Anticipated acquisition by Virgin Group Investments Limited and Stagecoach Group plc of the InterCity East Coast Franchise

Affected market: Rail franchise

No. ME/1370/04

14 April 2005
Following the Strategic Rail Authority's announcement on 22 March 2005 that GNER had been awarded the new franchise to operate the ICEC, the OFT no longer believes that arrangements are in progress or in contemplation whereby Virgin and Stagecoach might obtain control of the ICEC. Therefore the OFT is no longer seeking undertakings from Virgin and Stagecoach and will not refer the merger to the Competition Commission under the provisions of the Enterprise Act 2002.

The OFT's decision on reference under section 33 given on 21 December 2004.

Please note that the full text of the decision can be downloaded by using the link on the right.  What follows are extracts regarding the parties, the transaction, jurisdiction, assessment, undertakings in lieu and decision.

PARTIES

Virgin Group Investments Limited (Virgin) encompasses over 200 companies operating in a range of sectors including transport, financial services and entertainment. Ivanco (No. 1) Limited (Ivanco) is a wholly-owned subsidiary of Virgin and holds a 51 per cent shareholding in Virgin Rail Group Holdings Ltd (VRG).  VRG is the parent of the companies currently operating the West Coast Mainline (WCML) and Cross Country (VXC) passenger rail franchises.  The WCML franchise covers the western arterial rail network operating between London Euston, Glasgow, Manchester, Liverpool, Holyhead and the West Midlands.  The VXC franchise, which is to be re-tendered in 2006, covers the rail network from Aberdeen-Glasgow-Penzance and Brighton to North Wales.

Stagecoach Group plc (Stagecoach) is an international transportation group active in the UK, the USA, Canada and New Zealand.  Its UK bus division comprises 16 regional companies.  In 2003 Stagecoach launched megabus.com, a long-distance inter-city bus transport service, which operates a similar business model to a budget airline (with web-ticketing etc).  Stagecoach's rail division in the UK operates two wholly-owned passenger rail franchises: South West Trains (from Waterloo) and the Island Line (Isle of Wight).  Stagecoach also holds a 49 per cent shareholding in VRG.

Mr. Brian Souter and Mrs. Ann Gloag, as directors and shareholders in Stagecoach hold, together with their family interests, more than 25 per cent of Stagecoach's issued share capital.  They also hold a controlling interest (95 per cent of the issued share capital) in ScotAirways Group (ScotAir).  They therefore have a controlling interest in ScotAir and also have the ability materially to influence Stagecoach.

InterCity East Coast (ICEC) Franchise operates long-distance high-speed passenger rail services linking London with parts of East Anglia, East Midlands, Yorkshire, North East of England and Scotland.  The franchise is currently operated by Great North Eastern Railways (GNER) and the turnover for the year to 4 January 2004 was around £429 million.

TRANSACTION

Ivanco and Stagecoach have established Inter City Railways Limited (ICR) as their bidding vehicle for the ICEC franchise, through which they have submitted a bid to the Strategic Rail Authority (SRA) to be awarded the new ICEC franchise.

In May 2004, the SRA announced that four parties, one of which is ICR (via Virgin and Stagecoach), had successfully pre-qualified as a bidder for the new ICEC franchise.  The other three pre-qualified bidders are:  the incumbent operator, GNER;  Danish Railways (DSB);  and FirstGroup plc.  The SRA issued an Invitation to Tender to the four pre-qualified bidders on 6 October 2004 and is expected to announce its choice of preferred bidder in February 2005.  The franchise term (a period of six years and 11 months) is expected to commence on 1 May 2005.

The transaction was notified to the OFT by Virgin and Stagecoach on 27 October 2004.  The 40-working day administrative deadline is 23 December 2004.

The VXC franchise is to be re-tendered in 2006 and the OFT has therefore assessed the competition effects of this transaction including potential remedies on the basis that Virgin may no longer hold that franchise after that date.  Should Virgin be awarded the VXC franchise again, the OFT would reassess whether any competition concerns would arise from such an acquisition.

JURISDICTION

The award of a rail franchise constitutes an acquisition of control of an enterprise by virtue of section 66(3) of the Railways Act 1993 (as amended).  If ICR's bid for the ICEC franchise is successful, the businesses controlled by Virgin and Stagecoach (and Mr. Souter and Mrs Gloag) will cease to be distinct from ICEC. The franchise's turnover in the UK in the last financial year was in excess of £70 million. Therefore, the transaction meets the turnover test in section 23 of the Enterprise Act 2002 (the Act).

Accordingly, the OFT believes that arrangements are in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation for the purposes of section 33(1)(a) of the Act.

ASSESSMENT

Virgin and Stagecoach's ICR bid vehicle is one of the four competing bidders for the award of the ICEC franchise by the SRA.  The ICEC franchise will be subject to extensive SRA regulation.  Assessment of this merger must take account of the surrounding regulatory context.

Focusing on point-to-point journeys where the ICEC franchise rail services overlap with rail, bus, coach or air services already provided by Virgin and Stagecoach (including Mr. Souter and Mrs. Gloag), it is possible to identify a number of key overlaps where post-merger Virgin/Stagecoach would be the only supplier of rail services, particularly on various London-Scotland routes and in the North-East of England.

In relation to the rail routes from London to Edinburgh, Glasgow and Dundee, the evidence suggests that even where there is a clear overlap between an ICEC rail service and an existing Virgin rail service, as on London to Glasgow, there is every prospect for continued vigorous competition from airlines which transport the vast majority of passengers on these flows.  Any overlaps with Megabus do not raise concerns, in part because of the differentiation in the price and service offering between Megabus and the ICEC franchise and in part because Megabus will also face continued competition from National Express.  Similarly, any overlaps with Scotair do not raise concerns because of the limited overlap and proximity of strong airline competition at Edinburgh airport.

