ECML franchise to be broucht back under Public Ownership

[stovepipe]

Or did the cynical private sector bid too much knowing full well that NR would eventually fail to deliver its side of the contract, leading to huge compensation payments, just like on the WCML 15 years ago.

 

In the franchise bidding documents the TOC is responsible for the early years forecasts. VTEC got into trouble within 3 years of starting the franchise and before the upgrades were due to be delivered. They have only themselves to blame.

 

Edit that was in reply to Clearwater

Edited May 17, 2018 by stovepipe

[Mike Storey]

An proper investigation into this franchise should look closely at the role of the civil service: Did they get the specification right; was their analysis of the capability of VCEC to deliver its promises adequate, did they understand sufficiently the interface risk between network upgrades and the franchise contract etc etc?

 

It’s easy to blame the “profit hungry private sector” but the ability to be able to procure services effectively is an under rated skill.

David

 

The National Audit Office already has an investigation underway, primarily tasked with reporting on the DfT's management and handling of the franchise and its demise.

 

Report due in Autumn 2018.

[stovepipe]

Afraid it’s more subtle than that. The directors and the auditors are required to ensure that the company is a going concern and this includes disclosing where contracts, as is the case here, will lead to a loss. See extract from the accounts to 31/3/17 below (available from companies house if you search for “east coast mainline”

2DA42F81-2266-4882-95B3-34B34E9FD128.png

This charge pushed them into loss. The auditors and directors will have continued to monitor this position and this “look forward” disclosure de facto will be taking into account NR’s delayed upgrades and hence the future inability to make payments. Better for all parties to crystallise the loss now.

David

 

Yes exactly, VTEC, less than 2 years after they took over, have been undone by their own revenue predictions. The £200m bond provided has been drawn down, and the towel thrown in.

[Clearwater]

Or did the cynical private sector bid too much knowing full well that NR would eventually fail to deliver its side of the contract, leading to huge compensation payments, just like on the WCML 15 years ago.

In the franchise bidding documents the TOC is responsible for the early years forecasts. VTEC got into trouble within 3 years of starting the franchise and before the upgrades were due to be delivered. They have only themselves to blame.

Edit that was in reply to Clearwater

I think you’re being a bit consipriatoral if you think bidders enter into a contract expecting the another party to fail to deliver and then receive compensation payments. You may look at what the mitigant is to someone failing to deliver. But to go into a contract on the premise of failure? I don’t see it like that.

 

I don’t disagree that vcec are at fault in the situation - you can’t plausibly argue otherwise. However, a contract is between two parties. As demonstrated, it’s not in DfT’s interests for this to have failed either (both financially and reputationally.).

[Mike Storey]

Fully agree. There are private companies and industries with safety records which are second to none. For example, whatever criticisms I may have had of the electricity generation companies I worked for poor safety certainly wasn't one of them, they were world class in terms of safety.

 

I agree in principle. But those industries have had a century or more in which to consolidate the "best way" of doing things, within a progressing safety regime.

 

Whilst privatisation undoubtedly caused a hiatus to those industries, it was not on the scale of that of the railways. One cohesive industry split into 103 different companies. Railtrack tried to re-invent the application of the safety regime by outsourcing its primary responsibilities, in order to off-shore risk, to make its shares more attractive. In reality, the reputational risks remained with the primary operator, but they simply did not retain the necessary expertise to manage that.

 

The application of a new private owner to the infrastructure would require a significant number of restrictions and covenants, to heavily restrict its freedom of action, so as not to replicate RT's disaster. I am not sure how attractive that might be?

[stovepipe]

The National Audit Office already has an investigation underway, primarily tasked with reporting on the DfT's management and handling of the franchise and its demise.

 

Report due in Autumn 2018.

I don't suppose the ToR will include the political machinations behind the decision to rush through letting the franchise before the 2015 election, and will instead focus on the civil servants' failings whilst trying to do their masters bidding. Edited May 17, 2018 by stovepipe

[stovepipe]

I think you’re being a bit consipriatoral if you think bidders enter into a contract expecting the another party to fail to deliver and then receive compensation payments. You may look at what the mitigant is to someone failing to deliver. But to go into a contract on the premise of failure? I don’t see it like that.

