Transport Perspectives 2012

JUNE/JULY 2012

KPMG International

Transport Perspectives

This edition contains two articles on topics which could change the landscape of European transport.

Gerard Whelan looks at the development of the EU’s Fourth Railway Package, which has the potential to change completely the competitive landscape of European rail.

Steffen Wagner and James Stamp examine the trends in the M&A market in global transport and logistics during 2011. They look at the significant increase in transactions in Q1 2012 and make predictions for the outlook for M&A in the remainder of the year.

Contents

The Fourth Railway Package - A Game Changer?

Page 2

M&A Outlook - Transport and Logistics 2012

Page 5

TRANSPORT PERSPECTIVES / June/July 2012

© 2012 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative, a Swiss entity. All rights reserved.

2 | Transport Perspectives / June/July 2012

The Fourth Railway Package - A Game Changer? Gerard Whelan, Director – Regulation and Economics

The Fourth Railway Package, currently under consultation by the European Union, has the potential to transform European passenger rail with the introduction of new legislation aimed at opening up domestic passenger rail markets to competition.

Introduction This article considers the options available to the EU, examining how rail markets should be structured and regulated to maximise effi ciency, service quality, and value for money.

The result of the EU’s deliberations on liberalisation will transform the rail market for owning groups, governments and regulators. For many, this legislation will drive significant c hanges, the outcomes of which are uncertain.

Background Over the last 20 years, the EU has introduced three packages of legislation aimed at opening up domestic and international rail passenger and freight markets to competition. The legislation has included requirements for member states to:

• Un-bundle the management of infrastructure from passenger and freight operations.

• Establish non-discriminatory infrastructure access charges and capacity allocation rules.

• Establish an independent body to regulate competition.

• Establish open access rights for international rail passenger services between member states.

In the July 2011 edition of ‘Transport Perspectives’ we noted that implementation of the legislation has, in reality, varied from state to state, with each government adopting a different approach. Some countries have made quite radical changes to the ownership and regulation of their railways whilst

others have made only minor changes. Despite a sustained effort on market liberalisation by the EU, the majority of European rail operations remain state controlled. There is a lack of consensus on the best way to encourage and regulate competition.

In a bid to remedy this, and create a single European railway area, the EU is committed to the introduction of a fourth package of railway legislation. The package will ‘recast’ the requirements of existing legislation on track access to make it less ambiguous. More importantly for rail owning groups, it will introduce new legislation aimed at opening up domestic passenger markets to competition. The Fourth Railway Package is currently under consultation and is expected to be published at the end of 2012 or the beginning of 2013.

The method of competition – Open Access vs. Tendering Competition is regarded by many as the best way to deliver better services to customers. It provides incentives to invest to improve effi ciency and service quality. However, creating an environment to stimulate competition within rail markets is not easy. It requires a degree of separation in the management of infrastructure and operations and the creation of non-discriminatory infrastructure access rights. Once these rights are established, competition can be encouraged via franchising (i.e. competition for the market), open access (i.e. competition in the market) or a combination of the two.

There have been successes and failures with both franchising and open access operations in European passenger and freight markets. The successes have generally led to the development of innovative services at lower cost. The failures have often resulted in the withdrawal of loss making operations.

Competitive tendering has been the preferred method to encourage competition in passenger markets. Open access has been the preferred method to encourage competition in freight markets. There have also been open access operations in passenger markets, including those operating alongside non-exclusive franchised services.

Commercial interest in open access appears to be growing:

• Regiojet introduced open access services on the Prague-OstravaHaví㶣ov route in September 2011.

• WESTBahn introduced open access services between Vienna and Salzburg in December 2011.

• Deutsche Bahn introduced services between Frankfurt and Marsellies (with SNCF) in March 2012 and is planning to offer services between London and Frankfurt and London and Amsterdam.

• NTV started high speed services between nine Italian cities in April 2012.

The EU has traditionally favoured open access competition on profi table long distance routes and competitive tendering for unprofi table but socially necessary regional and urban services. However, the existence of economies


Transport Perspectives / June/July 2012 | 3

of scale and the fact that most markets require a degree of public funding mean that the scope for on-track competition is limited. Greater progress with market liberalisation may therefore arise from policies focused on competitive tendering. Indeed, this may also prove advantageous from a cost perspective. Allowing co-operation between the infrastructure manager and the railway undertaking as part of a longer franchise agreement may help reduce costs and align incentives to invest.

