Optimism can be an endearing quality, when it’s not blind. AA boss Simon Breakwell’s turnaround plan certainly seems optimistic, but only time will tell whether it’s wide-eyed or clear-sighted.
Breakwell has published his much-anticipated strategic review, which he began upon taking control in September. It’s redolent in growth opportunities and rosy projections.
First of all there’s insurance, which the AA smartly began selling to its existing customers in 2016. By targeting younger members and non-members, something the firm hasn’t really done so far, Breakwell sees the potential for 9-14% divisional earnings growth a year until 2023.
Then there’s roadside recovery. The AA’s core business resembles an old A-reg in desperate need of an oil change. Its market-leading three million strong membership has at best stalled; at worst it's in risk of steep decline as younger generations continue to steer clear. Yet Breakwell sees opportunity there too.
His big push is to target younger customers by offering a more technologically sophisticated, ‘Connected Car’ service – involving predictive breakdown cover (its Car Genie trial can predict one in three breakdowns), meeting the needs of electric/hybrid cars and, of course, an app.
‘Our implementation will mean that we are not simply layering digital onto the organisation, but actively embedding it deeply into our product set and operations,’ Breakwell said, anticipating the eye rolls without the need for predictive analytics.
This then will provide data for ‘compelling telematics economics’, that can be used to support other services, including those provided by B2B partners in the AA’s ecosystem. Roadside earnings should grow 3-6% a year to 2023, he said.
So why the cynicism?
AA shares plunged 21%, not because Breakwell’s plan doesn’t impress, exactly, but because he’s cut forecasts for 2019 EBITDA by £50m or so, to £335-£345m, to account for the investments needed to expand, and slashed the dividend from 9.3p to 2p. At 92p, the stock is now worth half what it was at the start of the year, and less than a quarter of what it was in mid 2015.
Breakwell was at pains to point out that the AA is nowhere close to breaching its banking covenants (EBITDA would need to drop to around £200m for that to happen) and that it was happily cash generative – recent memories of what happened to Carillion may have been fresh on his mind.
But what he did little to address directly, other than reducing the dividend, was the company’s greatest challenge: the AA is still wing-mirror deep in debt.
In 2015, net debt stood at £2.8bn; two years later it was down to £2.7bn (you can almost hear the slow applause). That’s three times the company’s 2017 revenues. Interest payments came to £147m last year alone.
On the upside
The traditional response to such an unpleasant-looking balance sheet would be to start cutting bits off – selling operations to pay the debt. Raising equity is an option too.
But in a way it’s refreshing to see Breakwell focus on growth – bottom line as well as top line – as a way of getting out of the mire, rather than retreat. If it works, the balance sheet should start to improve as trading does, so long as the company’s disciplined about it.
Breakwell is a good man for the job too. He made his name as co-founder of corporate venture Expedia (spun off from Microsoft in 1999), and later led Uber’s expansion into Europe in 2012-13. If anyone has the know-how to bring the AA into the 21st century it’s him.
It will be interesting to see whether young drivers respond to the AA’s increasingly hi-tech offering. Breakwell will surely hope they do it soon: debt festers, investor patience is fleeting and his honeymoon period as CEO is well and truly over.
Image credit: Been there YB/Shutterstock