I don’t disagree that vcec are at fault in the situation - you can’t plausibly argue otherwise. However, a contract is between two parties. As demonstrated, it’s not in DfT’s interests for this to have failed either (both financially and reputationally.).

Assessing what scope there is for compensation under the contract is absolutely part of any serious contract pricing process, and with the sky high cost of TOC franchise bidding, there is no mileage in coming second.

[Clearwater]

Assessing what scope there is for compensation under the contract is absolutely part of any serious contract pricing process, and with the sky high cost of TOC franchise

bidding, there is no mileage in coming second.

Yes but...

 

Of course you assess what compensation might be available and whether the mechanic if event x happens, what do we get works but you don’t go into any contract on the possibility of compensation.

 

Agreed - there is no mileage coming second but equally signing a deal you can’t deliver isn’t a good long term career option. An auction encourages over exuberant behaviour (cf eBay and the recent Slaters toplights going for £300!) but I’d wager the people who came second and third are quietly relieved that they saw things differently for east coast. Better to lose £2/3m bid costs than £50m+ on a deal. Besides any serious bidder knows they can’t win everything they bid for so factor in losing a few sets of bid costs per year/cycle.

[jjb1970]

I agree in principle. But those industries have had a century or more in which to consolidate the "best way" of doing things, within a progressing safety regime.

 

Whilst privatisation undoubtedly caused a hiatus to those industries, it was not on the scale of that of the railways. One cohesive industry split into 103 different companies. Railtrack tried to re-invent the application of the safety regime by outsourcing its primary responsibilities, in order to off-shore risk, to make its shares more attractive. In reality, the reputational risks remained with the primary operator, but they simply did not retain the necessary expertise to manage that.

 

The application of a new private owner to the infrastructure would require a significant number of restrictions and covenants, to heavily restrict its freedom of action, so as not to replicate RT's disaster. I am not sure how attractive that might be?

 

I think Railtrack were a disaster, and I don't advocate privatising NR but in principle I think the safety failures of Railtrack were down to its senior leadership and the culture they created, that is a failure of leadership rather than the result of being a private company I think. I don't think nationalised industries in general are any safer than private ones if well managed, but poor management and organisational cultures which we have to be honest exist in the private sector also exist in the public sector. I work in an industry which is brutally competitive and notoriously cost sensitive, there are some truly shameful shipping companies but at the same time an awful lot of shipping companies have first class safety cultures and records (for example the LNG fleet and chemical carrier fleet both have excellent safety records despite the obvious hazards of their sectors). I really think that safety performance say's more about organisational leadership than it does the form of ownership.

[stovepipe]

Yes but...

Of course you assess what compensation might be available and whether the mechanic if event x happens, what do we get works but you don’t go into any contract on the possibility of compensation.

Agreed - there is no mileage coming second but equally signing a deal you can’t deliver isn’t a good long term career option. An auction encourages over exuberant behaviour (cf eBay and the recent Slaters toplights going for £300!) but I’d wager the people who came second and third are quietly relieved that they saw things differently for east coast. Better to lose £2/3m bid costs than £50m+ on a deal. Besides any serious bidder knows they can’t win everything they bid for so factor in losing a few sets of bid costs per year/cycle.

I would agree you wouldn't enter a normal contract based on the other party not delivering, but these aren't normal contracts. It's a 1 in 7(?) year opportunity to operate a performance contact with a range of defined compensation events for day to day third-party non-performance, and on top of this an infrastructure owner offering the earth with almost no track record of delivery on time. Then the added bonus of a high chance of political intervention, which is ideologically pre-disposed towards the bidder. Its potentially a land of milk and honey.

 

Franchise bid costs have averaged between £5-10m it was found in 2016.

[stovepipe]

Robin

The East Coast franchise paid a premium to DFT last year of c£270m leading to an overall £25m loss. The issue is not they “failed to run” the line more that they bid too high premia to pay to DfT. DfT has arguably done well from the deal. Someone offered to pay them lots of money, put up loans and bond and has lost them. dft is in no worse a position than if it hadn’t signed the deal.

No-one steps in to “replace Maplin” because Maplin’s place in the market has been displaced by internet firms, Amazon, other retailers etc. They were replaced in advance of failing. THere is competition to rail too - road (private cars and coaches) and air (for journeys over 3hours).

