Threatened by the regulatory authorities and wary of the new government's plans, can Stagecoach stay ahead of the competition? Andrew Lorenz.
For the best part of 12 years, during the rip-roaring rise of Stagecoach via a £134 million stock market float to become a leading transport group valued at £1.4 billion, Brian Souter, its executive chairman, has cut an unconventional figure in British business.
This is partly because of the sheer commercial aggression that has been the hallmark of Stagecoach's growth in the bus industry, where it is now the third-largest operator with a UK market share of 17% - an aggression more redolent of America's raw, frontier capitalism, echoed in the company's name. Stagecoach has been scrutinised by the Office of Fair Trading and hauled off to the Monopolies & Mergers Commission more times than any other British company of its relative youthfulness. In one much-cited case - a Darlington bus battle which took place two years ago - its behaviour was deemed to have been 'predatory, deplorable and against the public interest'. As Souter says with a mischievous grin, 'Darlington was a venture that went a little bit awry'.
Away from the competition authorities, in the meeting-rooms of the City investment banks frequented by Souter during the 60-odd acquisitions made by Stagecoach in the British bus and, latterly, the rail industry, he has been received warmly despite his habitual attire. Souter has no truck with ties, suits, patent leather shoes and briefcases. He favours an anorak, an open-necked check shirt, track shoes and a plastic bag. He looks, to all intents and purposes, like a bus conductor who has just come off his shift. Or like the archetypal eccentric millionaire.
In fact, Stagecoach's co-founder is a bit of both. His near-20% shareholding in the company was valued at almost £300 million in mid-May. Back in 1980, he was an accountant with Arthur Andersen and working part-time as a bus conductor in Glasgow. Then the government passed the Transport Act, which deregulated long-distance coach and bus services.
Souter and his sister, Ann Gloag - a nurse - saw their chance. They borrowed £25,000 from their father, a retired bus conductor, bought a second-hand bus in Perth for £250 and developed a luxury double-decker coach service between Scottish cities and London. Their big breakthrough came five years later in 1985, when the National Bus Company, the state-owned group that ran all non-municipal services in England, was broken up. Stagecoach was the first company to buy a National Bus subsidiary (it acquired three, in Hampshire, Cumbria and the Midlands) and it never looked back, buying too from Scottish Bus and London Buses.
Encouraged by government attempts to inject private-sector enterprise into British Rail, in 1992 Stagecoach also made an early move into rail services, leasing two carriages from BR InterCity to run an overnight service between Aberdeen and London. Then when the Major government began privatising the railways in earnest, Souter was just as quick off the mark as he had been in buses. In February last year, Stagecoach took on South West Trains (SWT), the commuter services operator company that is one of the largest franchises.
Stagecoach also won the Isle of Wight franchise, but despite bidding for all the other franchises, Souter baulked at the asking prices and let them go. His eyes were on bigger game. Last year, he again rewrote privatisation rules by paying the vast sum of £825 million for Porterbrook, one of the three privatised rolling stock leasing companies (Roscos), becoming the first train operator to combine forces with a Rosco.
Porterbrook had been sold to its management less than a year earlier for £475 million - Souter was one of the disappointed would-be bidders. But even at a premium of £350 million, which made multi-millionaires of the Porterbrook executives led by Sandy Anderson and caused a political furore, he was sure he had a great deal. 'I have made more millionaires than the lottery,' Souter says. 'It never bothers me a bit, because it is about what's right for our shareholders. I don't mind how wealthy somebody becomes so long as there's a bob in it for us.
'Stagecoach is an unusual company, because it's not run by managers for the shareholders; it's run by manager shareholders.' These include Brian Cox, chairman and managing director of SWT, finance director Keith Cochrane and executive director Barry Hinkley - Cochrane has a handful of shares and Cox and Hinkley more than 100,000 each. Gloag still owns 16% of the company, a stake valued at almost £256 million.
