INFORMED SOURCES e-Preview October 2012
I’m afraid this month’s column is all about the Intercity West Coast franchise row. While my aim is to cover as many interests as possible each month, the issues exposed by Virgin’s legal action, challenge the whole concept of franchising.
Intercity West Coast franchise on hold.
Filling underused capacity the key to growth
Virgin played it safe.
West Coast – Virgin goes kinetic
Virgin not first with legal action
As we all know, Transport Minister Theresa Villiers, announced on 15 July that First Group had won the bidding competition for the replacement Intercity West Coast franchise. It will run for 13 years and four months from December 9 this year. There is an option to extend to 15 years.
Whether First will take over on 9 December is increasingly unlikely. In the event of a protest, the Invitation To Tender required DfT to return the contract documents, unsigned, to the winning bidder. And Virgin has mounted a legal challenge.
Since DfT reckons an incoming franchisee needs 120 days to mobilise, and there are only 77 days to go, time is running out. While DfT expects the legal issues to be resolved, it has put Directly Operated Railways, which already runs East Coast, on a war footing. A management team is being recruited ready to take over from Virgin on 9 December and is already working with First.
According to informed sources, it cost around £3million for
Profile
Let’s start with the financial nuts and bolts of First’s winning bid. It is based on the classic back loaded straight line premium profile and is more aggressive than First Great Western (which went into revenue support from year three). And FGW was more aggressive that NXEC (which defaulted before it got to revenue support in year five.
First Group Chief Executive Tim O’Toole denies that the
First is assuming a Compound Annual Growth Rate (CAGR) of 10.4% over the franchise term. Over the past 10 years Virgin achieved 10.2%.
Within the 10.4%, 3.1% comes from the Retail Price Index and 1.5% from yield management, revenue protection and enhanced products. This leaves underlying growth at 5.8% which equates to 64.5m passengers a year by the end of the franchise.
Penalty
Virgin’s challenge centres on the penalty for default. First’s largest financial commitment is a £190 million subordinated loan facility. There is also a £45 million performance bond. When National Express defaulted on its NXEC franchise, the Group forfeited a subordinated loan worth £40 million plus a £32 million Performance Bond
From Day 1 the new franchise will be subject to both profit share plus a Gross Domestic Product Adjustment (GDPA) – which replaces Cap & Collar.
Time for an embarrassing confession. While I understand the Cap & Collar formulae, I have failed to get my brain round the GDPA algorithms.
At a briefing with First Group I asked Hugh Clancy, Commercial Director of First’s UK Rail division, if he could enlighten me. Hugh declined my request and I felt much better when he explained that some of first’s ‘very clever people’ had required several iterations before they produced a spreadsheet that gave meaningful answers.
Anyway, GDPA is based on a forecast by DfT of the cumulative growth in
For the moments all we need to know is that GDPA offers less protection than Cap & collar.
Underused capacity to be exploited
First’s compound growth assumptions raised a few eyebrows. But as Vernon Barker, Managing Director of First’s Rail Division, explained at our briefing meeting, West Coast cannot be compared with the apparently similar First Great Western and National Express East Coast franchise.
Tim O’Toole told an analysts’ presentation that the West coast Main Line is ‘fully rebuilt’ with ‘substantial capacity’. With this investment already in place, ‘it is just a question of filling the unused capacity that is available’, Tim added.
This raised even more eyebrows and I pointed out to Vernon Barker that south of
So what about the reconstruction of Euston to accommodate High Speed 2 services? From mid 2019, the number of platforms will be cur from 17 to 14. To maintain capacity train turn-round times will have to be shortened.
First has worked with HS2 and
Paltry
Furthermore, Tim O’Toole argues that the opportunity to deliver growth is ‘ripe’ because Virgin has failed to exploit the available capacity. With a seat occupancy of only 35% Virgin’s modal share on the WCML is low compared with other routes.
This is attributed in part to Virgin’s ‘particularly low marketing spend’, described as ‘paltry’ during the final year. First intends to raise marketing expenditure ‘tenfold’ to more than £20m a year.
This under-promotion has been compounded by the perception among potential users that rail travel is prohibitively expensive, with walk-on fares ‘priced into growing insignificance’. To counter this ‘cliff-edge pricing’, within the first two years of the franchise, First will cut walk-on fares by 15%. It is hoped that this will encourage business travellers, to return to walk-on fares, reducing pressure on the heavily overcrowded ‘shoulder-peak’ trains out of Euston.
I also cover the new services and First’s rolling stock proposals. The existing fleets will be supplemented with 11 new six car EMUs, either ‘Baby’ Pendolinos or a new non-tilting train from CAF of Spain as a cheaper option.
Virgin’ structured premium profile.
Now we come to the casus belli the difference between First and Virgin’s premium profiles. In the column a chart compares the rival bids and the contrast between First’s straight line and Virgin’s compounded curves could not be more marked.
Virgin’s initial arc rapidly tops First’s line. But, Virgin believes when the station works start, congestion at Euston will affect demand. So Virgin’s premium profile flattens in 2020 while First continue unabated.
It is worth noting that both First and Virgin assumed that the first full year of the replacement franchise is going to be pretty flat. Virgin puts current underlying growth at around 3.5%, but when allowance is made for the effects of the Jubilee bank holidays, last year’s boost from the ash cloud and the effect of Temporary Speed Restrictions, current performance is nearer 1.7%.
Virgin goes to law
Once upon a time, franchise agreements were signed in the afternoon and announced before the Stock Exchange opened next morning. But for some reason, in the Invitation to Tender for Intercity West Coast DfT introduced a 10-day ‘voluntary standstill period’, during which the deal could be challenged.
Not only that. If there were a protest then the deal would then go on hold with the contract documents returned unsigned.
