Branson: Behind the Mask (11 page)

James Murdoch had set a deadline for cutting off BSkyB’s supply of programmes to Virgin. Branson telephoned him to offer an additional 19 per cent for access to the company’s channels, but twice he was told that Murdoch was in a meeting. ‘He never bothered to return my calls,’ complained Branson. On 1 March, Virgin Media’s 3.3 million households lost BSkyB’s programmes. ‘When Virgin say we did not want to do a deal,’ claimed Murdoch, enjoying Branson’s weakness, ‘it’s just not the case.’ That year, BSkyB would earn profits of £877 million, while Virgin Media lost £533.9 million. NTL’s accumulated global debts had risen to £12.1 billion. Some Britons sympathised with Branson’s lament about bullies.

‘I think it could backfire on the Murdoch empire in quite a
major way,’ said Branson. ‘I think the son has maybe opened a hornet’s nest with this one.’ The Office of Fair Trading was already investigating Murdoch’s stake in ITV. Branson’s lobbying of the government persuaded Ofcom, the broadcasting regulator, also to investigate BSkyB’s purchase of the ITV shares. The two inquiries would run in parallel. ‘I’m astonished,’ commented James Murdoch. The government, he said, was allowing its regulations to be ‘manipulated’.

On 26 April, Branson scored a small victory: Ofcom recommended that the Competition Commission should investigate whether BSkyB’s purchase of ITV shares was in the public interest. But Branson’s revenge barely compensated for the loss of more customers. Despite a rebranding campaign featuring Uma Thurman, his channel was being squeezed. Another 64,300 subscribers had been lost in three months, while BSkyB shares were heading towards a three-year high.

Branson bluffed when he was asked if the battle with Sky was damaging: ‘Most of the viewers seem to be staying loyal and I think we won’t lose very many.’ BSkyB, he demanded, ‘should lower its prices’ – an unusual sentiment for a capitalist. His solution was for Virgin to make its own programmes ‘rather than paying through the nose to BSkyB’.

At Virgin Media’s board meeting in Puerto Rico in April 2007, Branson was shown research by UBS, the bank, suggesting that a further 400,000 Virgin Media subscribers might switch to BSkyB. He received the news just as he sought cash for Virgin Galactic – just before the explosion, his team was rushing to meet his first deadline to take passengers into space – and he was investing at least $60 million in renewable energy. In June, he borrowed £113 million over two years from Credit Suisse. His collateral was one-third of his Virgin Media shares, then trading at $24. He gambled that if the shares fell to $19.68, he would compensate the bank, but if the shares rose above $31.98, he
would share the profits with it. The risk reflected Branson’s weakness. ‘It’s a bit of financial engineering to get some capital,’ he explained. Next, he borrowed a further $80 million – and the news got worse.

After another 70,300 subscribers deserted Virgin Media, Moody’s downgraded the company’s value from ‘stable’ to ‘negative’, and on 26 July the explosion in Mojave killed the three engineers. Then came the first reports of the sub-prime crisis that was threatening America’s financial system. Virgin Media abandoned the battle against BSkyB and substantially cut its subscription rates. The losses rose. Branson would later decline to buy back his shares from Credit Suisse.

His only comfort was the Competition Commission’s decision that BSkyB’s stake in ITV was ‘against the public interest’. Sky was ordered to reduce its stake from 17.9 per cent to below 7.5 per cent. Although ITV’s shares were cheap at 74 pence, Branson lacked the money to revive his bid. His options as a media mogul in Britain were exhausted. By contrast, Rupert Murdoch could comfortably suffer the loss of over £500 million on his ITV misadventure.

Branson was always looking for opportunities to raise cash. One option was to sell more shares, so during 2007 he approved the sale of Virgin Mobile to the American public. The previous proposed flotation in 2005 valuing the company at $1.6 billion had been abandoned. Two years later, Virgin Mobile had 4.6 million notional ‘users’ (out of America’s 229.6 million mobile-telephone users), but the profits were paltry. Ignoring reality, Branson hyped a ‘success’ story and pitched the company’s value at $2 billion.