The cheeky chappie in Souter - and his delight at the Porterbrook deal - were highlighted at a rail industry dinner last September, when he recited an irreverent song about the occupants of the transport department's London office, Sir George Young, then transport secretary, and his deputy Nigel Watts. To the tune of the Teddy Bears' Picnic, Souter sang: 'If you go down to Marsham Street, you'll never believe your eyes; the Porterbrook sale was never expected; poor Sir George is feeling rejected; and Mr Watts will never be re-elected.'
Until recently, the Stagecoach shareholders, managers and investors alike, have enjoyed a spectacular ride. After Porterbrook, and further encouraged by Stagecoach's £110-million acquisition of Swebus, the Swedish bus operator, the shares soared to an all-time peak of 804p in January. The figure was slightly artificial, being inflated by a stock shortage, but with pre-tax profits expected to more than double this year from £43.6 million to about £110 million, the general euphoria was understandable. Since then, however, the price has gone into reverse. By the start of May, the shares were down to a year's low of 594.5p.
The immediate trigger for Stagecoach's abrupt slump was an embarrassing problem on SWT, where a shortage of drivers just before Easter at one stage forced the company to cancel 39 trains a day, costing Stagecoach a £900,000 penalty and exposing it to the threat of a further £1-million fine by the rail regulator. In the event, Stagecoach sorted out the problems to the extent that no fine was exacted, a performance that lifted its shares back towards 700p. But in terms of City sentiment, the SWT problem was only a symptom of a deeper disquiet. Not for the first time in City/company relations, reaction to an apparently isolated difficulty revealed underlying doubts about Stagecoach's prospects. One analyst, who wishes to remain anonymous, suggested after Souter had embarked on a whirlwind tour of investor briefings in the wake of the SWT affair: 'My feeling was that he was rattled. He doesn't like declines in his share price. What the SWT events highlight is the importance to Stagecoach of Brian Souter. He left it to Brian Cox, chairman and managing director. The conclusion the City draws is that when you take Souter out of the equation, things can go wrong.
'The whole point about Stagecoach now is that it will have difficulty maintaining its extraordinary track record of growth. It has to expand, but the opportunities do not have the same potential as those in its earlier days. Porterbrook was a good deal but what it brought was a steady, boring stream of earnings where the margin will gradually decrease. For its part, Swebus margins could be raised from 6% to 9.5% over five years. That's the problem with Europe: it is slow, steady business. And the more Stagecoach expands, the more Souter's time will be diluted. Investors are right to be cautious.'
Souter, naturally, sees things differently. 'Fifteen months ago, we were a one-legged unstable stool,' he says. 'Now we are a very, very stable four-legged chair.' Where some analysts say the group is at a crossroads, Stagecoach's chairman maintains it has simply opened up a variety of new expansion routes. 'We are always interested in shaping rather than following markets, but we don't think the opportunities for consolidation in the future will be as great as those in the past.'
In the bus industry, the group, with 17% of the UK market, has been overtaken by its rivals FirstBus and National Express. 'We have quite willingly watched that happen, because we feel the prices of bus companies in the UK have got too expensive in the last 14 months,' says Souter. 'In the next year, we are trying to distinguish ourselves as the organic growth stock in the sector.' To do this, Stagecoach continues to employ much of the original thinking for which Souter is renowned. Now, however, his powers are being used not to spot acquisition opportunities but on product innovation. 'We are going for differentiation,' says Souter. 'That is not a term that was ever very familiar in the bus industry.' In its big city networks, such as Manchester and Newcastle, Stagecoach has developed parallel services aimed at different market segments.
One consists of all-new buses in Stagecoach's distinctive orange, red, blue and white livery, running at high frequencies and existing fare levels, 'which we think are quite high,' says Souter. Alongside them, Stagecoach is running older double-decker buses in a service called Magic Bus, with the company colours replaced by blue stars. Magic Bus is targeted at low-income earners. The fares are a third less than Stagecoach fares and the buses run less often. In Manchester South, the new system generated 11% passenger traffic growth in the first few months of operation.