The Regulator’s Role Given the push to open up rail markets to competition, what sort of regulation will be required to make those markets work?

A key enabling factor for market liberalisation will be the establishment of an independent regulator with a clearly defined set of responsibilities. The regulator must be independent from the government, the infrastructure manager and railway undertakings.

Regulation is by its nature a political process and there are strong political pressures for direct government intervention in rail markets. However, for competition to evolve, the regulator should be free to act independently to provide a stable and predictable environment for businesses to pursue their long-term commercial interests.

The regulator’s primary focus should be to ensure that the infrastructure manager allocates track capacity in a fair and efficient way. Other regulatory responsibilities, such as those surrounding fares and service quality, should be assigned to those who have the required capacity to manage them.

At the same time, the arrangements must avoid the danger of concentrating capacity within either the regulator or the Ministry of Transport. This would risk leaving the other without the necessary skills to function effectively.

The tendency to micro-manage markets should also be avoided. Regulation should promote competition rather than try to manage it. It should provide the right commercial incentives at the outset and invoke measures to correct anticompetitive practice or abuse of dominance if required. It may therefore be preferable to shift the focus of regulation from defi ning market prices and quantities in advance, to allowing markets to work and intervening only when necessary.

The principle of subsidiarity1 makes it unlikely that there will be a common approach to rail regulation across EU member states. However, the establishment of an Independent Regulators’ Group (IRG – Rail) will help harmonise a consistent application of the regulatory framework. The Group aims to facilitate the creation of ‘a single, competitive, effi cient and sustainable internal railways market’. It currently comprises regulatory bodies from 17 countries.

Encouraging Competition With the regulatory framework for market liberalisation in place, the EU, national Governments and tendering authorities will all also have a key role to play in ensuring that competition is delivered in the most effective way and that a level playing field for competition is established.

This would involve continued efforts to address the remaining structural and strategic barriers that exist to the establishment of a well-functioning Single European Passenger Railway Area, including:

• Technical interoperability barriers such as different track gauge widths, electricity systems and voltages, signalling systems, platform dimensions and operational rules.

• Absence of an effective rolling stock leasing market, cross acceptance procedures for rolling stock and access to depots.

• Fragmentation of tendered contracts and variability in approach across regional tendering authorities.

In addition, the last four years has seen signifi cant consolidation in the European passenger rail market, including:

• Deutsche Bahn’s acquisition of Arriva.

• The merger of Veolia and Transdev.

• NS’ acquisition of Abellio.

• SNCF’s increasing its share in Keolis to 70%.

Monitoring will be required to ensure that the continued trend towards consolidation does not result in increased levels of market power and anti-competitive behaviour.

1 The principle of devolving decisions to the lowest practical level



Real Competition Where competition has been successfully promoted, it has largely been via competitive tendering, although there have been some open access services in Britain, Germany, Austria, Sweden and Italy.

This is the model that is most appropriate for allowing effective competition, whilst ensuring the social obligations of the railway can be met.

Regulation should be at a level that is high enough to ensure safety, value for money for the taxpayer, and a minimum level of service provision. However, for the market to evolve and for competition to be free and fair, the regulator must

be allowed to act independently from government, and the operators must be given sufficient freedom to incentivise them to be competitive and deliver high quality service.

Finally, we must note that an absence of competition does not necessarily lead to declining standards on railways in Europe. Many rail passenger and freight markets experience strong cross-modal competition. This will continue to incentivise rail operators to provide a quality service at low cost, regardless of the specific arrangements in the rail market.

Private rail owning groups should continue to maintain a keen insight on market developments in the EU to position themselves for the opportunities it will bring. State owned railways must ensure that they are adequately prepared for possibly the most radical change in their history.


Graph 1 – Transactions in transport and logistics

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M&A Outlook – Transport and Logistics 2012 Steffen Wagner – Partner, European Head of Transport M&A James Stamp – Partner, M&A

Transport transactions in 2012: Stepping up a gear Transport and Logistics (‘T&L’) M&A activity hit a four-quarter high in the fi rst three months of 2012, with the underlying drivers of transactions aligning to fuel US $27.9 billion of completed and announced transactions.

