Once again, a franchise operator has bid too much for a contract and run out of steam

For the third time in a decade, an East coast rail franchise operator has shown little of the financial prudence once associated with the great cities linked by its trains from London to Yorkshire and Scotland. Following the failures of GNER in 2007 and National Express in 2009, Virgin Trains East Coast has run out of steam, with the government declaring a financial covenant breached and the contract set to fail in months.

The latest incumbent has, like its predecessors, bid too much to run a lucrative line whose potential revenues have fallen short, at a time when economic uncertainty has gnawed away at ticket sales.

But exactly why Stagecoach, the 90% lead partner to Virgin’s 10% stake in the current franchise, promised £3.3bn to run the line, and how that contract is now resolved, remain key questions – amplified by East Coast’s unique place in the blazing political row over how the UK rail network is run.

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In 2013, when bidding started, East Coast was nationalised, run by Directly Operated Railways (DOR), a government-owned firm returning around £200m a year in premium payments to the Treasury.

The previous year, the parallel line north, the West Coast intercity service from London to Glasgow run by Virgin with Stagecoach since privatisation, had been the subject of a bidding competition gone bad. The award of the franchise to First Group was overturned on legal challenge after Virgin argued that its rivals had won with a colossal but unsustainable bid.

Pointing at the lessons of the past, failed East Coast franchises, the Virgin founder Sir Richard Branson railed: “Insanity is doing the same thing over and over again and expecting different results. When will the Department for Transport learn?”

Not soon enough. A government-commissioned inquest concluded that franchising remained the best model. A queue of rail contracts were almost up, not least the Virgin-run West Coast. But the reletting of East Coast to the private sector was prioritised ahead of a 2015 election that was expected to see a hung parliament, potentially keeping the line in public hands.

The dust had hardly settled when the DfT invited bids with a vision that would lead to Branson and Stagecoach promising undeliverable riches of their own.

Investment was coming to the East Coast line, including track and power upgrades, critically bringing a new fleet of InterCity Express IEP trains, with more than half of a £5.7bn government order earmarked for the line. What was promised, pledged or inferred – and how relevant it is to the collapse of VTEC’s contract – is contested.

Stagecoach claim upgrades were promised and not delivered that materially impacted its franchise; a review by Peter Hendy axed or deferred engineering works around the country after the infrastructure body Network Rail blew its budget on the electrification of the Great Western mainline.

However, Network Rail is clear it has already done the work necessary to bring in new trains and a timetable that would have turbocharged passenger numbers – and Stagecoach’s premium payments – after 2019. Chris Grayling, the transport secretary, has also said that no cancelled upgrades have affected the franchise to date.

What was wrong, it appears, was Branson’s conviction that a new livery and “people hungrily trying to make a real difference” could propel passenger numbers upwards from when Virgin took over. Instead, fares went up and the outlook went down.

They got their forecasts wrong, Stagecoach’s chief executive, Martin Griffiths, admitted this week. But, he added, the DfT “decided we offered a high quality and realistic bid … indeed, I was personally told at the time that it was the highest quality bid they had ever seen”.

In March 2016, a year after taking over, Branson and Stagecoach’s chair, Brian Souter, rode into King’s Cross on one of the first government-bought IEP trains, now in Virgin livery and rechristened Azumas by the private operators, a name with echoes of the Japanese rising sun. “Like a new day dawning on the railway,” said Souter.

But City analysts were flagging concerns. And by the time Grayling came to the Commons in November 2017 to announce a “rail strategy” that slipped in news that VTEC’s contract would be replaced in 2020 by an East Coast Partnership, investors had already factored in heavy losses.

Stagecoach’s share price bounced back on Grayling’s plan, widely described as a £2bn bailout – the value of the remaining payments to the government due from VTEC’s owners had the contract continued from 2020 until 2023. Condemnation was largely led by Lord Adonis, the former Labour transport secretary who nationalised the line when National Express failed to meet payments in 2009.

It is not clear why Grayling then waited until this week to announce the franchise’s imminent collapse – stoking fury by simultaneously confirming a direct award to extend Virgin’s West Coast deal, a contract now held, without competition, from 2012 to 2020.

Officially, Stagecoach had “breached a financial covenant”, although the company has not acknowledged this, and the financials have not altered significantly. The mooted East Coast Partnership was met with some bemusement – one well-placed rail industry figure said there was “no chance of it being up and running, and absolutely the last place you’d do something like that”. A Stagecoach statement spoke of “a hardening of the DfT’s negotiating position, coinciding with increased media and political scrutiny”.

Adonis himself sees it differently – that once the ink was dry on the West Coast extension, the rules had changed and Grayling had lost his bargaining chips. He said: “I’ve sat around a table from Brian Souter. He knows when he’s got his man. Stagecoach are playing Grayling.”

DfT officials are now assessing the relative cost of returning the East Coast franchise to public sector control or allowing VTEC to continue on a “not-for-profit” basis – which would nonetheless relieve them of paying hundreds of millions due to be paid to the government in the original deal. Other train companies will be watching intently as they too grapple with franchises whose ambitious promised payments to the government rely on passenger growth that has not materialised, or even gone into reverse.

Had Stagecoach continued to deliver its payments, which in the second and third year were roughly 30% higher than East Coast under its previous operator DOR, and improved the service, it would have been compelling vindication for those who urged its restoration to the private sector. Instead, Virgin joins the ranks of those who bet high on East Coast and saw it all go south.