David

Sorry for the multiple responses, but I would like to understand the £270m payments to treasury part. In table 2.13 of the UK rail industry financial information report 2016-17, the receipts for the east coast are £272m, so far so good. In the same table the network rail grant for east coast is shown as £243m, with a net receipt therefore of £29m. East coast and south western franchises are the only ones in profit, all the others are net costs. It would seem to be somewhat irrelevant to talk about how much VTEC have returned to the treasury, when they have received 90% of it back. No doubt there is some sleight of hand going on, but can anyone explain it?

[Mike Storey]

I don't suppose the ToR will include the political machinations behind the decision to rush through letting the franchise before the 2015 election, and will instead focus on the civil servants' failings whilst trying to do their masters bidding.

 

Feel free.....

 

We expect to examine the Department’s management of the franchise to date and the implications of its plans for the new ‘Partnership’.

 

If you would like to provide evidence for our study please email the study team on enquiries@nao.gsi.gov.uk, putting the study title in the subject line. The team will consider the evidence you provide; however, please note that due to the volume of information we receive we may not respond to you directly. If you need to raise a concern please use our contact form.

[QuoitsPlayer]

Without being pro/anti privatisation if Intercity had carried on post April 1994 presumably the cost of the trains on ICEC would of been maintenance/refurbishment only as the capitol costs would of been paid off instead of paying the ROSCOs £x? per year?

[Clearwater]

timestamp="1526590295"]I would agree you wouldn't enter a normal contract based on the other party not delivering, but these aren't normal contracts. It's a 1 in 7(?) year opportunity to operate a performance contact with a range of defined compensation events for day to day third-party non-performance, and on top of this an infrastructure owner offering the earth with almost no track record of delivery on time. Then the added bonus of a high chance of political intervention, which is ideologically pre-disposed towards the bidder. Its potentially a land of milk and honey.

Franchise bid costs have averaged between £5-10m it was found in 2016.

Edit (somehow managed to delete a bit)

 

I don't think these are massively attractive contracts - see National Express https://www.nationalexpressgroup.com/investors/presentations/2018/. Where they quote the "high risks" of UK rail. I'd share that view - high adverse publicity and, frankly, not massive money (in a plc context). Last time I looked at equity research on the sector, rail divisions were being valued in the low hundreds of million. That's consistent with capitalising a profit of £25-50m using a discount rate of 10-12% (reasonable for equity risk).

 

http://www.stagecoach.com/~/media/Files/S/Stagecoach-Group/Attachments/media/press/pr2017/pr-2017-12-06.pdf Shows UK rail has 50% of the group's H1 turnover but just c. 20% of the operating profit. Compare it to the North America buses on the line above!

 

 

On bid costs, I've seen that data point and think it's high. I've worked on other large corporate transactions and whilst you can get to that level of fees, often the abort costs are much less as advisers are asked to share the risk. Frankly, these companies can't really afford to be writing off £30m quid (if you think fees are £10m and your chances 1 in 4, on average that's what you lose. Of course everyone kids themselves they're better than average...)

 

 

 

Sorry for the multiple responses, but I would like to understand the £270m payments to treasury part. In table 2.13 of the UK rail industry financial information report 2016-17, the receipts for the east coast are £272m, so far so good. In the same table the network rail grant for east coast is shown as £243m, with a net receipt therefore of £29m. East coast and south western franchises are the only ones in profit, all the others are net costs. It would seem to be somewhat irrelevant to talk about how much VTEC have returned to the treasury, when they have received 90% of it back. No doubt there is some sleight of hand going on, but can anyone explain it?

 

The £270m is lifted from the East Coast Mainline Accounts via companieshouse.gov.uk:

 

Its unambiguous that is how much they've paid out. What DFT then does with the cash and how it reallocates within its budget is a different question. I've seen that rail report and I agree its not clear. I think that its trying to show how much grant is allocated to each part of Network Rail. That money isn't repaid to the franchisee but to NR. The franchisee income is the farebox, car parking etc - again fairly transparent.

 

I think their track access charges are not uniform across the network (I'm sure others will know better than me and be delighted to correct me). If the charges are not uniform, it would be logical for them to be higher on the ECML than other parts of the network.

