National Express eased restrictions on its £1.2bn debt burden today but analysts warned that the deal had not resolved the dilemma over its onerous east coast rail franchise or the likely need for a £400m rights issue.

The public transport group is up against a debt covenant that limits its borrowings to no more than 3.5 times its earnings before interest, tax, depreciation and amortisation (EBITDA). Faced with escalating payments to the government for the east coast contract and an underperforming Spanish coach business, National Express is widely expected to hand back the London-to-Edinburgh franchise and tap shareholders in order to prevent a breach over the next year.

With no movement on either of those issues in today's statement, analysts were unenthused. National Express announced that it had extended the debt covenant to four times EBITDA and had secured changes to how its debt was calculated in euros and dollars. However, the covenant change is temporary and will not apply when its debt guidelines are tested again in December.

The group confirmed that it would have met the 3.5x covenant test at the end of this month anyway but the temporary uplift to 4x EBITDA will not apply in December when, according to one analyst, National Express faces a tougher task in passing the 3.5x test without dumping the east coast franchise or staging a rights issue. Andrew Fitchie, analyst at Collins Stewart, said today's move did nothing to lessen the urgency of a deal on the east coast franchise or a significant cash call.

"It is almost inevitable that they will breach covenants unless they do something on a grand scale in terms of restructuring or a fundraising," he said.

Even those analysts who expect National Express to squeeze past the December test warned that investors are expecting the group to remove all uncertainty over its debt with a rights issue – which would entail giving up the east coast franchise. "The market would probably like to see a rights issue as part of an overall restructuring of the balance sheet," said Douglas McNeill at Astaire Securities.

In order to meet payment terms on the east coast franchise, which is costing the group £1.4bn over a seven-and-a-half-year contract, National Express needs revenue growth of about 10% a year on what is one of Britain's most prestigious rail routes. However, it managed only 0.3% in the first three months of the year, suggesting that passenger numbers are falling and that those who are travelling are avoiding the first-class bookings that are a key earner for the route.

According to Fitchie, the east coast contract will lose the group £90m over the next two years as payments to the Department for Transport rise from £85m to £133m – reaching £395m by 2015. With no increased government subsidy to ease the pain until 2011, National Express must fund the contract from its own resources even if it is loss-making. Under that scenario, shareholders are not expected to back a rights issue, which has stoked speculation that it is a question of when, not if, National Express hands back the contract.

There is strong speculation within the rail industry that an announcement is imminent, with outstanding questions on whether National Express will retain the east coast route on a management contract until it is retendered and whether it will retain its other rail contracts – c2c and National Express East Anglia. Under cross-default clauses, the transport secretary, Lord Adonis, could strip National Express of all its contracts if the group hands back one franchise.

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UPDATE: National Express Group Agrees Relaxed Covenant Terms

WSJ: JUNE 17, 2009
By Kaveri Niththyananthan
Of DOW JONES NEWSWIRES

LONDON (Dow Jones)--National Express Group PLC (NEX.LN) Wednesday said it had agreed with banks to extend the terms of its banking covenants, which will provide the bus and rail group with more financial flexibility on its debt.

The transport operator, which has suffered from lower growth in passenger revenue, said that it had agreed with its banking group, subject to receipt of signed documents, to retain current covenant terms at a maximum four times adjusted net debt to earnings before interest, tax, depreciation and amortization, or EBITDA, at June 30, which would provide the company with "more headroom for the next six months."

At the same time, National Express said it has gained approval to change the calculation of net debt for covenant purposes. It will now use average foreign currency rates, rather than spot, which would reduce foreign-exchange-rate volatility, it said.

The company still expected to meet its key covenant of adjusted net debt to EBITDA not exceeding 3.5 times at June 30, following cash generation in the first half of the year.

National Express May 22 said it had sold its London bus operations to NS Dutch Railways for GBP32 million, the proceeds of which would help pay down debt. It has already cut dividend payments to ease the pressure of its debt, which stood at GBP1.18 billion at Dec. 31.

Douglas McNeill, analyst at Blue Oar Securities, said the developments would be helpful, but Gerald Khoo, analyst at Arbuthnot, said the covenant test for December, 2009, appeared unchanged, and added this "(very temporary) relaxation of banking covenants solves nothing in the long-term."

Khoo said the group still had to refinance EUR540 million due September, 2010, and GBP800 million in June, 2011, which will lead to a step-up in interest costs in the current credit environment.

"It also has to find a way to stem losses in the U.K. rail division in order to provide sufficient certainty to launch a rights issue to create clear headroom relative to its covenants," Khoo added.

The InterCity East Coast rail franchise has proved to be a headache for National Express, as it was for its previous operator GNER, whose parent company Sea Containers eventuallywent bankrupt. National Express bid for the franchise during the boom years, promising to pay the government some GBP1.4 billion on a net present value basis over the life of the franchise, which runs until 2015.

While National Express has been in regular talks with the Department for Transport, the government department has been adamant it will not renegotiate the terms of franchises. That could leave National Express with little option but to exit the franchise if its financial outlook gets worse. Instead, it could be paid a fixed sum by the government to manage the line, until a new operator can be found.

McNeill added the company needed to continue prioritizing on cash generation, but discouraged selling assets.

"It's not a good time to sell assets," he said, adding the company instead should "clamp down on capital expenditure."

At 0811 GMT, National Express shares traded up 3 pence, or 1%, at 304 pence, while the FTSE 250 index traded down 0.7%.

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National Express in debt talks

Financial Times: June 17 2009
By Gill Plimmer

National Express has renegotiated terms on part of its £1.2bn ($2bn) debt as it moves to address fears that the bus and rail operator will breach loan conditions in December.

The group confirmed on Wednesday it will pass a key test on the terms of its debt at the end of this month. But it also said it had agreed a relaxation of the conditions, retaining the current covenant test of 4 times underlying earnings for the next six months, to give the company additional financial flexibility.

The shares, which were trading above 550p in January, fell 13¼p or 4.4 per cent to 287¾p.

The deal underlines the problems faced by the company as it wrestles with its £1.2bn debt mountain at the same time as it struggles with a slowdown in passenger revenues on its East Coast train franchise and rising payments to the Department for Transport to run the services.

While Jez Maiden, finance director, said recently he was confident a programme of “self-help” aimed at improving cash flows by £100m this year will bolster the group’s finances, the City has continued to speculate that it will be forced to launch a £400m rights issue.

The company has slashed its dividend and cut costs, shedding jobs and selling its £33m London bus business to raise cash last month.

The bus and rail operator is struggling under the weight of the most expensive rail franchise in the industry.

Under the terms of a contract negotiated in 2007 at the height of the economic boom, National Express is contracted to pay the government £1.4bn to run train services between London and Edinburgh until 2015. The amount it has to pay the DfT rose steeply from £85m in 2008 to £395m this year.

The company needs passenger revenue growth of 9 to 10 per cent to meet original bid forecasts, but it managed only a 0.3 per cent rise in the March quarter.

National Express is in talks with the government to renegotiate its East Coast rail franchise agreement, though Lord Adonis, transport minister, has so far ruled out any changes.

Industry experts said that the lack of progress in the franchise renegotiations meant it made sense for the company to agree as much flexibility as possible on its £1.2bn debt burden, £484m of which needs refinancing by September 2010.

National Express said: “We expect to pass our covenants, we are committed to reducing debt and we maintain a close dialogue with our banks.”