A leak in the Guardian newspaper on 29 July, which not only named First Group as the clear winner but got the 15% premium advantage right too, got Sir Richard writing to then Transport Secretary Justine Greening, copied to the Prime Minister. Virgin Rail Group Chief Executive
All to no avail of course. But once the franchise award became official everyone piled in. This included an e-petition on the No 10 Downing Street web-site urging the government to reconsider the franchise award decision. This topped 150,000 signatures within 11 days. An e-petition attracting over 100,000 signatures makes the topic eligible for a House of Commons debate.
Stonewalling
As the row grew during the standstill period, DfT stood firm. ‘No reason has been put forward to convince the Department that the new franchise agreement should not be signed’, was the stock response.
Next, the chairwomen of both the Transport Select Committee and the Public Accounts Committee went public. Louise Ellman wrote to the Transport Secretary Justine Greening asking for the contract signing to be postponed ‘for a short while to allow the Transport Committee to explore the matter first’. Margaret Hodge, said, pointedly, that the PAC ‘will want to see that the Department has learnt the lessons from its past failures to secure value for money’.
Finally on August 28, Virgin confirmed that it had begun courts proceedings seeking a judicial review of the decision. This was backed with a parallel claim under EU procurement law.
Note that the First bid is not the target for Virgin’s legal challenge. The central issue is risk mitigation, given the heavy back-loading of the premium profile with Virgin challenging the size of the subordinated loan facility from the parent group to the new franchise.
Virgin claims that had ‘the criteria set out in the Invitation to Tender’ been followed, First’s loan should have been set at more than three times the £190m required. DfT is charged with failing to use the required ‘risk adjusted view of the premium offered by the bidder’, in line with the
Lack of transparency also underpins Virgin’s separate challenge under EU procurement law. The company claims that since the deal was announced, DfT had ‘repeatedly’ refused to answer its questions on why it lost the bid. Under EU law, a contracting authority is required to provide ‘an adequate statement of reasons to unsuccessful Tenderers’, argues Virgin..
Responding to the ‘challenge’ a Department for Transport spokesman was reported as saying ‘we maintain that the allegations by Virgin and Stagecoach are ill-founded and misconceived but cannot comment further on ongoing litigation’. DfT submitted its Statement of defence to the High Court on 20 September. The hearing could be a couple of weeks away.
First first with franchise challenge
Virgin came in for some heavy flak for its legal challenge to the award of the Intercity West Coast franchise. The Financial Times was typical, arguing that reforms to the franchising process should be considered on their merits ‘and not at the behest of a peeved rail franchise owner’ who was in fact ‘little more than a sore loser’.
People do have short memories. Back in 2003, when First owned the Great Eastern franchise, the Group failed even to qualify to for the new Greater Anglia Franchise. And promptly took the Strategic Rail Authority, then responsible for franchising, to court.
A right old ding-dong ensued. Here is the
Anyway, the High Court instructed the SRA to hand over First’s Greater Anglia application form scores.
Having studied these, First backed down. But, when I suggested that the climb-down meant that
Stagecoach too,
More recently, in 2009, Stagecoach challenged the DfT over the eligibility of South West Trains for revenue support under Cap & Collar. Stagecoach interpreted the franchise conditions as meaning that assessment started in April 2010. DfT claimed February 2011. Up to £100 million was at stake.
DfT issued proceedings ‘on a preliminary point of jurisdiction’ in the High Court. Stagecoach Chief Executive Brian Souter responded by describing DfT as ‘dysfunctional or deceitful’ and threw in various other issues to bring the total claim to £200 million.
In the event DfT pulled its court action. Arbitration followed, ruling in favour on the main SWT claim.
During the current argy-bargy a DfT spokesman, claimed that Stagecoach, ‘owners of 49% of Virgin Trains, is actively involved in other ongoing franchise competitions based on the same process without complaint’. That to me is a non-sequitur.
It’s the application of the process which is at dispute. And we can be sure that if Stagecoach is unhappy with the outcome of its other bids it will not shrug its shoulders and walk away.
Roger’s blog
What an unkind lot Modern Railways readers are. Earlier in the year I was interviewed for a BBC 4 documentary on Intercity 125. One of the director’s foibles was to ask interviewees to sing the theme song from BR’s ‘Age of the train’ commercials. I duly obliged. But when the programme was broadcast earlier this month texts and tweets poured in – all with the same message: ‘great programme – shame about Roger’s singing’.
Meanwhile I’m looking forward to the Modern Railways Golden Jubilee trip to York on Friday where we will unveil the results of the Readers’ voting on the most definitive developments on the railways in Modern Railways’ 50 years. Chris Green will be our guest speaker.
As I always point out, a frown is my default facial expression. So if you are on the train please don’t be deterred, come up for a chat during the day.
This months Modern Railways is also THE 50th anniversary issue, with special features galore. My contribution is an informal history of IC125 – but the planned cover CD of ‘Roger Ford sings great BR commercials’ wasn’t ready in time.
However, I suspect ‘Age of the train’ may materialise the following week when two old PR (and BR) chums Steve Knight and Allan McLean have invited the railway press to a ‘retirement breakfast’ at Euston.
October is then fairly clear until the Railway Industry Association’s
And on the very last day of October, the Guardian is holding the second of its George Bradshaw lectures, Guest speaker is Tim O’Toole who I expect will focus on the work of the Rail Delivery Group which he chairs with aplomb. There are developments proposed for the RDG which I will cover next month.
But before then I have to agree a date for a day out at Siemens’ Northam Depot. And, of course, try to get my head round DfT’s blasted
Finally, next month’s column will be back to its normal ‘mixed traffic’ content, including more on those London-Edinburgh Pendolino timings.
Roger