Britain's largest train operator is about to get bigger. FirstGroup has outbid incumbent operator Virgin Rail and will begin running the potentially lucrative West Coast main line from London to Glasgow in December. On the surface, this looks like a massive coup for First, but the numbers look wildly ambitious and it may struggle to make them work.
A furious Sir Richard Branson is so sure he's expected to call for a judicial review. His Virgin Trains joint venture with Brian Souter's Stagecoach has more than doubled passenger numbers since it took over in 1997. Branson's team bid £4.8bn to keep the franchise on the basis it could grow passenger revenue by 8.5 per cent a year until 2026. First thinks it can do 10.4 per cent, more than Virgin managed over the past decade, which explains why they bid £700m more.
That is aggressive. First will pay the government £390m a year compared with the £160m Virgin hands over now. It reckons there's plenty of spare capacity on the line and accuses Virgin of complacency. There'll be lots of shiny new trains and extra services, too, but the government is taking a big risk here. Comparisons with the East Coast line, where National Express bailed out in 2009 after just two years, are obvious.
Still, premium payments are likely to be back-end loaded, so, in the short term at least, profits will get a boost. First made £110m from rail last year and a margin of 5 per cent on West Coast and annual revenue of £900m should add £45m-£50m at the operating level. That makes a rights issue or cut in the dividend much less likely. Still, fare increases and heavy cost-cutting are inevitable, and unions won't make things easy.
Sceptics in the City are giving the shares a wide berth, too - gains of 33 per cent ample reward for a West Coast win. Stagecoach, however, remains popular. It goes up against FirstGroup on both the Great Western and Thameslink franchises and a large, well-run bus business makes it one to own.
