Mystery tour for Stagecoach

WHEN Brian Souter, Stagecoach's chairman, bought a 28 per cent stake in Road King, a Hong Kong-listed company that develops and operates Chinese toll roads, the markets applauded by boosting the company's share price.

Ditto when the bus-driver-turned-entrepreneur bought the Swedish bus company Swebus two years ago. When the company bought the rail-leasing firm Porterbrook, the reaction was ecstatic. Even Stagecoach's acquisition for pounds 41m of Scotland's Prestwick Airport, whose main claim to fame is that it is the only spot on British soil to have been touched by Elvis Presley, met with no criticism from the City.

The reaction from Stagecoach investors last Monday when it announced it was buying a 49 per cent stake in Richard Branson's Virgin Rail Group for pounds 158m was quite different. Stagecoach shares fell 4 per cent to pounds 13.63 on the news and closed the week down even further at pounds 13.10. The City, it seems, has more questions to ask about Virgin's West Coast rail link from London to Scotland than it does about Chinese road building. Even the prospect of a dream team to revitalise Britain's privatised network at a time when rail company shares are doing well was not enough to incite enthusiasm for the deal.

"For the first time the markets have begun to question whether Brian Souter walks on water," said Nick Davies, an analyst with Panmure Gordon. "This is the first deal he has done where the market has not given him the benefit of the doubt."

According to Andrew Darke, transport analyst with Williams de Broe, which last week downgraded Stagecoach from hold to sell: "The deal with Virgin was a trigger. It altered the risk profile of the group. The commercial case for the acquisition is much more difficult to see at this stage."

There are several theories and reasons for the market's negative reaction to the deal, put together in less than two weeks. First, and most obviously, it suspected that Mr Branson was the winner. He had, after all, planned to float the company, and the wholesale purchase of half of it by Stagecoach meant Virgin earned more for the stake than it would have done on the stock market. The whole company was expected to go to the market with a price tag of about pounds 250m. In addition, Stagecoach was the underbidder for the West Coast main line, which is most of Virgin Rail, when the railways were privatised, offering a price of just one-third of what it is paying now. Stagecoach's move valued Virgin's initial pounds 18m investment at pounds 144m.

Second, analysts and investors wonder what exactly Stagecoach is buying. Mr Branson's troubles with the rickety service have been well documented. But recently Virgin struck two important accords that could do much to boost the West Coast main line rail services fortunes. One was with Railtrack, the privately run company that operates the nation's rail infrastructure, a risk-sharing agreement concerning the latter's performance obligations. The other was with rolling stock manufacturers by which Virgin would be compensated if the technology for the rolling stock didn't work on the West Coast's curved line that requires tilting trains. The trouble is, the details of both deals are unclear, leaving the markets powerless to evaluate them.

Lastly, analysts are questioning whether Stagecoach simply has too much money now for its own good. With a market capitalisation approaching pounds 3bn, there are not many companies left big enough for Stagecoach to buy and investors are beginning to wonder if Mr Souter, who prefers a plastic carrier bag to a briefcase, isn't turning into a corporate shopaholic. "Its like Hanson's implosion," said another City analyst. "Stagecoach has to find deals to keep the momentum of profit growth to keep shareholders happy and finding ones that are of a size that can make a difference is becoming increasingly difficult." Even so, in the long run, analysts expect to see both Mr Branson and Mr Souter laughing.

Under the agreement, Stagecoach is buying out the 59 per cent stake held by Virgin Rail's four venture capital backers - Bankers Trust, Texas Pacific Group, JP Morgan and Electra - for pounds 108m cash and pounds 50m of Stagecoach shares. They paid about pounds 45m for their stake, effectively trebling their money in 18 months.

Stagecoach will then allow Virgin to raise its 41 per cent stake to 51 per cent for a nominal sum. According to Mr Branson: "The flotation would have reduced Virgin's stake to 35 per cent. I didn't like the idea of being in a public company with a minority stake. The only reason we were floating was because of the arrangement we had with our venture capitalists." Many suspect he also wants to rid himself of the trains business which has, until now, brought him endless grief amid criticism of the quality of the Virgin service.

"If you look 15 years ahead I suspect Branson will be out of railways and Stagecoach will be running about a third of them in Britain," said another Scottish-based analyst.