Bloomberg News

Virgin’s Rail Lifeline in Doubt as U.K. Mulls Seizure

October 11, 2012

Virgin’s Rail Lifeline in Doubt as U.K. Mulls Seizing West Coast

Allowing Richard Branson to keep the route pending a new contest once the current contract expires on Dec. 9 could be legally problematic, Transport Minister Norman Baker said. Photographer: David Paul Morris/Bloomberg

Richard Branson’s U.K. rail business faces a fresh threat as the government considers taking over the West Coast route a week after halting its transfer to FirstGroup Plc (FGP) following the discovery of flaws in the bidding process.

Allowing Branson to keep the route pending a new contest once the current contract expires on Dec. 9 could throw up legal issues, Transport Minister Norman Baker said. The other option would be to assign the line to Directly Operated Railways Ltd., set up by the government in 2009 to run failed franchises.

“Both are still being evaluated,” Baker said in an interview in London. “The issue is that the franchise will have expired. Can Virgin continue under the present arrangement, or should the state come in with the existing operation that runs the East Coast mainline and deal with the West Coast as well?”

Transport Secretary Patrick McLoughlin will make his plans known to Parliament on Oct. 15. Plumping for the nationalization option would “kill Virgin Rail off” because the company has no other franchises and could not keep the current management team in place for the two years it might take to rerun the West Coast selection process, spokesman Arthur Leathley said.

‘Dead-End Solution’

“Directly Operated Railways would in some ways be the worst option of all,” he said. “A move to FirstGroup wasn’t popular with staff, but they’re a strong company and the contract would have run for 13 years. DOR is a dead-end solution, with nothing happening and no investment, as with the East Coast.”

Aberdeen, Scotland-based FirstGroup, which was awarded the West Coast franchise on Aug. 15 after a 5.5 billion-pound ($8.8 billion) bid, before being stripped of the contract on Oct. 3, declined to say if it would sue the Department for Transport in the event of Virgin being allowed to keep the operation.

David Brown, chief executive officer at Go-Ahead Group Plc (GOG), said today that franchising has become a “delicate issue,” and that it’s not even clear if new bidders could compete for the West Coast route when it’s eventually re-tendered. His company, currently focused on commuter routes, may be interested by then. “Our objectives might have changed, who knows,” he said.

‘Top Dollar’

The West Coast is Britain’s busiest inter-city artery, carrying 31 million people a year between London and Glasgow in Scotland via a network that includes Birmingham, Liverpool and Manchester. Virgin, which has run the line since privatization, reckons the 150 or so contracts required to operate the business couldn’t in any case be properly negotiated in the period left.

“The reason they give you four months to hand over the franchise is because it takes four months to get these things done,” Leathley said. “DOR would come in absolutely cold and even if they could arrange the contracts they’d pay top dollar.”

Baker, a Liberal Democrat who was the only transport minister to survive a government reshuffle last month, said DOR has demonstrated its competence on the London-Edinburgh East Coast line, where performance has shown a marked improvement.

“We are pretty confident, if we decide to take that route, that there would be no problem with them operating it,” he said on the sidelines of the Travel 2020 transport conference.

Branson would be willing to run the West Coast network on a not-for-profit basis, with proceeds going to good causes until the re-tendering took place, Leathley said. Other options might include payment via a flat fee or as a percentage of revenue.

“We understand the politics” he said. “If we are seen to be milking this it’s not going to be acceptable.”

‘Political Ramifications’

Stagecoach Group Plc (SGC), Branson’s minority partner in Virgin Trains with a 49 percent stake, declined to specify what terms might be acceptable, adding that it won’t discuss negotiations before an announcement from McLoughlin. The Perth, Scotland- based company invests a proportion of its earnings in community projects “as matter of course,” spokesman Steven Stewart said.

London-based JP Morgan analyst David Pitura said that on balance the government probably won’t bring in DOR.

“Given the political ramifications of doing this, and shutting Virgin out of the rail market, we believe Virgin will be given an extension and continue to run the West Coast franchise,” he said today in a note to investors.

Still, DOR is going ahead with preparations to take over the West Coast in the event that the Department for Transport asks it to do so, spokesman Paul Emberley said. The East Coast route, while “consistently at the bottom” of on-time performance tables in 2011-2012, has shown signs of improvement, the company said in its annual report last month.

FirstGroup Chief Executive Officer Tim O’Toole is reserving judgment on whether to seek redress for losses incurred after being stripped of the West Coast until an official inquiry discloses findings at the end of the month, according to the company, which has seen 274 million pounds wiped from its market value since the contract decision.

Bid Refunds

“We are exploring all of our rights and options at this point,” FirstGroup said in an e-mailed response to questions. “We have not yet had the full and detailed briefing from the DfT for us to understand exactly what happened.”

The DfT has said only that it will refund costs to the four West Coast contenders, which included French state railway SNCF and NV Nederlandse Spoorwegen of the Netherlands, as well as FirstGroup and Virgin, which spent 14 million pounds on its bid.

Three civil servants have been suspended pending the investigation into the West Coast award and another into the wider franchising process that’s due to report in mid-December.

Threat to Savings

A new West Coast franchise is unlikely to start until March 2014, Peter Hyde, an analyst at Liberum Capital in London, said this week in a note to investors. Bidding for the Great Western, Essex Thameside and Thameslink franchises, which were slated for renewal in 2013 and have also been suspended, will most probably be delayed for six months, he said.

Go-Ahead’s Brown said the holdups risk jeopardizing the 30 percent cost saving being sought following last year’s review of the U.K. rail network by Roy McNulty, as well as the benefits of integrating train companies with Network Rail at local level, as specified in new franchise arrangements. Delays would also deprive the government of cash from operator premiums.

“You’ve got to crank the handle,” Brown, whose company controls the London Midland, Southern and Southeastern franchises, said in an interview at the Travel 2020 conference. “Otherwise you’ll never achieve those savings. If you delay for two years, that’s two years of savings lost.”

Passenger Focus, set up by the government to protect the interests of train passengers, said the West Coast crisis will “nibble away” at public confidence in the railway. The franchise process needs to be more open and responsive, Anthony Smith, the body’s head, said in an interview today at the same event.

“The taxpayer has an absolute interest in getting a commercial return, but at its core this is about moving people around the country and giving them value for money,” he said. “If passengers are happy with current service, shouldn’t that be given a little more weight? If an incumbent is doing well, then maybe we don’t need a change.”

To contact the reporters on this story: Tom Metcalf in London at tmetcalf7@bloomberg.net; Chris Jasper in London at cjasper@bloomberg.net

To contact the editor responsible for this story: Chad Thomas at cthomas16@bloomberg.net


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