly dilutive rights issue.
