Oct. 3 (Bloomberg) -- Richard Branson was handed a lifeline that may keep him in U.K. rail after FirstGroup Plc was stripped of Britain’s West Coast inter-city route, which it won from his Virgin Group in August. FirstGroup fell almost 21 percent.
The contest to run London to Scotland expresses was halted because of “serious flaws” regarding the choice of FirstGroup’s 5.5 billion-pound ($8.9 billion) bid, according to Transport Secretary Patrick McLoughlin, who said staff have been suspended and three other franchise tenders frozen. Among errors was a failure to take full account of inflation and passenger numbers.
Branson, who planned to quit U.K. rail after a West Coast decision he reckoned reflected the “insanity” of the franchise system and could bankrupt FirstGroup, said in an interview he aims to win the contract when it’s retendered and may seek more routes. The Department for Transport detected errors only after Virgin argued the award was based on a defective assessment of the relative risks of bids and pursued a judicial review.
“I am pleased to say that the DfT has looked at all of the facts and found significant flaws in the way its officials handled the process,” the billionaire said in his online blog, adding that McLoughlin called him in New York to relay the findings. “They have basically acknowledged that what we had been saying is correct. We are hopeful they will now accept that Virgin Trains should carry on running the West Coast main line.”
Aberdeen, Scotland-based FirstGroup dropped as much as 22 percent, the steepest tumble since a 1995 listing, and closed 50.60 pence lower at 193.40 pence in London. That reflects the loss of “significant” short-term cash flow, said Gert Zonneveld, an analyst at Panmure Gordon in London who rates the stock “hold.” The shares fell 6.1 percent on Aug. 15, the day of the contract award, on concern that the bid was too high.
FirstGroup Chief Executive Officer Tim O’Toole said in a statement that the DfT made clear his company wasn’t at fault.
Virgin Trains is closely held, with Branson owning 51 percent and Stagecoach Group Plc, which closed 1.9 percent higher at 288.80 pence. Stagecoach said today it will hold discussions with the DfT and update the market as appropriate.
Ed Miliband, leader of the opposition Labour Party, said the revelations have disclosed a “screw-up” and a “fiasco.” Christian Wolmar, a transport historian and the author of “Broken Rails,” an analysis of the U.K.’s train network, said they cast doubt over a host of earlier contract awards.
“The extent of this catastrophe is breathtaking,” Wolmar said. “The key embarrassment is not for the civil service but the government, who said the process was robust and fair. What about the past franchises. Have they been evaluated properly?”
The West Coast route, operated by Virgin since 1997, was due to transfer to FirstGroup for at least 13 years on Dec. 9.
The decision threatened to exclude 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 to cities including Birmingham, Edinburgh, Glasgow, Liverpool and Manchester, and was unlikely to ever run a railway again.
Virgin has been outbid for franchises on four occasions, and in three cases the winning operator came “nowhere close to delivering their promised plans and revenue,” according to Branson, who had said the West Coast bid cost 14 million pounds.
The DfT said it had already spoken with Virgin, FirstGroup and the other two bidders, French state railway SNCF and NV Nederlandse Spoorwegen of the Netherlands, and would reimburse their expenses. A fresh West Coast contest will begin “as soon as the lessons of this episode are learned,” it said, and talks will start today to decide who will run the line in the interim.
Branson told Bloomberg Television that McLoughlin had apologized for the DfT’s errors in a late-night phone call, and predicted that Virgin would “hold the reins” on the West Coast route over the next year or so pending a new bid process.
“As runners up we’d like to have our bid accepted and moved forward but it looks like they will put it all back out to tender again,” he said. Virgin will rebid provided the process is fair and could also now seek to run the East Coast route and apply to run trains through the Channel Tunnel, he said.
Maria Eagle, the Labour transport spokeswoman, said the West Coast award had exposed “shambolic incompetence” in the Conservative-Liberal Democrat coalition.
“The government’s belated admission that it ran a flawed tendering process will come as a surprise to no one,” she said in a statement. “Passengers and staff deserve immediate reassurance about the future of the West Coast service.”
In addition to the suspension of the Great Western, Essex Thameside and Thameslink franchise awards, the government should also abandon the privatization of the East Coast main line, which is currently in state hands, she said.
McLoughlin, who has been in charge of transport for less than four weeks, said on BBC radio’s Today program that while a “terrible mistake” had been made, there would be no impact on rail operations or bookings. Errors that may have included bidders being given different information came to light only as the DfT compiled its defense against Virgin’s legal case, which is no longer being contested, he told Sky News.
Three officials involved in the West Coast competition have been suspended while the full facts are established and two independent reviews have been ordered, the DfT said.
One, overseen by Sam Laidlaw, CEO of Centrica Plc, Britain’s top energy supplier, and Ed Smith, formerly of accounting firm PricewaterhouseCoopers LLP, will examine the West Coast award and report back by the end of this month, McLoughlin said. The other, under Eurostar Group Ltd. Chairman Richard Brown, will evaluate the wider franchising process and deliver findings by the year’s end.
The Association of Train Operating Companies said by e-mail that it would engage with the review of franchising, adding that the system “has delivered for the country,” with rail travel more popular than at any time since the 1920s.
Britain’s Institute of Directors said in a statement that the failure of the franchise model was “shocking” and that the tendering process must be “whiter than white.”
FirstGroup’s O’Toole had said his bid was justified by the ability to maintain compound annual revenue growth at 10 percent by adding capacity. The company said today that prior to its notification of the DfT findings there had been no indication of “any issues” with the franchise-letting procedure.
“We are extremely disappointed to learn this news and await the outcome of the DfT’s inquiries,” it said. “The DfT have made it clear to us that we are in no way at fault, having followed the due process correctly.”
FirstGroup already runs the Great Western route to Wales and western 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 longer.
Virgin Trains lost its only other contract, the long-distance CrossCountry network, in 2007.
Branson had been keen to develop 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.
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