National Express loses East Coast line

A bitter row between the Government and National Express over the terms of a key rail franchise has ended in defeat for the rail operator
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The Independent Online

National Express is handing the East Coast rail franchise back to the Government after admitting that funding for the distressed London-to-Edinburgh network will run out towards the end of the year.

After months of attempts to renegotiate the £1.4bn contract, the company admitted yesterday that its NXEC subsidiary – which holds the franchise – has slipped £20m into the red this year and is rapidly burning through its resources. Richard Bowker, the group chief executive, will step down at the end of August.

A publicly owned company will take over East Coast operations when NXEC hits the buffers, Lord Adonis, the Secretary of State for Transport, announced yesterday. The process of finding a replacement operator from the private sector will then start at the end of 2010.

The decision is just the start of a lengthy row over liabilities. The Government yesterday criticised National Express's refusal to stump up further funds and threatened to withdraw its two other rail franchises, c2c and East Anglia. However, National Express said it was only legally committed to funding NXEC to the tune of £72m – £32m in a bond that acts as a default penalty and a £40m subordinated loan, of which £17.5m has already been drawn. It also disputed the legality of claims on its other two rail contracts, maintaining that they are only forfeit in the event of a default. Technically, there is no default, National Express said. Handing back the franchise when it has used up all the money the parent group is contracted to provide is within the remit of the deal. It is reported to have offered £100m to terminate the deal amicably.

John Devaney, National Express's executive chairman, said: "It is disappointing that it has not been possible to find a solution that protects the best interests of all stakeholders. Our clear legal advice is that the group's financial obligations to the franchise are clearly defined and limited."

Regardless of the legal technicalities, National Express's future in the UK rail industry looks bleak. "I note that the parent groups of previous franchise failures are no longer in the UK rail business," Lord Adonis said. "It is simply unacceptable to reap the benefits of contracts when times are good, only to walk away from them when times become more challenging."

East Coast's problems are not about performance. The trouble is that recession has blown a hole in the revenue predictions in the contract. In 2007, National Express's winning tender was based on assumptions that annual passenger revenue growth would be 10 per cent, and set annual payments to the Government accordingly. But with consumers shopping around for cheap, pre-booked tickets, and business customers trading down from first class, growth in the first half of 2009 came in at just a single percentage point.

The problem for the parent company is that it has £1.2bn in debt and cannot afford to pump more cash into a haemorrhaging subsidiary. It is already costing the company £72m to forgo East Coast, and while critics may baulk at a penalty so small relative to the size of the deal, it is enough to hurt National Express.

Gert Zonneveld, an analyst at Panmure Gordon, said: "For a company with a market capitalisation of about £400m, £72m is still a huge number, and if the group is forced to hand over the other two franchises, that hit would end up being more than £100m."

Even without East Coast, National Express's problems are not over, with a rights issue or substantial disposals expected before the end of the year. "Last year's Ebitda number for the rail business was close to £100m, this year it will be not much above zero," Mr Zonneveld said. "The company needs to rethink its balance sheet structure: it has too much debt for the profits it is making, and by the end of this year will probably be breaching its banking covenants."

In the short term, such decisions will fall to Ray O'Toole, the chief executive of the UK division, who is stepping in as chief operating officer until Mr Bowker's successor is found.

The company yesterday claimed Mr Bowker's departure is not linked to the East Coast debacle. He is leaving to take the top job at Union Railway in the United Arab Emirates.

However, the City was not convinced. "The guy that digs the hole is rarely the one to get you out," one source said. "Someone has to take responsibility for East Coast and the company would have struggled to raise fresh equity with the same person in charge. The jury was always out about whether Richard Bowker was a top-quality chief executive and this disaster has forced him out."

This week National Express rejected an all-share offer from rival FirstGroup, which may now be tempted to approach the company again. It has also been linked with possible suitors from the European transport sector.