Management review

Mainland Europe

As expected, mainland Europe is now the group’s largest division, recording the seventh consecutive year of double-digit increase in revenue. Operating profit* rose 15 per cent to £64.5 million (2006: £56.1 million), on revenue* up 23 per cent at £927.5 million (2006: £752.3 million).

The growth in revenue and operating profit in the year has come from acquisitions, investments, contract wins and start-ups. The full year impact of investment in the associate company Barraqueiro SGPS SA (Barraqueiro) was positive, but the divisional operating profit margin was diluted by the low operating margin acquisitions of Osthannoversche Eisenbahnen AG (OHE) in Germany and Veolia's bus operations in Denmark, which have considerable scope for improvements. Higher fuel costs and bid costs incurred in tendering for the Oresund rail contract in Scandinavia also had some impact. The order book for mainland Europe, reflecting estimated revenue over the life of the contracted business, based on prices at the 2007 year end, has grown by 18 per cent, to £4.0 billion.

* Including share of associated companies’ revenue and operating profit

Germany

Operations in Germany have delivered significant growth in 2007, with revenue up 80 per cent to £219.2 million (2006: £121.7 million). Included in these results is revenue of £81.1 million and operating profit of £2.2 million from OHE, which we acquired in March 2007. OHE operates more than 400 buses and passenger rail in Lower Saxony, as well as rail infrastructure, road and rail freight and port storage. A break-even business on acquisition, OHE has integrated well and is performing as expected. Through its passenger rail subsidiary, Metronom, OHE is entering the next phase of growth after commencing two new franchises in December 2007, with combined lifetime revenue of approximately €228 million (£166 million). OHE provides much potential for future growth in both passenger transport and rail freight.

Tender successes in 2006 have resulted in mobilisation of a number of other contracts. In December 2007, we began operation of two 10-year rail contracts in southern Germany, with combined expected lifetime revenue of approximately €370 million (£270 million). In the same month we started a seven-year bus contract near Frankfurt, and ODEG, in which we have a 50 per cent interest, started a small two-year rail contract.

In December 2007 and January 2008 we won three further bus contracts, starting in the Frankfurt area later this year, with a combined lifetime revenue of approximately €38 million (£28 million). In December 2008, ODEG will start operating the 10-year Spree-Neisse rail contract, in the east of the country, and in December 2009, we are due to start operating a 12-year rail contract in southern Germany, as part of a 50/50 joint venture with Salzburger Lokalbahn.

In 2007 we strengthened management capacity to facilitate our future growth in Germany. We will continue to consolidate our businesses, mobilise new contracts, and bid for new work, in addition to pursuing a range of acquisition and investment opportunities.

Netherlands

Revenue rose slightly by four per cent to £178.5 million (2006: £172.1 million), reflecting the net impact of won and lost contracts in the Dutch market.

2007 was the first full year of the 12-year DAV bus and rail contract started in December 2006 in the central Dordrecht region. A €30 million (£22 million) investment in these operations will see the introduction of seven new electric trains by December 2008. We have also invested €16 million (£11 million) in new buses for the eight-year bus contract we began operating in the East Brabant region in January 2007, and have increased patronage following the introduction of a new timetable.

Over the course of 2006 and 2007 we started running 43 new trains as part of the 15-year contract to operate rail services in the provinces of Groningen and Friesland, significantly boosting passenger numbers, and as a result expect to receive further funding for the introduction of three more new trains this year.

In January 2008, we started operating the Hoeksche Waard and Goeree Overflakkee bus contract to the south of Rotterdam, adjacent to our DAV operations. The seven-year contract, won in July 2007, has a one-year extension option, and is expected to generate lifetime revenue of approximately €150 million (£110 million).

Scandinavia

Growth in our Swedish operations helped revenue rise three per cent in 2007, to £242.4 million (2006: £234.9 million), excluding Veolia Denmark. The acquisition, in August, of Veolia’s Danish business added a further £27.8 million to revenue.