There are four flows between Edinburgh and Doncaster however where there is a realistic prospect that the merger would result in a substantial lessening of competition.  On these flows, the available evidence indicates real scope for adverse effects from the merger.  On the one flow (Edinburgh-York) where there are substantial unregulated, dedicated fares, competition will be eliminated by the merger. On other routes where fares are interavailable or unregulated fares are only a low proportion of total fare revenue on the route, there may still be some prospect of a substantial lessening of competition emerging from changes in the availability or mix of ticket types.  The risk of these adverse effects is not mitigated by the prospects of air or rail new entry. 

The OFT does not believe that the merger would lead to adverse effects on competition in bus and/or coach services.  The CC's 10 per cent rule produced three routes in this case that have been assessed in more detail, none of which raises serious concerns because sufficient competition, especially from National Express, bus services and ScotRail, will remain post-merger.  As to network effects, there is no evidence that Virgin and Stagecoach would have an incentive to develop favourable inter-relationships with their own local bus services.  Such effects would in any not raise competition concerns, unless they result in other operators being excluded from the network.

Consequently, the OFT believes that it is or may be the case that the merger may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom in particular on the flows between Edinburgh to York, Doncaster to York, Newcastle to Berwick and Berwick to Edinburgh.

UNDERTAKINGS IN LIEU

Having concluded that the transaction should be referred to the CC, the OFT has considered whether there might be undertakings in lieu of reference, pursuant to section 73 of the Act, which would address the concerns outlined above.

The parties offered a range of undertakings to address the potential concerns identified above.  Specifically, Virgin and Stagecoach offered:

(a) not to bid again for the VXC franchise when it is re-tendered in 2006 (see note 1)
(b) to continue to offer all current GNER/ICEC fares on the flow from [London via] (see note 2)  Edinburgh to Glasgow (see note 3), and
(c) a behavioural undertaking to maintain the particular ticket mix currently offered by the ICEC franchise and, in addition, [on certain flows] (see note 4) to introduce a price cap for [certain] (see note 5) ICEC standard class fares that would be directly linked to the SRA's regulatory framework (see note 6).

The OFT has considered these undertakings proposals carefully.  In doing so, the OFT has taken into account the extensive regulatory framework already in place in this the sector and the fact that the VXC franchise is itself due for re-award in 2006.  In these circumstances, given that the OFT has identified a competition concern that relates primarily to the four flows around the Edinburgh-York line and to the ability of the successful bidder for the ICEC franchise to raise prices for unregulated ticket fares, the proposed behavioural undertaking offered by Virgin and Stagecoach might be appropriate.  More specifically, the following considerations are relevant.

• The VXC franchise will be re-tendered in 2006 and it is possible that Virgin might no longer hold this franchise after that date.  Any remedy in respect of the overlap between the ICEC franchise service and VXC might therefore be in place for only a short time.  In the event that Virgin/Stagecoach were to be a preferred bidder for the VXC franchise again, the OFT at that stage could re-assess the competitive situation on these overlap flows. 
• TOCs are already subject to close regulatory scrutiny when operating passenger rail transport franchises.  

In view of their very limited duration and the close regulatory scrutiny to which TOCs are already subject, the OFT considers it appropriate to consider the behavioural undertakings offered. 

• The parties have offered to ensure that the current fare offerings and ticket mix on the four ICEC franchise services are maintained.  This proposal is a clear-cut response to the identified competition concern taking into account the period of time for which this undertaking would be in place.
• They have also offered to introduce a price cap for ICEC standard class fares.  This is a straightforward proposal that links directly into existing SRA fare regulation mechanisms.  This will make compliance monitoring extremely easy.

Although the OFT has a strong preference for structural as opposed to behavioural undertakings, the behavioural proposals in this case warrant more detailed consideration given their very limited duration and the regulatory context of the merger.  In this circumstance, concerns about the cost and burden commonly associated with behavioural undertakings appear less acute than usual.

As noted above, Virgin and Stagecoach have offered a structural undertaking (ie, not to bid again for the VXC franchise) which is akin to a divestment remedy. However, this undertaking could not be implemented prior to the re-tendering of the VXC franchise. The behavioural undertakings described above address the interim period. If Virgin does bid for the VXC franchise again, the OFT will have a further opportunity to consider the competition issues at that stage.  Accordingly, it is not necessary to accept this structural undertaking now, as the competition issues arising on the four identified flows from the overlaps between VXC and ICEC can be reconsidered in the near future.

In light of the above, the OFT believes that the proposed behavioural undertaking represents a clear-cut remedy to the competition concern identified.  The OFT therefore concludes that this is an appropriate case in which to exercise its discretion not to refer a merger to the CC since it is considering whether to accept an undertaking in lieu.

DECISION

The OFT is not referring the anticipated acquisition by Virgin and Stagecoach of the ICEC to the CC on the information currently available to it because it is considering whether, instead of making a reference, to accept appropriate undertakings from Virgin and Stagecoach to address the competition concerns arising from the merger.

NOTES

1. The parties wish to highlight that this structural undertaking is not required, see paragraph 87.
2. Included for clarification at the parties' request.
3. The parties whish to highlight that this structural undertaking is not required, see paragraph 44.
4. Included for clarification at the parties' request.
5. Included for clarification at the parties' request.
6. The parties whish to highlight that this undertaking will only be relevant for the period of overlap, see further paragraph 87.

Back to top