Branson Ejected From U.K. Rail as FirstGroup Wins Routes

Virgin Group Founder Richard Branson
Richard Branson, the founder of Virgin Group Ltd. Photographer: Chris Ratcliffe/Bloomberg

Richard Branson plans to quit the U.K. rail business after FirstGroup Plc won a contract to run Britain’s premier express route with a bid he said reflects the “insanity” of the franchise system and could end in bankruptcy.

The West Coast line, operated by Virgin Trains since 1997, will be transferred to FirstGroup for at least 13 years from Dec. 9 in a deal generating 5.5 billion pounds ($8.6 billion) for the government, the Department for Transport said. The RMT union said that the winning tender, worth more than Virgin’s, is based on a “massive cuts plan” that it will oppose.

The decision excludes Branson from the U.K. rail industry for the first time since its privatization. The Virgin founder said he made a “strong and deliverable” offer for the West Coast line, which transports 31 million people a year between London and the cities of Birmingham, Edinburgh, Glasgow, Liverpool and Manchester, and that he’s unlikely to ever run a railway again.

“To have bid more would have involved dramatic cuts to customer quality and considerable fare rises, which we were unwilling to entertain,” Branson said in a statement. “We also did not want to risk letting everybody down with almost certain bankruptcy at some time during the franchise. Sadly the government has chosen to take that risk with FirstGroup.”

Winner Falls

Shares of Aberdeen, Scotland-based FirstGroup fell as much as 9.6 percent and were trading 7.9 percent lower at 238.5 pence as of 12:04 p.m. in London. The stock has declined 29 percent this year, valuing the company at 1.15 billion pounds.

Perth, Scotland-based Stagecoach Group Plc, which owns 49 percent of Virgin Trains and said it was “disappointed” with the government’s decision, traded 0.7 percent higher. The stock has advanced 6.1 percent this year. Virgin is closely held.

Branson, who established Virgin Trains with a pledge to bring a flavor of travel with his Virgin Atlantic Airways Ltd. brand to the railway, said West Coast could go the same way as the East Coast route, from which winning bidder National Express Group Plc withdrew after revenue fell during the global slump, forcing the government to re-nationalize the service.

Virgin Trains has now been outbid for franchises on four occasions, and in three of those cases the winning operator has come “nowhere close to delivering their promised plans and revenue,” Branson said, adding: “Insanity is doing the same thing over and over again and expecting different results.”

Flawed Process

Bidding for West Coast cost 14 million pounds, the entrepreneur said, with the process too costly and uncertain.

“Based on the current flawed system, it is extremely unlikely that we would bid again for a franchise,” he added.

Transport Minister Theresa Villiers said in a statement that the award will deliver passenger improvements. Eleven 125-mile-per-hour, six-car electric units will be ordered, totaling 12,000 seats a day, and FirstGroup has pledged to cut the cost of standard anytime fares by 15 percent in the first two years and add trains to Blackpool, Telford, Shrewsbury and Bolton.

FirstGroup will also provide 10 million pounds of shareholder capital, a 45 million-pound performance bond and a 190 million-pound subordinated loan to support its bid, the DfT said, though the company could still walk away from the contract without defaulting on its four other rail franchises.

Villiers said in a BBC television interview that she’s hopeful Virgin will stay in the rail market, though “that is of course a matter for them.”

‘Modal Shift’

The West Coast business, which currently generates annual sales of about 900 million pounds, will deliver an operating profit equal to about 5 percent of revenue over the span of the deal, according to FirstGroup. Chief Executive Officer Tim O’Toole said its bid is justified by the ability to maintain compound annual revenue growth at 10 percent by adding capacity.

The job total will be “flat” through the life of the franchise he said, though positions may be created in areas such as catering as FirstGroup carries out a complete rebranding. Seats will also be renewed and more luggage space added.

“Of course we want to see buoyant economic conditions,” O’Toole said on a conference call. “But we are in the middle of a long-term modal shift and this is a corridor where we are going to see growth in both professional and leisure travel.”

The RMT said FirstGroup’s bid contains “a billion-pound black hole” and requires cuts of 20 percent “across the board.” The union is preparing a ballot on industrial action to defend 800 train-crew jobs now “on the block” as on-board shops and catering are reconfigured to add seats, it said in a statement.

Pricier Tickets

Maria Eagle, transport spokeswoman for the opposition Labour Party, said in a statement that the government must show it has “not been swayed by an unrealistic bid that does not in the end deliver the payments that have been promised,” adding that it may prove tough to increase revenue through passenger growth, given “severe and worsening capacity constraints.”

The West Coast tender also permits fare increases of 8 percent above retail price inflation in 2013 and 2014 and 6 percent for the rest of the franchise, she said. Companies can lift prices by RPI -- currently running at 3.2 percent -- plus 3 percentage points from January, while a fares-flexibility option allows for a further 5-point raise, making 11.2 percent overall.

CrossCountry Loss

Branson’s remarks suggest he could seek a judicial review of today’s award, delaying the handover, according to Patrick Twist, a rail expert at law firm Pinsent Masons, though a challenge would require him to show that the decision was “perverse,” something that would be tough to do.

“The process does go beyond ‘highest bidder wins, but not as much as you’d think, and one suspects that cash is always the primary consideration,” Twist said by telephone.

Virgin Trains lost its only other contract, the long-distance CrossCountry network, in 2007. French state rail operator SNCF and NV Nederlandse Spoorwegen of the Netherlands had also bid for the West Coast contract.

FirstGroup already runs the Great Western route to Wales and southwest England, against which it took a 59.9 million-pound charge last year in turning down a three-year contract extension to boost its chances of retaining the franchise for a longer period. The new term will begin in 2013 and run for 15 years, with the winner better able than at present to influence development of a line earmarked for electrification.

West Coast benefited from a 9 billion-pound upgrade that was Europe’s biggest construction project last decade. At the same time, the work led to closures at weekends and on holidays, frustrating Virgin’s ability to get the best from a 583 million-pound fleet of Pendolino trains that tilt into corners, boosting speeds on a 175-year-old route that’s 70 percent curved.

Banks, Gyms

Branson had been keen to develop some of the stations on the 1,660-mile West Coast network to include innovations such as bank branches after his Virgin Money Holdings U.K. Ltd. agreed to buy Northern Rock Plc last year for 747 million pounds.

While some West Coast stations such as Crewe and Preston serve limited local populations, they’re also major interchanges with extensive buildings, many of them unoccupied, offering scope to accommodate expanded retail sites, as well as more novel facilities such as business centers and gyms. Branson’s Virgin Group includes the Virgin Active health club chain.

SNCF last month signed a deal with Regus Plc to open six “drop-in” business centers at railway stations in France, offering workspace equipped with printers, scanners and video-communication facilities for as little as 10 minutes a session.

The French company said that it, too, was disappointed with the outcome of the West Coast contest, though it’s still committed to the U.K. market, where future tenders will be judged on their merits.

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