Edited May 17, 2018 by Clearwater

[Mike Storey]

Sorry for the multiple responses, but I would like to understand the £270m payments to treasury part. In table 2.13 of the UK rail industry financial information report 2016-17, the receipts for the east coast are £272m, so far so good. In the same table the network rail grant for east coast is shown as £243m, with a net receipt therefore of £29m. East coast and south western franchises are the only ones in profit, all the others are net costs. It would seem to be somewhat irrelevant to talk about how much VTEC have returned to the treasury, when they have received 90% of it back. No doubt there is some sleight of hand going on, but can anyone explain it?

 

You are confusing company income and costs with industry income and costs. Read more of the ORR's website if you want to understand the industry financial framework.

 

Essentially, NR's grant did not go to the TOC. NR keeps it. The days when NR's grant payments flowed through the TOC are long gone. That grant to NR would be more or less the same whoever ran the franchise. The franchise pays what it pays to govt. Another company who had won that franchise, may not have promised as much (or may have promised more). That is a premium to govt which is variable, according to the franchise let.

 

So it is inapplicable to net off the NR grant to VTEC's contribution, as far as VTEC's accounts are concerned.

[Clearwater]

VTEC paid £24m in track access charges to NR in 2016/17. Arguably you can add that to the £272m as their contribution to DfT. If they didnt pay that, NR would need the £24m from somewhere else.

[Mike Storey]

timestamp="1526590295"]I would agree you wouldn't enter a normal contract based on the other party not delivering, but these aren't normal contracts. It's a 1 in 7(?) year opportunity to operate a performance contact with a range of defined compensation events for day to day third-party non-performance, and on top of this an infrastructure owner offering the earth with almost no track record of delivery on time. Then the added bonus of a high chance of political intervention, which is ideologically pre-disposed towards the bidder. Its potentially a land of milk and honey.

Franchise bid costs have averaged between £5-10m it was found in 2016.

Edit (somehow managed to delete a bit)

 

I don't think these are massively attractive contracts - see National Express https://www.nationalexpressgroup.com/investors/presentations/2018/. Where they quote the "high risks" of UK rail. I'd share that view - high adverse publicity and, frankly, not massive money (in a plc context). Last time I looked at equity research on the sector, rail divisions were being valued in the low hundreds of million. That's consistent with capitalising a profit of £25-50m using a discount rate of 10-12% (reasonable for equity risk).

 

On bid costs, I've seen that data point and think it's high. I've worked on other large corporate transactions and whilst you can get to that level of fees, often the abort costs are much less as advisers are asked to share the risk. Frankly, these companies can't really afford to be writing off £30m quid (if you think fees are £10m and your chances 1 in 4, on average that's what you lose. Of course everyone kids themselves they're better than average...)

 

 

 

 

The £270m is lifted from the East Coast Mainline Accounts via companieshouse.gov.uk:IMG_0198.PNG

 

Its unambiguous that is how much they've paid out. What DFT then does with the cash and how it reallocates within its budget is a different question. I've seen that rail report and I agree its not clear. I think that its trying to show how much grant is allocated to each part of Network Rail. That money isn't repaid to the franchisee but to NR. The franchisee income is the farebox, car parking etc - again fairly transparent.

 

I think their track access charges are not uniform across the network (I'm sure others will know better than me and be delighted to correct me). If the charges are not uniform, it would be logical for them to be higher on the ECML than other parts of the network.IMG_0198.PNG

 

 

ECML track access charges used to be the highest on the network, from day 1 of privatisation. That honour now falls to WCML operators, post the West Coast Upgrade. East Coast will pay lower access charges per mile where their trains run in Scotland and extensions to Hull, Bradford etc, but this is a pretty minor part of their total train /vehicle mileage.

 

The ORR determines what level of track access charges are allowable and "efficient" and that is decided by a set of criteria, which includes capability, capacity, RAB and goodness knows what else these days.

 

"Regulated" Franchisee income does NOT include car parking, telesales operation, first class lounges, third party retailing etc (unless these have been declared franchise assets, which would be unusual, although less rare than it used to be). This is important because these costs/incomes are excluded from the calculations that allow the franchise to charge other TOCs (and FOCs) to use the stations which they lease from NR. They are thus not applicable for the purposes of evaluating franchise revenue for the purposes of DfT premia (although any bidder will have of course made assumptions about this non-regulated income stream in order to assess their ability to pay those premia). It is all included however for the purposes of Company House accounts.

