Société Générale has closed the $95 million debt financing for the Tangula luxury train service project in China. The financing has no precedents and a commercial proposition – hotel-style accommodations for Chinese tourism – that has not been tested commercially, let alone in debt markets. The deal, which closed in February, and is set to meet its conditions precedent as Project Finance went to press, takes place as Tibet, one of Tangula's destinations, suffers from its most severe political instability in over a decade.

Tangula will operate three trains on two routes, between Beijing and Tibet's capital, Lhasa, and between Beijing and Lijiang, in Yunnan province. The borrower for the project is RailPartners, whose shareholders are Wing On Travel, the largest travel agency in Hong Kong, TZG Partners, a Shanghai-based conglomerate focused on leisure and financial services, and PYI Corporation, an infrastructure and logistic operator headquartered in Hong Kong. They are contributing a total of $45 million towards the $140 million total cost.

The project has been in development since 2003, part of a broader initiative to open up Tibet to tourism from the rest of China. Tangula is a 50-year joint venture between RailPartners and the Qinghai-Tibet Railway Corp, which completed the rail line to Lhasa in June 2006, and formed the Tangula joint venture three months later. The line runs from Xining, capital of Qinghai Province, to Lhasa, across a plateau that has been dubbed the "Roof of the World".

The rail line has already carried a large number of passengers, in the region of 5.95 million to the end of 2007, according to the Tibet Tourism Bureau. This equals a roughly 43% share of passengers, with air accounting for most of the rest. Tangula is a slightly more rarified proposition.

Its central premise is that the country's tourism industry can now support a long-distance luxury train service along the lines of the Orient Express. The operator of the onboard hospitality is Kempinski Hotels, which runs eight hotels in China, and several high-end European properties. The trains feature spas, entertainment, dining, and personal butlers, and take three days to reach their destination.

The financing does not cover the line, which remains the property of Qinghai-Tibet Railway, but the rolling stock. A joint venture of Canada's Bombardier and local Sifang Locomotive and Rolling Stock Co is building the trains under a fixed-price, date-certain construction contract, with staggered payments when the work reaches predetermined milestones. The joint venture built the passenger trains that already run on the line, and the chief changes to that design are larger windows, larger water tanks (for on-board showers) and hotel-like interiors. Lenders' familiarity with Bombardier makes up for their lack of exposure to Sifang, which is nonetheless one of China's larger manufacturers.
TZG is the developer of the project, and mandated SG to arrange the debt for what was then nicknamed the Dragon Express in early 2006. Later Wing On, which has the marketing reach necessary to ensure the train stays full, bought a 72% stake in the borrower in June 2007, paying a reported $53 million for the holding. A four night-trip on the train costs roughly $5,000 per person, and the train sleeps roughly 96 people. Assuming a very small number of days (maybe five) out of service, the venture could bring in $43 million in gross revenue per year.

Since Wing On arrived the financing process has picked up speed. The biggest imponderable, and the area in which lenders require most reassurance, the venture's commercial prospects, is now partially mitigated through the presence of Wing On. Further security comes through Chinese government support that includes 16-year exclusive right to serve Tibet, a rolling stock buy-back promise, subject to specified instances of financial and legal distress occurring, and a promise that Tangula receive treatment as good as any future venture along the same lines.

For all that, the project uses an offshore special purpose vehicle and security provisions in line with international norms. The train will initially only take bookings outside China, and so proceeds from ticket sales can be trapped there for the benefit of lenders. The offshore SPV then provides a payment sufficient to meet operating costs to the Chinese venture. Should local buyers eventually buy tickets, then proceeds from these sales would be deducted from the amount due from the offshore SPV.

The 8.5-year debt consists of a senior tranche of $90 million and a junior tranche of $35 million. Among the banks that came in to the deal were HSH-Nordbank, which took $30 million, as original senior lender. SG was sole bookrunner, documentation, technical, insurance, market study and modeling bank, as well as joint interest rate swap provider.

The cars entered construction in June 2007, and the first of 49 carriages is scheduled to arrive in August 2008. The line is set to enter service in September, shortly after the end of the Beijing Olympics, and the sponsors hope that the timing will be useful in attracting overseas passengers, some of which might pay roughly $1,000 per day to be on the train.

But the timing of close on the project was far from auspicious. On 10 March, a demonstration by Tibetan monks was the catalyst for several days of rioting by Tibetans. China's response to the riots, as well as existing campaigns by Tibetan autonomy campaigners and activists against China's involvement in Sudan, have all contributed to pressure on Western governments to reassess their involvement with the Beijing Olympics.

China's government has encouraged greater outside cultural and economic involvement in Tibet, and the railway is a key part of this policy. But resentment against this process, whether for economic or cultural reasons, has been a factor in the unrest. The Qinghai-Tibet Railway, as an engine of economic development, cannot help but be identified with this. A more sustained period of unrest, or wider negative images of China overseas, will have a direct impact on Tangula's prospects.

But there is a useful comparison to made with the growth of high-end gambling in Macau, one that the lead arranger, which financed the first outside operator in Macau, would be anxious to encourage. Both involve an unfamiliar commercial prospect but are set to be sustained through the so far unstoppable rise in economic confidence of the Chinese population.

RailPartners, Inc
Status: Closed February 2008
Size: $140 million
Location: Tibet
Description: Luxury train service linking Lijiang and Beijing with Lhasa
Sponsors: Wing On Travel, TZG Partners, PYI Corporation
Debt: $60 million senior debt, $35 million
Lead arranger: SG
Participant: HSH-Nordbank
Lender legal: Allen & Overy; King & Wood (local)
Sponsor legal: Frank Rocco & Associates