Stagecoach pays £1.2bn to keep rail franchise

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Stagecoach, the bus and rail group, has agreed to pay the Government £1.2bn to retain South West Trains, the country's biggest commuter rail network, for the next 10 years. The amount took the rail industry by surprise, and immediately led to fears that fares will have to rise.

The £1.2bn in premium payments compares with £500m in net subsidies that the company has received to operate the franchise over the past 10 years.

Stagecoach's chief executive, Brian Souter, who pulled out of an earlier contest for the Great Western franchise describing the bidding as " frenzied", justified the amount being paid, saying the company had submitted a "value-for-money" bid.

However, the rail unions attacked the deal, describing it as "deeply worrying". Bob Crow, the general secretary of RMT, warned that it could lead to a re-run of the East Coast Mainline fiasco, where the incumbent operator, GNER, paid £1.3bn last year to retain the franchise but has since been forced to slash jobs and increase fares because revenues have fallen short of projections. The Conservatives also warned that fares were likely to rise.

South West Trains, which operates commuter and mainline services out of London's Waterloo station, and the Isle of Wight's Island Line, which Stagecoach also runs, will together form the new South Western franchise. It starts from next February and will have revenues of £530m. Stagecoach said it expected to make a profit of £15m to £20m in the early years of the franchise, giving it a margin of 3 per cent. It was previously earning margins of more than 10 per cent.

Martin Griffifths, the finance director, said this reflected the much more competitive bidding environment that train operators now found themselves in. But he insisted that Stagecoach was comfortable with the premium payments it would have to make. "The margins are considerably lower but we believe the business plan is deliverable," he added. "This is a great railway in the economic powerhouse of the UK."

Stagecoach faced competition for the franchise from First Group, Arriva and a partnership between National Express and MTR of Hong Kong. None of the rival bidders would divulge what they offered to pay, but one of them said: "Put it this way, there was a sharp intake of breath when we saw what Stagecoach has agreed to pay."

Under a revenue-sharing and support arrangement, taxpayers will gain if the franchise generates bigger profits than expected, while Stagecoach will be protected if income falls short.

The revenue-sharing clause kicks in immediately and will require Stagecoach to hand back half of any extra income if revenues exceed forecasts by between 2 and 6 per cent. Beyond that the taxpayer takes 80 per cent of all additional revenues. The revenue support agreement works the same way in reverse, so that the Government pays half the shortfall if revenues are 2-6 per cent below target, and 80 per cent of any shortfall beyond that. But it does not kick in until the fourth year.

The payment of annual premiums to the Government will be loaded into the latter half of the franchise, so that 60 per cent of the £1.2bn will be paid in the final four years.

Under the new franchise, Stagecoach has agreed to increase seating capacity at peak times by 21 per cent on mainline services and by 20 per cent on suburban trains and invest £40m on station enhancements and improved security. Stagecoach will also introduce a "smart ticketing" system, enabling the Oyster cards now used widely on the London Underground to be used across the South Western network.

The Department for Transport admitted that there would be fare increases for some passengers, although those travelling on season tickets outside peak times could qualify for discounts.

Separately,the RMT union published a Mori survey showing that 68 per cent of the public still wanted the railway to be run by the public sector.

'The bidding process has become frenzied and the prices being offered are toppy. If there are too many hungry pigs in the trough, let them eat first' - Brian Souter, 7 December 2005, explaining why Stagecoach had pulled out of the bidding for the Great Western franchise

'We submitted a high-quality, innovative and value-for-money bid and the new franchise is an excellent result for passengers, taxpayers and our shareholders' - Brian Souter, 22 September 2006, explaining why Stagecoach is paying £1.2bn to keep the South Western franchise