During the preparations, he approved a plan which resulted in penalising the key staff who had helped to build the business over the previous seven years. As an incentive at the outset, the thirty had been given share options which they hoped to cash in
on after the flotation. Usually, employees do not actually pay for those options but take the profits of a notional ‘sale’ after the flotation. Branson ignored that convention. Harshly, he insisted that the thirty should actually pay for their options before the flotation and be prevented from selling the shares for a period afterwards. To finance the shares’ purchase, the staff would have been obliged to mortgage their homes to gamble that the company’s future value did not fall below $650 million. ‘They can’t take the risk,’ Gordon McCallum was told. ‘They’ve made a big contribution, and you’re treating them very badly.’ McCallum’s silence prompted the staff to send messages to Branson. To their surprise, Branson ordered his lawyers to freeze all communications. ‘It’s out of my control,’ said McCallum, finally. ‘I can’t do anything.’ Most of the thirty walked away from Virgin, cursing Branson. His homily in Chapter Eight of
Screw
Business
as
Usual
– ‘Screw it, let’s do it’ – seemed to have been ignored. Under the subheading ‘Have Respect’, Branson urged his admirers to ‘Do the right thing’ and ‘Be fair in your dealings’.

The flotation on 10 October 2007 raised $412 million (£202 million), valuing Virgin Mobile USA at $800 million, a far cry from the $2 billion Branson had expected. His personal stake was worth about $295 million, much less than he had hoped. Five months later, the share price had fallen by 85 per cent to $7. Branson’s ‘paper’ loss was a further $250 million. Within a year of the flotation, Virgin Mobile’s debts were rising and the network was losing 100,000 customers a month. Branson decided to quit, selling his remaining 28 per cent stake to Sprint for $5.50 a share. He claimed to have earned $250 million as pure profit. By the end of the year, Virgin Media’s shares had fallen further to $5.76. At the same time, Branson also withdrew from Canada, selling his indebted network to Bell. Even his putative Indian venture was struggling. He had finally found a partner – Tata Teleservices – and would launch the service in March 2008,
but three years later Branson abandoned that venture too, giving his 50 per cent stake to his partner.

Regardless of all the setbacks, Branson’s magic attracted unrivalled loyalty among the British media. In summer 2007, over a hundred journalists gathered at his Oxfordshire home to report on Virgin Media’s glories. All were convinced about the authenticity of his vision. There appeared to be no reason to doubt his self-confidence. In its potted description of the chairman, the
Guardian
reported that Branson ‘lives in London’, rather than the reality – as a tax exile in Necker. United by a common dislike of Murdoch and empathy for the hippy tycoon, the reporters relished Branson’s message that Virgin Media would emerge successfully from its troubles.

‘Like Virgin Trains,’ he said, ‘it’ll be like that great success story. Virgin Trains is now one of our top three brands.’

In 2002, Branson had conceded that running Britain’s trains was not a natural Virgin business. Contrary to his expectations ten years earlier, the railways had not offered a chance for easy profits. His publicised outburst in 1992 that ownership of a railway franchise would be ‘a licence to print money’ had proved to be mistaken, and in Virgin Trains’ early years the brand had been trashed.

Long before he had applied to run two rail networks, Branson had preached to members of the House of Commons Transport Committee about the enviable benefits he would bestow on Britain’s dilapidated railways. As the owner of a successful airline, he said, ‘Our trains will arrive faster because Virgin drivers will be more motivated.’ The image of Virgin Trains overtaking its rivals raised the politicians’ eyebrows, as did Branson’s advocacy of breaking up British Rail and fragmenting the track authority to encourage competition.

‘Your understanding of the railways’, said a Labour MP, ‘does seem to be on a protozoan level.’

‘I have not said anything as daft as you seem to indicate,’ replied Branson, who was discomfited whenever his image was scorned.

Branson knew his limitations. His skill was to recruit outstanding advisers. Among those he had selected to help him in his bid for a rail franchise was Jim Steer, a transport consultant who predicted that motorists would ditch their cars and return to modernised railways. Steer also believed that the government
was so committed to privatisation that the franchise contracts would guarantee the operators healthy risk-free profits.

