Wednesday 15 August 2012

West Coast Rail Franchise

The DfT has announced this morning that the West Coast Franchise has been awarded to First West Coast Ltd.

Stagecoach has issued the following statement

Stagecoach Group plc ("Stagecoach") is disappointed that its joint venture, Virgin Rail Group, has been unsuccessful in its bid for the new West Coast rail franchise, due to commence in December 2012.

Virgin Rail Group has operated the West Coast rail franchise since 1997, and:

·     Has transformed the West Coast operation from a heavily loss-making operation into one that makes significant payments to Government;
·     Passenger journeys have more than doubled to over 30 million;
·     Last year, the franchise had the highest customer satisfaction of any long distance operator.

We believe that Virgin Rail Group submitted a strong bid for the new franchise, which offered the prospects of continued, high quality services for passengers and a substantial yet deliverable benefit to taxpayers. 

Stagecoach and its joint venture partner, Virgin, were both committed to Virgin Rail Group winning the new franchise but only on terms that resulted in an acceptable risk-reward profile and which would add value to the partners' shareholders.  We understand that Virgin Rail Group was the Department for Transport's ("DfT") second choice bidder and that the reason it failed to secure the new franchise was because another bidder contracted to pay significantly higher premium payments to the DfT.

We considered that a number of the features of the new franchise increased the risk to the train operating company relative to other franchises awarded over recent years.  These features included:

·     The longer duration of the franchise and the additional challenges that presents in predicting revenues and costs;
·     The replacement of the revenue share/support arrangements with a GDP sharing mechanism, which we considered increased the risk borne by the train operating company in respect of revenue falling short of the expectations reflected in the bid - further information on this can be found at
·     Increased macroeconomic uncertainty, the risk of which has been emphasised by recent UK macroeconomic data being worse than that anticipated at the time the bids for the new franchise were submitted in May,  when bidders went on risk for their economic assumptions;
·     The requirement to procure a guarantee from a financial institution of the shareholder loan facility required for the franchise;
·     The requirement for a parent company guarantee of certain additional responsibilities being transferred to the train operator in respect of stations.

However, Virgin Rail Group was able to assess these risks and its bid was positioned accordingly.  In addition, Stagecoach was also mindful of the risk that a default on one franchise can result in a default in all franchises in which it has an interest, which in turn could result in significant contingent liabilities crystallising.   In summary, the Virgin Rail Group bid reflected:

·     Nominal premium payments to the DfT of £8.6 billion over the core franchise period from 9 December 2012 to 31 March 2026, rising to £11.0 billion when the potential extension period to 12 December 2027 is included;
·     A net present value of premium payments of £4.8 billion for the core franchise period and £5.8 billion including the potential extension period;
·     Base passenger revenue for the year ending 30 April 2013 of approximately £870 million;
·     A forecast, nominal, compound annual growth rate in passenger revenue of 8.5% (5.4% in real terms) over the period from 1 April 2012 to 31 March 2026, including the revenue enhancing effect of a number of carefully developed growth initiatives;
·     Annual cost savings of £45 million (before taking account of inflation  and additional costs to support the revenue growth initiatives contained in the bid), including through building on Virgin Rail Group's key relationship with Alstom, with whom VRG had agreed contractual terms, and further enhancing the supply chain.
·     Initial capital at risk of £105 million, reflecting an initial performance bond of £45 million (which would increase over the franchise term in line with inflation), an initial season ticket bond of £5 million (which would increase over the franchise term as season ticket revenues grew), an initial guaranteed shareholder loan commitment of £40 million and a parent company guarantee of stations obligations of £15 million.

While Stagecoach recognises that the revenue growth assumed in Virgin Rail Group's bid was ambitious, Virgin Rail Group had the advantage of being the incumbent operator meaning that: (i) given its knowledge of the franchise and access to management, it was able to validate and test its revenue-enhancing initiatives, (ii) it had access to established, Virgin Rail Group owned  revenue and yield management systems and (iii) it would have been able to commence initiatives well before the commencement of the new franchise and without the added challenges of managing the transition from a different train operator.

Stagecoach is shortlisted to bid for the Greater Western and Thameslink rail franchises.  Stagecoach continues to progress its bids for these franchises and in addition, it will consider other franchise opportunities as these arise. 

In addition, Stagecoach continues to develop various other opportunities for further growth as we explained in more detail in our preliminary results for the year ended 30 April 2012 announced on 26 June 2012, and the outlook for the Group remains positive.

Commenting on the announcement, Sir Brian Souter, Stagecoach Group Chief Executive, said:

" Virgin Rail Group has revolutionised train travel on the West Coast Main Line. I am bitterly disappointed that Virgin Rail Group has been unsuccessful in its bid for the new West Coast rail franchise.  After 15 years, it is difficult to imagine a West Coast rail service without the Virgin brand.  I would like to thank all those that have been involved in delivering the Virgin vision over that time and all those that contributed to the strong bid for the new franchise.  The outcome is a blow to all of those people.  Stagecoach will now continue to assess other franchise opportunities and, where appropriate, will work in conjunction with its Virgin partner."

Richard Branson says Here