Description

Firstgroup PLC (“FGP”) made a statement on the 26th of May 2022 that it had received an unsolicited approach from I Squared, a global infrastructure private equity fund manager, at 118p + a CVR.

The price action in in FGP in recent days has been indicative of an offer being in the works. So here we are and the market is at 134.4p offered, putting a value of ~16.4p on the CVR with a stated pay out of 46.5p, warranting a closer look.

Given this is a preliminary offer situation and not recommended (nor dismissed), the situation remains fluid and speculative. However, we think the case exists to take a position now as there is a good chance this offer closes, whilst we see limited downside and also a decent chance that an improved offer or competing offer will be realised.

For background on Firstgroup PLC, we would point to the earlier write-up on VIC.

1.       Valuation breakdown of the prospective CVR

The CVR has a pay out linked to two assets that are currently in run-off at FGP:

1)  Earnouts that FGP would receive from First Transit, which has been sold to EQT infrastructure in 2021, and

2)  Greyhound, majority sold in 2021, where legacy assets/liabilities have been retained at FGP and are in run-off.

1.1   First Transit earn-out

The First Transit earnout mechanism has been described as follows in the AGM materials:

“The Purchaser has agreed to a deferred, contingent payment of up to $240 million (approximately £170 million) (the “Earnout Amount”) which will allow FirstGroup to share in the future value of First Transit, calculated and payable on the earlier of the third anniversary of Completion or a sale of, or certain other specified transactions involving, First Transit by the Purchaser (the “Earnout”). Pursuant to the Earnout, the Purchaser will pay FirstGroup 62.5 per cent. of the proceeds (calculated based on an adjusted equity value derived from an initial enterprise value of $370 million) from such sale of, or such other transaction involving, First Transit within three years of Completion, up to a maximum of $240 million”

The earnouts have been earmarked by FGP for future distributions to shareholders. This logic seems hence to be carried over in the structure of the offer via the prospective CVR (ditto for Greyhound).

1.1.1         Fair value in company accounts

In the latest trading update (to 27 September 2021) we see the earnout being fair valued at £102m, which is kept constant from the value as mentioned in the annual account (to 27 March 2021) of $140m. The FY accounts disclose that this valuation is based on “stochastic modelling of discounted cash flows and assumes that EQT does not dispose of the business by the third anniversary (21 July 2024)”. If we dis-apply a discount factor of 10% (a guess) we get to a value of $186m for the expected stochastic value at 21 July 2014, which is 20.1p to the prospective CVR.

1.1.2         Multiple based view of earn

In the latest FY account the EBITDA of First Transit (as a discontinued operation) was $121m. This was when operations were still at 87% of the pre-pandemic levels. Assuming this level of EBITDA at the “strike” of $370m of the earnout, implies an EV/EBITDA multiple of 3.06x and the full earn out is achieved at a multiple of 6.23x, which is unassuming given that the transaction itself occurred at 8.9x. It seems then that the earn-out could pay the maximum $240m, which is 25.9p to the prospective CVR.

The Trading Update on the 25th of February 2022 provided an upbeat statement regarding the performance of First Transit up to the sale date (21 July 2021). The annualised revenue from that point was running 3% higher than the previous year. This further underpins the maximum pay out scenario of the earn-out.

1.2   Greyhound Lines Inc. (“Greyhound”) legacy assets and liabilities

Greyhound Lines Inc. was sold on the 21st of October 2021. It was not a straightforward sale, with the end result that FGP ended up retaining some property assets, some net liabilities (“including pension, self-insurance and finance leases settled at closing”) and some net assets (“grant receivables, buy out premia and other items”).

I have not been able to find a detailed description of the assets and thus we are currently relying on the statement in the same announcement summarising that the run-off of these retained assets and liabilities should lead to:

• “ c.$178m (c.£128m) in net value for the Group being realised over time”.

Where initially “over time” was indicated as “over the next three to five years”. However, in the 9 December 2021, half-yearly report we see:

• “estimated £120m net realisable value from FY23” (i.e. from 27th of March 2023)

• “four subsequent Greyhound property sales for $6.8m in total”

• “the Group has begun receiving such CARES and ARP payments ($1.5m to date from a potential total of c.$80m).”

• “that the balance of the total Greyhound assets and liabilities retained will result in c.$155m (c.£120m) in net value for the Group being realised over time, based on current valuations.”

After taking this in, we think it’s fair to assume a payment at the 4 year point of USD 155m for modelling purposes, which is 17.4p to the prospective CVR.

2.   CVR valuation Model

We now assume:

• funded notional at 75%;

• A funding of spread of 150 bps and; and

• A time to completion of 6m months

 to compute a base and upside case scenario.

2.1. Base case scenario 

2.2. Upside case scenario

3.   Closure/risks

• The rule 2.4 announcement stated that I Squared had submitted multiple offers previously, which were rejected. This implies that I Squared has been improving terms along the way and that this was at the least the third offer from them, meaning I Squared is engaged,

• It would be rational for the first “plausible” offer to be leaked by parties related to FGP in order solicit further competition before any acceptance. The fact that the offer details were “smoked out” hence could be seen as a positive sign as to the engagement of the board.

• The UK market is generally cheap and with the rates driven FX movements recently even further so for USD based global PE buyers.

• The combination of the above puts in our opinion the probability firmly above 85%, that either the offer as stands is consummated, is improved or a bid situation emerges.

• We think short term trade could be in place as well from here until an offer is recommended.

• If no offer comes along we think the break price would be to 110p, knowing that in all likelihood a floor has been put on the core business.

• Remaining risks:

• The detail of the earn out structure has not been seen and in particular the fallback valuation mechanism in the absence of a sale of First Transit could be a volatile element in the final pay out.

• Greyhound: the exact nature of the remaining underlying property assets has been not been seen, ditto for the liabilities that are still outstanding.

Catalyst

• The recommendation of the current offer
• The improvement of the current offer
• The arrival of a competing offer
• Once consummated: the realisation of the earn-out at First Transit and/or realisation of net assets at Greyhound