The emerging trends suggest that 2012 is poised to be a year for accelerating global M&A activity in the transport and logistics sector. We think that activity will be driven by four factors:

• Signifi cant war-chests built up during the economic crisis are now ready for deployment.

• Strategic and fi nancial investors looking to capitalise on emerging trends in high growth niche markets including e-commerce, time and temperature sensitive delivery, and secure courier requirements.

• A need for scale and consolidation in traditional T&L segments including post, passenger transport and shipping.

• Continued appetite from infrastructure investors for quality airport, port, and road assets.

M&A activity has traditionally been a barometer of confi dence, and on this basis the prognosis is good. 2011 and 2010 transaction levels (measured by value and number) exhibited a return to normality over crisis-hit 2009. Although M&A levels in the second half of 2011 were impacted by sovereign-risk related fi nancing uncertainty, the new-year has hit a higher gear.

Although short-term factors such as further fuel-price shocks and debtmarket jitters may influence the timing of activity, we think that the imperatives for change are aligned to drive activity in the medium term.

This report looks at the transactions landscape in transport and logistics in 2011. It examines the driving forces behind these trends, which can be characterised as follows:

• Average transaction values lower than 2010 (particularly in North America) refl ecting the distorting impact of the US $36.7 billion Burlington Northern Santa Fe deal in prior year, and the impact of “distressed M&A” particularly in H211.

• Strong growth in EMEA fuelled by a number of landmark transaction including the divestment of TNT Express for US $7.2 billion.

• EBITDA and Sales multiples increasing for the third consecutive year, as EMEA multiples converge.

Transactions Market in 2011 – Reduced speed in the second half As graph 1 shows the number of transactions in 2011 remained at a similar level to the previous year. This demonstrates that 2010 was not an

exception, and that the recovery from the 2009 post-recession low point appears stable.

Indeed, the first half of 2011 recorded an increase in the total value of transactions on the second half of 2010. The second half decrease refl ects the increased uncertainty and reluctance of investors in the wake of the debt crisis in the European Union.

In value terms, 2011 average transaction size was lower than 2010. Although there were large strategic transactions in the first half of 2011, more small transactions and bailouts (“distressed M&A”) were observed in the second half of the year, depressing average values for the year.

Despite the drop in total transaction values compared to 2010, the mergers and acquisitions market for transport and logistics remains buoyant. In 2011 M&A transactions totaled US $52.1bn: twice the equivalent figure in 2009.



Europe leads the way The drop in total transaction value in the transport and logistics sector in 2011 was most pronounced in the regions of Asia-Pacific (ASPAC) and North America, as shown in Graph 2 (right).

In North America the number of transactions was stable, however the total transaction value declined to US $4.7bn from US $45bn in 2010. 2010 was exceptional in North America, due to the purchase of Burlington Northern Santa Fe by Berkshire Hathaway with a transaction value of US $36.7bn. In ASPAC there was also a (less dramatic) decrease in transaction value. In Latin America the transaction value grew significantly, albeit from a low base.

However the major story is the increase in transaction value in the Europe, Middle East and Africa (EMEA) market. Transaction values in 2011 were US $30.1bn in comparison to US $12.7bn in 2010. The number of transactions in EMEA was very similar to 2010, indicating a number of landmark transactions in 2011.

These include:

• The divestment of the TNT Express branch for US $7.2bn.

• The investment of French sovereign wealth fund, Caisse des Depots & Consignations of 26.3 percent in La Poste SA, with a value of US $2.1bn.

• The sale of 38 percent in equity of the Brussels airport to Ontario Teachers Pension Plan for US $1.7bn.

Strong valuation levels suggest positive outlook Valuation multiples of transactions (the ratio of enterprise value to sales, and EBITDA) during the last three years have increased.

Valuation levels are now almost at the levels prior to the outbreak of the fi nancial crisis in 2008. This demonstrates the increased confidence of in vestors in the transport and logistics sector, and the renewed appetite for mergers and acquisitions. Graph three (right) demonstrates this.