Edited May 17, 2018 by Mike Storey

[Clearwater]

Thanks Mike - not a straightforward picture. I thought only commuter fares in the peak were price control regulated or is that why you've used quotation marks around regulated?

[Mike Storey]

I think Railtrack were a disaster, and I don't advocate privatising NR but in principle I think the safety failures of Railtrack were down to its senior leadership and the culture they created, that is a failure of leadership rather than the result of being a private company I think. I don't think nationalised industries in general are any safer than private ones if well managed, but poor management and organisational cultures which we have to be honest exist in the private sector also exist in the public sector. I work in an industry which is brutally competitive and notoriously cost sensitive, there are some truly shameful shipping companies but at the same time an awful lot of shipping companies have first class safety cultures and records (for example the LNG fleet and chemical carrier fleet both have excellent safety records despite the obvious hazards of their sectors). I really think that safety performance say's more about organisational leadership than it does the form of ownership.

 

Maybe. But the primary duty of a Board to its shareholders, in order to maximise their stock value and dividends, is to minimise risk. That is what the RT Board thought they were doing when they outsourced. I do not disagree that many private companies have successfully managed risk in-house or as an informed buyer of externalised risk. I just don't see the margins in managing regulated rail infrastructure, within the constraints we now see as necessary, to have sufficient attraction to private capital, despite their likely long term income stream, given the huge amount of capital investment needed each year.

 

Where it is almost completely unregulated, in the USA, we can see the clear results of that. They manage on the basis of the lowest quality they can get away with, and passenger services are a nuisance. Only effective regulation would obviate that, which is where I came in......

 

I would suggest the margins in the energy industry (and almost any other industry away from transport) are rather higher and well worth going for, despite their respective regulatory regimes (much of which Trump is actively dismantling now anyway, and a rabid Tory party would probably do the same).

 

Perhaps a not-for-dividend private company would be the best half-way house. Oh, er, the government just did away with that........

[Mike Storey]

Thanks Mike - not a straightforward picture. I thought only commuter fares in the peak were price control regulated or is that why you've used quotation marks around regulated?

 

Sorry I was not clear. I was not talking about fares payable by passengers (for which you are more or less right) but about attributable income and costs to the franchise operator over which the DfT has oversight - that is ALL farebox income (both through their own ticket outlets, agencies and allocated by ORCATs from others), directly provided catering to any passenger (i.e. not First class lounges or similar) income and costs, station access charges (from other TOCs) and payments (to other TOCs or NR major stations), station lease charges (to NR), track access charges, Schedule 4 and Schedule 8 payments and receipts, depot access charges and receipts, depot lease charges, buildings maintenance and repair liabilities as tenant, ROSCO lease and refurbishment charges where applicable, staff, agency, admin and approved overhead costs, and proportions charged by others, and any capital investments or mitigations by or compensations made to, the franchise, as approved by the DfT. There are many other minor elements which I have long forgotten (like utilities, sub-charging, over-leases, performance bonds, season ticket bonds, etc etc) where only the franchise assets declared as part of the franchise agreement, are concerned. Car parking fees always used to be outside the franchise terms, but these days, I am not so sure.

 

The total company accounts (for the franchise company created by the parent company as a subsidiary) will include items not included in those, so that figure will always be different.

[Mike Storey]

VTEC paid £24m in track access charges to NR in 2016/17. Arguably you can add that to the £272m as their contribution to DfT. If they didnt pay that, NR would need the £24m from somewhere else.

 

Highly theoretical, but in theory, no they would not.The track access charges payable these days are presumed to be "marginal" as in directly related to the extra amount of maintenance and renewal caused by that TOC's trains, in terms of quantity of mileage, type of train, damage to track, OLE/third rail electricity charges etc. If no trains ran, in theory, there is no extra cost or loss, bar the odd few quid gained or lost on the performance and outside-the-rules engineering possession schedule payments.

 

The grant, again in theory, is there to provide and renew the infrastructure in the first place, as a fixed cost.