Souter is also re-defining bus networks by adopting the airline industry structure of hubs and spokes. In Lancashire, for instance, it has established Preston as a hub from which radiate routes to and from Lancaster, Blackpool, Southport, Blackburn and Manchester.
'We are simply giving people more choice,' says Souter of the development. 'There is a big gap in the market for this kind of thing.'
Souter does not rule out returning to the bus takeover trail, but says that for now, Stagecoach is holding fire. 'We are having a sabbatical until we know what the Labour party policy on the bus industry is going to be.' Stagecoach is aiming to raise its share to 25%, the maximum permitted before a Monopolies Commission reference is triggered.
Acquisition activity has concentrated instead on finding new sources of growth. Rail privatisation, ostensibly unpopular and dogged by Labour's verbal opposition, offered Souter and Co a classic opportunity to get a good deal from a government desperate to launch the franchise process: 'We like to get in early, because while that's where the risk is, that is also where you find the bargains. Inevitably, if you get in first, you get the best deal. When we bid for SWT, it was generally believed that only three people in the country were interested in train franchises. We assess the risk, take a position then let the crowds come. Then they (our rivals) can all blow their brains out, and usually do,' Souter says, finishing with a favourite phrase.
It might sound smug, but the fruits of his philosophy have been recently endorsed by SBC Warburg, the investment bank. Warburg's predicted that, because Stagecoach negotiated such a generous government subsidy arrangement, SWT will make an operating profit of more than £100 million at the end of 2002 if passenger revenue increases at a modest annual rate of 4%. On SWT this year, the increase should be about 7%. The bank's report also predicted that some of the other, later bidders which had obtained tougher terms would struggle. Seven of the 25 franchises, Warburg's said, would need a new subsidy injection before their seven-year franchise period was over.
Both Souter and Cox believe they benefited from their experience with the Aberdeen-London service when they came to bid for SWT. Says Cox, 'The scope for improving both efficiency and service is enormous. We paid £1 for SWT. Because we were the first in, our subsidy profile reduces very slowly over the franchise period, and there is a lot of cost we can tackle while passenger growth is very good.' Cox sees a further benefit from the earlier trains experience: 'We lost a lot of money on the operation, but we learned an awful lot. Above all, we learned how complex, conservative and difficult it was to change the BR culture.'
Souter does not argue with either the suggestion that SWT will make a lot of money for Stagecoach, or that other franchisees will get into trouble. On the prowl as ever, he is clearly weighing the opportunities for taking over other franchises. However, Souter does not expect a repetition of the bus experience: 'There will be an element of consolidation, but not the type of rapid consolidation we saw on the buses. Buses was completely deregulated; railways is the reverse. It is highly regulated; in fact it is prescriptive.'
Under Labour, however, that will be no bad thing. In buses, Labour could clamp down on deregulation: 'That's why I'm not getting heavier into buses until I see what the policy is,' Souter says. But from the outset, he took the view that the strict and detailed seven-year rail franchise contracts offered protection against political risk. 'You can't change the legal framework of these contracts without having a breach of the law,' he says. 'If Labour made any fundamental changes, we would have a claim in law.'
Labour appears to recognise this, so its approach is likely to entail a rigorous enforcement of the franchise contracts, down to the last dot and comma. Perhaps it is as well for Stagecoach that the SWT mistakes were made in the final days of a more tolerant government. Cox's attitude was robust: 'You cannot make an omelette without breaking eggs when you have to become more efficient in the private sector after years of restrictive practices in the public sector,' he said when the SWT cancellations were at their height.
