How did Stagecoach and Virgin of all people walk into the 8% CAGR of Doom?

When Stagecoach announced that it was expecting to lose £84.1 million over the next two years at Virgin Trains East Coast, there were suggestions that the over-exuberant franchise-winning bid had less to do with the 90% dour Scots in the joint venture than the flamboyant 10% Virgin influence. I don’t agree. Despite it’s hard-nosed image, Stagecoach has form.


Following the failure to win the Great Western and Thameslink/ Great Northern replacement franchises in 2006, Stagecoach Chief Executive Sir Brian Souter complained about ‘toppy’ bids. So the eyebrow-raising £1.9 billion Net Present Value for the premium payments when Stagecoach retained the South West Trains franchise in September 2006 inspired suggestions that Sir Brian had let head over-rule heart and made a ‘win-at-all-costs’ bid to retain the franchise which Stagecoach had held since 1996.

So, the next time we met I asked Sir Brian whether he had indeed succumbed to the ‘red mist’. ‘Roger, would you expect me to do that’, the wee man replied, a trifle disingenuously, I thought.

Studying the cold numbers suggested that he had. For the first two years the replacement franchise would still require subsidy. After that a rising premium would be paid.

Confirming some sharp-pencil work by the bidding team, the forecast profit in those initial years was only £15-20 million on a turnover £530 million. This compared to £58.9 million in the final year of the three-year extension to the preceding franchise.

Passengers at King’s Cross: are there enough of them?
M. John Stretton


If not gung ho, the bid was, to use a phrase of Sir Brian’s, ‘sporty’. But at the time Stagecoach’s then Finance Director, Martin Griffiths, now Chief Executive, reckoned that the Group could double SWT’s revenue over the life of the replacement franchise.



This provided graduated revenue support linked to the percentage shortfall on the revenue forecast in the franchise agreement. DfT will provide support equivalent to 50% of the shortfall between 98% and 94%. If it out-turns below 94%, then DfT will provide support equivalent to 80% of the further shortfall.

According to that invaluable reference book The Modern Railway, SWT’s revenue for 2015-16 was £1,234 million. So even allowing for inflation Mr Griffiths was spot on. However, revenue growth has not been enough to cover the back-end loaded premium payments. As soon as cap & collar protection became available, SWT went straight into revenue support. According to DfT’s latest figures (2015-16), SWT paid a premium of £568.5 million. Even after revenue support of £180.3 million, SWT’s net premium was the largest of any operator.




Boosting premium payments towards the end of the franchise which boosts the Net Present Value of the bid.


Indeed, as Table 3 shows, Stagecoach franchises generate 62% of DfT’s net income from passenger operators. But only two other operators receive revenue support in addition to SWT and EMT. These are CrossCountry at £121 million and Southeastern at £16.5 million.


In addition to Stagecoach’s direct experience of the risks in over-bidding, and cap & collar is no more, there were the awful warnings of the grandiose Inter-city East Coast (ICEC) replacement franchise bids in the noughties.

In August 2007 National Express (NatEx) won the ICEC franchise with a premium profile even more back-end loaded than the failed Great North Eastern Railway franchise it was replacing. NatEx took over in December 2007 and for the first year all seemed rosy, with ‘robust’ revenue growth of 9%.

But by early 2009, the recession was biting, revenue was falling and NXEC was not eligible for cap & collar until 2011. In the first half of 2009 NXEC lost £20 million while its premium increased by £48 million.

So with DfT proclaiming ‘we do not renegotiate franchises’, and NXEC haemorrhaging cash, NatEx said that it would continue to support the franchise until the £72 million of the funding it had committed was used up. Then it defaulted and Directly Operated Railways (DOR) took over as East Coast.


As they say in the City, the four most dangerous words in the English language are ‘This time it’s different’. So what made Stagecoach think that ICEC would break out of its groundhog day cycle of death by over-optimistic growth forecasts?

A quick and dirty analysis suggests that the VTEC premium profile assumes a compound annual growth rate (CAGR) of around 8%. Even without the bitter experience of two previous ICEC franchises, Stagecoach’s optimistic growth projection was still puzzling, given that in East Coast’s final full year revenue growth was 4%, which fell to 2.16% in 2014-15.


It could be that Stagecoach was expecting to revive the original 1997 Virgin Trains West Coast (VTWC) franchise bid. Like the current VTEC, VTWC was predicated on major, and inter-related, infrastructure and rolling stock upgrades, which would generate strong ridership and revenue growth.

But while the new train fleet and timetable should have driven ridership VTEC from 2019, that doesn’t explain why the pre-IEP years were over-optimistic to the tune of £84 million.

As we now know, the West Coast Route Modernisation ran out of financial control and time, resulting in the triple whammy of massive overspend, reduced scope and delayed completion. Even so, once the descoped upgrade was eventually commissioned, the company was able to launch the new Virgin High Frequency timetable in 2008 and the growth came.

In 2009-10 VTWC received a net subsidy of £50 million. This became a premium of £153 million in 2015-16. Backed by the Route’s focus on infrastructure reliability (p68), the franchise is currently bucking the general decline in rail ridership, with revenue growth in 2016-17 of 6%.


This revival is what Tim Shoveller is hoping to replicate with the renegotiation of the VTEC franchise from May 2019. But is it feasible?

First, there are some key dates to consider. The VTEC franchise ends on 31 March 2023. The very earliest the full IEP timetable could be introduced is May 2021 and that depends crucially on the funding available for Control Period 6 (2019-24).

Even if it is all systems go with the May 2021 East Coast timetable, ridership and revenue will take time to build up. VTEC allowed for a slight drop in premium in 2019-20, reflecting the increased costs of the IEP fleet. But the following year, the new service was forecast to be worth an extra £100 million.

Clearly the cost of supporting the losses over the next two years cannot be recovered over the remaining life of the current franchise. So what sort of deal can be renegotiated?

A management contract, as with ICWC, seems the obvious solution, but to manage what? Presumably the replacement of IC125 and IC225 with IEP will go ahead, but operating pretty much to the existing timetables?

Martin Griffiths reckons that any renegotiated arrangement would be profitable from 2019. Clearly DfT would still receive substantial payments from the new arrangement, but even if growth of 6% kicked in from 2021, there would still be a £200-250 million hole in DfT’s CP6 budget.

This is, potentially, the biggest franchising crisis yet, extending beyond the East Coast. Renegotiation would set a precedent for other franchises, such as TransPennine Express, which are also dependent on infrastructure enhancements that are not happening.


Lilian Greenwood (Nottingham South): To ask the Secretary of State for Transport, with reference to Stagecoach Group PLC’s press release dated 28 June 2017, preliminary results for the year ended 30 April 2017, what assessment he has made of the effect of Network Rail’s reprioritised infrastructure programme on the finances of the Inter-city East Coast franchise.

Paul Maynard (Blackpool North and Cleveleys): Delivery dates for certain planned enhancements to the East Coast main line are due after the end of Control Period 5 (2019). If this affects Virgin Trains East Coast’s track access rights beyond 2019, this may lead to financial impacts on the franchise. We regularly update our forecasts of franchise finances as part of our management processes.

DfT is separately negotiating extensions with Stagecoach at East Midlands Trains (EMT) and VTWC. EMT is also affected by deferred infrastructure upgrades.


In August 2006, only 14 months after the start of its replacement GNER franchise, owner Sea Containers announced that revenue growth had been 3.3% compared with the forecast 9.9%. Factors contributing to the shortfall included the London bombings and a softening of the economy.


Franchise premium £million