Branson’s relationship with Steer had begun in 1996 with a blunder over Virgin’s participation in launching Eurostar, the new train linking London and Paris through the Channel tunnel. Virgin had won the bid to market the new route. ‘I’ll be offering a completely different service to travellers, with all the Virgin flair,’ Branson told his partners. Their relationship quickly fractured. First, his partners were angered about Branson’s poor marketing, and then they were aggravated by his bid to rename the train ‘Virgin Eurostar’. In its first year, Eurostar carried half the number of passengers Steer had predicted. Branson was blamed and Virgin was shunted out of the picture. But Steer remained as Branson’s adviser. By then, several franchises to run the national rail services had been awarded, and Branson was persuaded to follow the trend. Having missed the best routes, he bid for Cross Country, a ragbag of the remaining network which would not be allocated in other franchises. In 1996, Virgin won the franchise by promising to replace the thirty-year-old trains and attract thousands of new customers.

His next bid was for the West Coast line linking London to Birmingham, Manchester and Glasgow. The north-south artery had been rebuilt in 1965, with a life expectancy of thirty years. In the early 1980s, British Rail’s experts had investigated whether the line could be redeveloped for the Advanced Passenger Train, which would connect London with Scotland in four hours and Manchester in two hours. The high speed depended on the train tilting through bends at over 150 mph. The project was abandoned as technically impossible, but was partially revived a few years later. British Rail’s engineers had designed the InterCity 250, a non-tilting train which could cruise at 155 mph. The new train required new tracks, and since at that speed the train driver could not see the old signalling lights on the side, the planners
discussed inventing a new system whereby the signals would be displayed on a screen inside the driver’s cab. The research was stopped when the government decided in 1992 to privatise the railways.

Branson was a natural target for ministers keen for a trophy owner of the West Coast line. ‘It’s a brave new world where bidders are invited to innovate and take risks,’ Branson was told. Scrutiny of the contract’s financial terms showed that with minimal risk, Branson could earn a fortune at the taxpayers’ expense.

Ever since privatisation was announced, the deterioration of the West Coast’s tracks and rolling stock had accelerated, discouraging passengers from using the railway. Branson shared the common prejudice that British Rail was inefficient and unresponsive. He held to the credo that free enterprise would encourage innovation. ‘We can make the railways different and better,’ said Branson, embracing privatisation.

His team pondered how to build on the requirements stipulated by Railtrack, the franchising agency. ‘Let’s offer to run tilting trains at 140 mph,’ suggested one of Branson’s team, ‘but only if the government gives us a fifteen-year franchise – and allows no other operator to compete against us on the line.’

‘This is all guesswork,’ replied Richard Bowker, who had been recruited from London Underground to plan Virgin’s bid.

The pitch for a long monopoly contradicted Branson’s presentation to the politicians in 1992, but his scenario of trains racing from London to Manchester in 1 hour 50 minutes by 2005 excited John Edmonds, Railtrack’s chief executive. Faster trains would generate profits as people abandoned cars and planes. Virgin won the franchise. Tom Winsor, an accomplished lawyer, was assigned by Branson to negotiate a contract which, according to the government’s plan, at the outset committed the taxpayer to bear the costs and risk, while Virgin took the profits. Virgin Trains, ultimately owned by Virgin Group Holdings,
registered in the Virgin Islands, could expect to earn about 3.5 per cent of the revenue in annual profits.