With the Porterbrook acquisition Souter has cannily acquired a huge hedge against a Labour hardline on the franchises. 'To comply with their franchise obligations, people will have to buy or lease new trains,' says Souter. Porterbrook is targeting the commuter sector, which Souter says is the most attractive. 'Politically, Stagecoach's purchase of Porterbrook could be seen as very astute,' commented Peter Hyde, transport analyst at BZW, at the time of the deal last year. 'Porterbrook's growth virtually relies on its ability to encourage new rail investment. In the future, Stagecoach will therefore be justifiably able to take the moral high ground in positively encouraging rail investment.'
Within a fortnight of Labour's election victory, Stagecoach proved the point by ordering 30 new trains for Porterbrook to lease to SWT, to replace some of its antique rolling stock. With a touch of Souterian impudence, Cox said SWT would have liked to order more, but that this could only be justified by an extension of the franchise. Ministers may find they are not the only ones who can play politics with the privatised railways.
For Souter the fast-moving entrepreneur, Porterbrook also represents permanence. Its innate financial strengths - both its size and its cash-generative powers - have, he implies, cemented Stagecoach's foundations, making the group both more stable and underpinning its future. It could also play an integral part, he says, in the overseas expansion he is now planning. 'Porterbrook can work with bus and rail companies in other markets: in a bus infrastructure scheme in an emerging country, for instance. Porterbrook could easily own the infrastructure while Stagecoach could operate the buses.'
Contrary to his critics, Souter believes the potential for Stagecoach overseas is boundless. 'There are stacks of opportunities, because all of Europe has to deregulate their transport services between now and 2000. And in emerging nations, the pent-up demand for transport is just unbelievable. Africa and Eastern Europe will have chronic transport needs for many years to come.'
Souter and Gloag were quick to take Stagecoach overseas, and bus operations in Kenya, Malawi and New Zealand were established relatively early. South Africa is another likely destination. 'The only thing that is going to constrain our overseas growth is not opportunity or capital, but the pool of available management actually to take these opportunities,' Souter says.
Gloag, 55, is now taking a back seat, devoting about half her time to the company where she focuses on Africa and on managing Stagecoach's property assets. She spends much of the rest of her time on work for voluntary organisations. But Souter, 43, rejects the image of Stagecoach having become a one-man band. 'The company is moving to a management meritocracy,' he says. 'We have the best pool of bus managers to get both organic UK growth and overseas growth.' Souter acknowledges, however, 'a need for us to develop railway management' but maintains that, led by Cox, this will be forthcoming. As for Porterbrook, it is still headed by Anderson, who is now on the Stagecoach board. Among the other executives is finance director Keith Cochrane, whose most notable contribution has been the innovative securitisation of £535 million of debt taken on by Stagecoach when it bought Porter-brook. By securing the debt against Porterbrook's leasing assets, 80% of which were contractually guaranteed by the government, Cochrane ensured there will be no recourse to either Porterbrook or Stagecoach if lease receipts fail to cover the debt financing costs, while also keeping the company's initial post-purchase gearing to a manageable 200%.
Barry Hinkley, the other executive director, is evidence of Souter's eye for managerial talent. The Stagecoach boss found him, almost literally, holding an oily rag at the Cumberland bus depot, where Hinkley was chief engineer. 'It was so obvious that his vision of the future was the same as mine,' says Souter. 'Our styles contrast. I do the charming stuff while he is the Rottweiler. He reorganises most of the companies we buy.' Hinkley is now working on the restructuring of Swebus with Lars Mattson, another Stagecoach find, who was a regional director of the company with 20 years' experience of the industry.
Souter says the combination of a deep-rooted corporate culture and its consistent refreshment by new managerial blood is what will keep the company dynamic. 'The success of Stagecoach is in finding good busmen and railwaymen and making them into businessmen. If you share the same philosophy as your colleagues, you don't have to have an enormous number of formal management meetings. We meet at least once a month to keep in touch with each other, but we aren't bound by protocol.'
But with the Government, the regulatory authorities and the competition all breathing down his neck, the big question is whether Souter's Stagecoach can stay ahead of the game. The man who delights in defying convention may yet confound the sceptics.
Andrew Lorenz is business editor of the Sunday Times.