Why M&A and digital innovation will be key to getting rail back on track

The pandemic has had a dramatic effect on the rail industry. In Europe, as with so many transportation sub-sectors, rail saw passenger traffic drop by an average of nearly 50% across Europe in 2020, according to the Independent Regulators Group for Rail. While rail freight was more resilient to the ravages of COVID-19, a 5% global decrease in freight traffic mirrored the 4.8% drop in EU GDP during 2020. Now, after another 12 months of intermittent restrictions and new variants emerging, freedom of movement is returning and rail traffic is on the upswing once again.

While the industry lifeblood of a world in motion may be gradually being restored, rail still faces a number of other challenges in its quest to evolve, innovate and improve the service it provides to businesses and consumers as they return.

Margin pressure

No industry is insulated from the commodity price spikes we see today, and in the world of rail, continued margin pressures are being applied due to rising raw material and energy prices. Alstom’s recent reporting of increased sales but limited upside in margins due to a backlog of unprofitable business represents just one example of a trend being acutely felt across much of the industry.

In an effort to mitigate these impacts, players are looking to standardise and differentiate, which in turn points to a need for market consolidation. Alstom’s January acquisition of Bombardier Transportation is a case in point – harnessing a comprehensive product portfolio and R&D innovation capabilities set to drive value creation for all stakeholders. In addition, the deal speaks to a broader challenge of reducing environmental impact in an industry already preferred by many passengers as a more considerate means of travel to air.

Innovation is a key focus for rail companies as they adapt to new market realities. Over the last decade, rail companies have been challenged by fundamental changes in their business environment and have had to rethink their strategies. Emerging from a time of crisis, rail players are facing some of the most competitive market conditions ever seen, and a growing number of rail players are dialing up innovation efforts to address the challenges posed by this changing environment.

Supply chain integration

Facing increased global competition, rail companies are seeking to work more effectively with their partners in the development of low-cost solutions and reduced time-to-market for these innovations.

Recent supply chain issues have led to companies considering how to implement more resilient and integrated supply chains, where delays in production can be materially mitigated. This is not isolated to rail – Ford has ventured into a partnership to develop computer chips and joined the Initiative for Responsible Mining Assurance in 2021, demonstrating a commitment to improving practices at the very beginning of the supply chain. IKEA has also purchased its own shipping containers to closely manage the disruptions being witnessed globally.

M&A presents an opportunity to pursue such an integrated value chain strategy, epitomised by Hitachi Rail’s acquisition of Thales’ Ground Transportation Systems business in August 2021, which positions Hitachi as a global leader in the rail signalling market and will accelerate its “Mobility as a Service” (MaaS) offering globally.

Digital innovation, enabled through M&A

Providing digital stretch for further growth is fundamental to this deal, and advances in rail technology will prove critical for other industry players in leveraging future growth opportunities.

By way of example, better maintenance control will provide a significant competitive edge, enhanced by digital innovation. Predicting when breakdowns may occur can drive more effective and efficient servicing, again highlighted in Hitachi Rail’s 2020 acquisition of Perpetuum – a UK technology firm that is pioneering digital technology to optimise railway operations, offering improved efficiency, safety and quality of service. Hitachi Rail’s recent long-term alliance with Intermodal Telematics also provides complementary technology that incorporates real-time monitoring in its freight service and enables companies to better monitor and control their supply chains.

In addition, as with all industries, customers now expect a seamless journey, after the pandemic raised the stakes in terms of our accelerating demands in online purchase, delivery, and overall interconnectivity. Integrating travel as part of MaaS dynamics – for example, developing single wallet tickets for passengers’ complete journeys, including in-journey items such as Wi-Fi and food and beverage purchases – will prove to be a technological game-changing leap forward for the industry.

With this in mind – and appreciating that full details regarding technology-related deals are not always publicly disclosed – data indicates that tech-focused transport deals are attracting a significant premium. The average EV/EBITDA multiples in the mid-20s compares favourably to the general rail sector multiples average of 13.1x.

This market position makes clear that greater operational effectiveness through digital transformation, allied to a much-improved customer experience, will be the value drivers for rail players looking to get back on track after two years of unprecedented disruption.