 

In reality therefore, all TOCs and FOCs are heavily subsidised, but not to the benefit of their shareholders. When ALL costs were passed via the TOCs (and FOCs maybe - I can't remember their regime at the time), it was done on the basis that it would put more pressure on Railtrack, then NR, to keep their costs down, and subsidies for RT/NR would pass through the TOCs, to be paid to RT/NR as part of their track access charges and station leases. In reality, the ORR pushed for efficiencies far more effectively, and there was growing evidence that part of this grant was being creamed off into shareholders, as TOCs were using their total costs as the basis for their margin. I cannot remember how that was done exactly, by the TOCs, but that is why it is done this way today, so that TOCs can only use their marginal costs as the basis for shareholder margin.

 

That's the theory anyway......

Edited May 17, 2018 by Mike Storey

[stovepipe]

Arghh.... I think I need to lie in a dark room for a bit....

 

Possibly the most true thing I've read tonight was 'UK rail privatisation - impossible to understand from the outside and impossible to explain from the inside.....'

[jjb1970]

Maybe. But the primary duty of a Board to its shareholders, in order to maximise their stock value and dividends, is to minimise risk. That is what the RT Board thought they were doing when they outsourced. I do not disagree that many private companies have successfully managed risk in-house or as an informed buyer of externalised risk. I just don't see the margins in managing regulated rail infrastructure, within the constraints we now see as necessary, to have sufficient attraction to private capital, despite their likely long term income stream, given the huge amount of capital investment needed each year.

 

Where it is almost completely unregulated, in the USA, we can see the clear results of that. They manage on the basis of the lowest quality they can get away with, and passenger services are a nuisance. Only effective regulation would obviate that, which is where I came in......

 

I would suggest the margins in the energy industry (and almost any other industry away from transport) are rather higher and well worth going for, despite their respective regulatory regimes (much of which Trump is actively dismantling now anyway, and a rabid Tory party would probably do the same).

 

Perhaps a not-for-dividend private company would be the best half-way house. Oh, er, the government just did away with that........

Regardless of duty to shareholders there is also an obligation to be legally compliant. I think there are arguments over how attractive track ownership would be in commercial terms and the quality of service you might associate with different ownership regimes but I think in terms of safety Railtrack's failure was entirely one of corporate leadership. When I was in the industry electricity generation was not a particularly high margin activity unless it was renewable in which case the business was subsidy generation rather than electricity generation and unlike transmission and distribution and to some extent retail the generation business was not a highly regulated one. During my time with a certain one of the big six their share price fell from approaching 150 Euros to less than 10 (I found it reassuring to know German corporate leadership can be as incompetent as anybody else's) but despite being a low margin business in a company with a share price in free fall there was no relaxation in safety management. I think much of it was that their leadership (or at least the generation bit) had a pretty good appreciation of the truth in the old aphorism that if you think safety is expensive then try having an accident. I think as well that because many of the senior leadership team were engineers they understood both the safety implications and longer term costs of not maintaining their asset base.

[jjb1970]

Arghh.... I think I need to lie in a dark room for a bit....

 

Possibly the most true thing I've read tonight was 'UK rail privatisation - impossible to understand from the outside and impossible to explain from the inside.....'

Whatever was intended in the 1990's we do not have a private passenger railway. The track is nationalised and all the important decisions regarding franchises are made by government. With splendid results in the case of Southern especially. Government seems to have taken it upon itself to get involved in rolling stock design and acquisition. All that privatisation means is that service delivery is outsourced, from what I can see the main purpose of the TOCs is to provide political body armour, whenever something goes wrong they can take the blame while DafT and politicians sit in the background.

[rodent279]

Whatever was intended in the 1990's we do not have a private passenger railway. The track is nationalised and all the important decisions regarding franchises are made by government. With splendid results in the case of Southern especially. Government seems to have taken it upon itself to get involved in rolling stock design and acquisition. All that privatisation means is that service delivery is outsourced, from what I can see the main purpose of the TOCs is to provide political body armour, whenever something goes wrong they can take the blame while DafT and politicians sit in the background.

That's pretty much how I saw privatisation from the start-an exercise in blame shifting on the part of politicians/civil service. If it goes wrong-just blame the "private" companies running the railways.