We are pleased with our growing presence in the Swedish market. Our first Swedish rail contract started smoothly in June. The nine-year contract, will generate lifetime revenue of approximately SEK 1.8 billion (£146 million). In December we were awarded two bus contracts in Stockholm, which are scheduled to start later this year. Together the two five-year contracts, with five-year extension options, will have a total fleet of 164 buses, and lifetime revenue of approximately SEK 1.5 billion (£122 million). We have also retained and increased our existing operations in the Jönköping area for another eight years, with a tender won in October 2007. The contract adds extra routes starting in June 2008, and lifetime revenue of approximately SEK 995 million (£81 million).

The contracting environment in Denmark has been challenging for a number of years and there was an underlying decline in the scale of our activities in the Danish bus market as low margins persisted. The acquisition of the loss-making Veolia bus division in Denmark, the second largest operator, has given us the opportunity to consolidate our operations, optimise the location of our facilities, implement synergies and improve efficiency. Veolia’s services, and 640 buses, are now fully integrated into Arriva Scandinavia creating the strongest and largest public transport group in the country. Our market share is unlikely to remain at current levels, but we anticipate improved profitability in future, as unprofitable contracts expire and margins improve as we bid for new contracts.

There is a range of growth prospects in Scandinavia, and in particular we will continue to grow our bus operations in Sweden in 2008.

Italy

Revenue, including share of associates, rose seven per cent to £146.8 million (2006: £137.8 million) at our Italian operations.

In September 2007, Arriva strengthened its position as the largest wholly private bus operator in the Italian market with the acquisition of 49 per cent of SPT Linea, for €6.8 million (£4.6 million), as part of a 50/50 joint venture with Lombardy-based bus and rail operator Ferrovie Nord Milano Group (FNM SpA). SPT Linea which operates 317 buses in the Lombardy region of northern Italy, was previously wholly publicly owned. In January 2008, we increased our shareholding in Brescia-based bus company SAIA Trasporti Capital to 100 per cent.

The tender process in Italy is expected to accelerate as the market moves towards competitive tendering, and Arriva is well placed to use its strong network of relationships and growing credentials.

Iberia

Operations in Spain and Portugal have reported revenue, including share of associates, up 23 per cent to £105.4 million (2006: £85.8 million), reflecting the full year effect of the 21.5 per cent stake in Barraqueiro acquired in May 2006.

In January 2008, we acquired a further 10 per cent of Barraqueiro, the leading Portuguese passenger transport operator for €50 million (£37 million), taking our holding to 31.5 per cent. This investment includes an option to re-integrate our Lisbon operation TST, laying a path for further developing Arriva’s involvement in Portugal’s evolving public transport market. Arriva’s share of post-tax profit of Barraqueiro in 2007 was £2.9 million.

In Spain, we consolidated our strategic position around Madrid with the acquisition of two small bus operators in 2007.

In Portugal we are reinforcing our position ahead of a potential market-changing move to tendering of routes in the metropolitan areas of Lisbon and Oporto. In Spain, the expiry of concessions with exclusive rights accelerates into 2013, bringing new opportunity, in addition to the possibility of competitive tendering in cities like Madrid where we have established a position.

Eastern Europe

Revenue from the Czech Republic and Poland was £7.4 million in 2007.

After entering the Czech Republic in December 2006 with the acquisition of Transcentrum Bus s.r.o., we strengthened our position around Prague with the acquisition of Bosak Bus s.r.o. and Osnado Spol s.r.o. in January and November 2007 respectively. Bosak operates 50 buses, and Osnado 106 buses.

In December, Arriva began rail operations in Poland as part of the PCC Arriva 50/50 joint venture. The small three-year contract in the Kujawsko-Pomorskie region in the north-west of Poland was the first to be awarded to a private company, and could signal the start of a significant market change in the country. After some initial challenges, we are pleased with operations and the foothold we have secured in this emerging market. The contract is expected to generate approximately PLN 105 million (£22 million) over its lifetime.

We are sowing the seeds for future expansion in Eastern Europe, where investment is currently relatively modest, but we foresee excellent potential as these economies develop and market liberalisation proceeds.