According to the standard ‘cap and collar’ contract, Railtrack guaranteed Virgin that there would be tracks and stations to run the trains to an agreed timetable. Virgin would not buy the rolling stock. Instead, the engines and carriages would be leased from Angel, a private company whose income was guaranteed by the government. Virgin risked no money because the lease of the rolling stock would be transferred to whichever operator followed Virgin Trains. Branson’s only risk was the amount of money he guaranteed to pay to the government during the franchise. The sliding payments were in two parts, based on Virgin’s calculations of its income. In the early years, Virgin stipulated the subsidy required from the government. In the second period, it quantified its payments to the government from the profits. In the jargon, the contract was ‘back-end loaded’ – Virgin’s payments would exceed any continuing subsidy. At the outset in 1997/8, Virgin expected a government subsidy of about £200 million, and by 2012/13 the company would be paying the government a premium of up to £200 million, subject to profits. Those depended on attracting the maximum number of passengers paying for the highest-priced tickets, and Virgin’s managers maximising productivity. The unmentioned profit was the cash flow – Virgin could use the cash without paying interest. In the beginning, the company would receive about £900 million from Railtrack and the passengers. Passengers paid in advance, while Virgin paid its suppliers in arrears, so with the exception of season tickets, all the cash could be used by Virgin.

On that basis, in February 1997 Virgin was awarded the contract known as Passenger Upgrade 1 (PUG1). The fifteen-year deal had barely been signed before negotiations began for a revised contract known as PUG2. John Edmonds and Railtrack’s directors had embraced Virgin’s suggestion that the original
specification of new trains running at 125 mph by 2005 should be replaced by trains running at 140 mph. PUG2 would commit Railtrack to building entirely new tracks and installing a new signalling system.

Virgin’s directors understood Railtrack’s risk. To minimise the cost of failure, Winsor inserted into the contract a series of penalty payments if Railtrack failed to upgrade the network. His irrefutable reasoning was that Virgin’s financial model depended on persuading passengers to switch from airlines and cars to trains.

Edmonds did not understand Branson’s customary terms of business. Although the new contract was Branson’s idea, he expected Railtrack to take the financial risk. Virgin challenged Railtrack’s directors and lawyers to resist Branson’s familiar ploy. ‘We played an A team,’ said one of the Virgin negotiators, admiring Branson’s talent of employing the best lawyers. ‘Railtrack’s was a C team.’

By then, most of British Rail’s traditional engineers had resigned, but Edmonds did retain Professor Brian Mellitt of Manchester University as Railtrack’s director of engineering. Over the years, the professor had promoted his vision of a new signalling system. Called ‘moving block’, his proposed system combined sensors, wireless technology and computers to monitor a train’s speed and flash the relevant signals to the driver’s cab. Caught up in Mellitt’s enthusiasm, Edmonds did not question why no other railway network in the world operated a similar system or whether wireless could penetrate through tunnels and operate around sharp curves. Remarkably, he did not appear to realise that the introduction of Mellitt’s ideas into the London Underground’s Jubilee line was proving to be technically unsuccessful. Instead, he relied on a consultants’ report which stated that moving-block technology was ‘relatively mature’, and contracted Alstom in France to develop Mellitt’s scheme.

In September 1997, just as the PUG2 contract was presented to Railtrack’s board for approval, Edmonds was replaced by Gerald Corbett, the former finance director of Grand Metropolitan, the food and drinks multinational. Corbett knew little about railways or engineering. Like many of the property specialists who were replacing experienced railwaymen, Corbett was certain Railtrack had a glowing future because the company’s shares, originally £3, were heading towards £17.

Presented on his arrival with PUG2, Corbett accepted assurances that rebuilding the line and including Mellitt’s signalling scheme would cost £800 million. ‘We’ll just click a switch in 2005 and it’ll all be working,’ was his understanding. Without further scrutiny, he signed the contract. By then, Branson was energetically imposing Virgin’s style upon BR’s dilapidated network. ‘Call it the Virgin Difference,’ he told the marketing staff. Quietly, he had refocused his plans. In 1998, he had bought out his original partners and split the ownership of Virgin Trains with Brian Souter, the founder of Stagecoach, a transport specialist. Souter had proposed a fifty-fifty venture, but Branson insisted on owning 51 per cent.