On closer observation, however, there are large differences between the individual regions. In EMEA, for example, the valuation levels are particularly high. A trend toward increasing valuation levels can also be seen in North America and ASPAC, albeit somewhat less dramatic than Europe. Despite an increase in total deal value in Latin America, the valuation levels are decreasing.

In North America and EMEA it can be seen that in 2011, the EBITDA and EBIT multipliers have converged so that they are now almost identical to each other. This shows that in 2011, a number of the key transactions in these regions related to asset-light companies.


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Graph 2 – Transactions by region

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Graph 3 – Valuation multipliers for transport and logistics M&A

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Graph 4 – Transaction value by investor type

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Graph 5 – Quarterly deal values in transport

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The new transport investors The final key conclusion from 2011 is that Private Equity businesses are showing renewed appetite for the transport and logistics sector.

Historically the market was unattractive to financial investors, due to comparatively low growth and small margins. However, from 2006 fi nancial investors started to show strong appetite for the sector. Private Equity has been interested niche markets with high margins and growth opportunities, and high entry barriers. Companies in those niche markets are typically logistics companies active in the transport of time-sensitive and temperature controlled products.

These include food, medicines, chemical products or hazardous freight.

Against the general trend total transaction value traded by fi nancial investors actually grew in 2011 compared to 2010, though still remains low compared to 2006-2008. Transaction value by investor type is shown in graph 4 (right).

Outlook 2012: On the runway? The first quarter of 2012 showed growing M&A activities in the transport sector compared to the second half of 2011. This can be clearly demonstrated in graph 5 (right).

Overall, 177 transactions with a total value of US $8.2bn have been completed. A further 147 mergers and acquisitions with a total value of almost US $ 20bn have been announced in the first quarter of 2012 representing a signifi cant increase on 2011.

Again, Europe has been the centre of M&A activity, with the largest number of transactions completed in Q1.

To make this strong start to FY12 sustainable, three key factors must be met. Confidence in sustainable economic recovery:This depends mainly on continued market trust in the solutions to the European debt crisis. Should the economic outlook remain stable, business activity could improve as early as the second half of 2012.

Investment pressure on fi nancial investors:The pressure on fi nancial investors to deliver strong returns is high, following a disappointing year in 2011. However, many Private Equity firms are finding it difficult to attract financing, and the ability to attract new

financing will be a key factor in the outlook for 2012.

M&A Appetite of strategic investors: The M&A appetite of transport and logistics firms is often correlated with their debt capacities. This is higher than in previous years. In particular, companies in the Logistics and Express segments currently have deep pockets and stand ready for more strategic acquisitions.

This has been recently evidenced by UPS’ acquisition of TNT Express.

The key sectors to watch over the coming year are shipping and logistics. In the global shipping market, the outlook for the next year is bleak, with overcapacity expected to remain.

As a result, there is likely to be further need for consolidation through distressed M&A, though the transaction sizes will be reasonably small.

The logistics market, particularly in Europe, remains fragmented. Private equity investors looking to invest in niche markets, and the ongoing need for consolidation, are likely to drive M&A activity in this sector.

Should the trend established in Quarter 1 continue, 2012 could be an exciting year for transport and logistics.


Contact us

Dr Ashley Steel Global Chair - Transport and Logistics T: +44 (0)20 7311 6633 E: [email protected]

Daniel Lawrence Global Executive - Transport and Logistics T: +44 (0)20 7694 8348 E: [email protected]

Dr Gerard Whelan Director - Regulation and Economics, KPMG in the UK T: +44 (0)20 7694 1595 E: [email protected]

Dr Steffen Wagner Partner, European Head of Transport M&A, KPMG in Germany T: +49 69 9587 4102 E: [email protected]

James Stamp Partner, M&A, KPMG in the UK T: +44 (0)20 73114418 E: [email protected]

www.kpmg.com

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member fi rms of the KPMG network of independent fi rms are affi liated with KPMG International. KPMG International provides no client services. No member fi rm has any authority to obligate or bind KPMG International or any other member fi rm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member fi rm. All rights reserved. Printed in the United Kingdom.

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Transport Perspectives 2012