During 1998, Virgin Trains became notorious for delays and bad service. Plagued by the old infrastructure and disrupted by privatisation, Railtrack was unable to fulfil its commitments. Simultaneously, Virgin lacked the expertise to repair its trains. The public’s anger turned against Branson. Daily, the media trashed Virgin for failing to deliver on Branson’s promises. To save himself, in January 1999 Branson appointed Chris Green, the former head of InterCity trains, as Virgin Trains’ new chief executive. Green was horrified by his inheritance. To save money, Branson had merged the management of Cross Country and the West Coast line and, as Green discovered, appointed ‘lots of marketing and customer specialists who were unemployable and knew nothing about railways’. Virgin Trains’ management,
Green announced, ‘is a nightmare and a mess’. None of his staff knew how to make the old trains work. Service on board was similarly chaotic. Virgin had replaced the traditional service in British Rail’s dining cars with airline ‘hostesses’ serving small portions of food on plastic trays. Passengers frequently complained that Virgin’s staff were rude, especially after the trains broke down. Branson did not understand railways, but the criticism, he believed, could be alleviated by good public relations. ‘How can I help you?’ he regularly asked Green, who had ordered the management of Cross Country and Virgin Trains to be split up once again. Branson wanted to position himself as Corbett’s ally.

First, they arranged to meet for a photo shoot at Euston station. Branson’s banter with two Virgin stewardesses irritated Corbett. ‘He was too smarmy with those girls,’ he complained later. ‘All those cheap suggestive remarks to the girls, with his hands all over them. I don’t like him.’ Next, they agreed to meet for dinner. ‘I’ve got to try to get on with him,’ Corbett explained. Branson arrived with Holly, his sixteen-year-old daughter. ‘That’s utterly inappropriate,’ thought Corbett. Every attempt he made to engage in a business conversation was forlorn. ‘He always feigned ignorance about numbers,’ Corbett later reported. ‘He kept saying, “I need to ask my team.”’ Unaware that Branson was genuinely ignorant about detail, Corbett concluded, ‘He’s wasting my time. He never looks me in the eye. I’m a straightforward bloke, and he just irritates me.’ At the end of a frosty meal, Corbett decided to ‘quickly bugger off’.

In December 1999, Green was summoned to Railtrack’s headquarters. In what was codenamed ‘Black Diamond Day’, he was told by Corbett that Mellitt’s signalling system could not be designed.

‘It’s all pie in the sky,’ said Corbett. ‘We’ve decided to put our hands up now instead of wasting more time and money.’

‘You’ve been chasing a rainbow,’ replied Green, with a sense of disbelief.

‘We rumbled the mad professor,’ continued Corbett, referring to the delays on the London Underground’s redevelopment, which had been blamed by some on Mellitt’s similar signalling proposals. ‘He’s got qualifications coming out of his backside, but it hasn’t done any good. He’s retired.’

Green appeared to be sympathetic.

‘We were naive,’ said Corbett, defensively. ‘We’re going back to PUG1 with conventional signalling. We will rebuild the tracks. It will cost £2 billion.’ No one queried why the estimated cost had nearly tripled within three years. PUG2 – and the 140 mph trains – was abandoned. Corbett assumed that Virgin would be understanding and, without recrimination, revert to trains travelling at 125 mph. ‘If you expect them to be nice guys, you’re in for a shock,’ he was warned.

‘You’ve been sold something which is not deliverable,’ Green reported to Branson in his office in Holland Park.

‘Oh shit,’ said Branson. ‘We must make it work.’

‘They haven’t even put a spade into the ground to rebuild the track. Nothing’s happened,’ said Green, incredulously.

Branson was unforgiving. No mercy could be shown even for unforeseen problems. ‘We want £1 billion of compensation,’ he announced, listing some anticipated losses – the slower service would require extra trains, and the additional passengers he’d hoped for would not now be switching from airlines to faster trains. His attack was based on Tom Winsor’s watertight contract – ‘One of the best contracts in history,’ Green would admit. Virgin demanded that Railtrack immediately pay £250 million in compensation. The relationship between Branson’s team – Patrick McCall, Virgin Trains’ chairman, and Tony Collins, the contracts director – and Corbett became acrimonious. The arbiter of the dispute was none other than Winsor, who had
moved from Virgin to become the rail regulator. As a lawyer, he was unsympathetic to Corbett’s plea that the contract should be ignored to save Railtrack from insolvency. Corbett’s fate was then further endangered by a terrible accident.