Rift Valley Rail: Return of the Lunatic Express

The financing for the acquisition and rehabilitation of the Kenya-Uganda rail line took place in the shadow of the mania surrounding the stock market debut of KenGen. But it offers a better model for the upgrading of infrastructure assets using strategic investors. Nevertheless, Rift Valley briefly struggled to line up in equity investors, although its final shareholder line-up reflects a business with potentially solid cashflows.

Rift Valley Rail is the concession company for the main rail line across Kenya and Uganda and its associated branch lines. It connects Kenya's main port, Mombassa, its capital, Nairobi, and Uganda's capital, Kampala. The British colonial administration built the line between 1895 and 1901, and the cost of the line in time, money and human life gave it the name the "Lunatic Express".

Once primarily a passenger railway, the 2,350km line now carries predominantly freight traffic. The operations have rarely made a profit, and losses from poor controls over fare revenue have been substantial. Most of the landholdings of the Kenya Railways Corporation have already been sold.

The Kenyan and Ugandan governments, advised by the International Finance Corporation, ran a tender to hand over the running of the lines to the private sector. The tender stipulated that qualified operators would have to pay an upfront concession fee, and then set down whether they needed a subsidy, or would be able to share revenues with the two governments.

The tender took place in October 2005, and a Sheltam-led consortium beat a Magadi Soda/RITES grouping by promising that the governments would receive a share of freight revenues beyond a certain point, and that it could operate passenger services without needing a subsidy. Sheltam, based in South Africa, and 50% owned by Grindrod, is a rail and logistical services provider. It won in conjunction with Comazar, Prime Fuels, Mirambo Holdings, and and CDIO Institute for Africa Development Trust of South Africa, which offered a combination of local users and continent-wide support.

Sheltam bid the minimum concession fee, and will thus pay $3 million to the Kenyan government and $2 million to the Ugandan government. It is also committed to paying 11.1% of freight revenues to the government, investing $5 million in the Kenyan operations, and $1 million in Ugandan operations, in each of the first five years of the concession. The Kenyan government is also contributing $1 million towards passenger coach rehabilitation.

The concession's most unique feature, and a key part of the resulting debt financing, was its termination provisions. There are a number of circumstances under which the governments may terminate Rift Valley Rail's concession, but the payment must equal the balance of the conceded asset account. This account is designed to reflect the amount of value remaining in the concession for sponsors and lenders, but at the same time to avoid parking a large and uncertain commitment on the balance sheet of the two awarders.

The obligations of the two governments in turn benefit from a partial risk guarantee from the World Bank's IDA. This product, which adds to the World Bank's efforts in extending such partial guarantees elsewhere, is considered sufficient to at least ensure recovery of principal in the event of termination. The debt consists of a $32 million direct loan from KfW, an IFC A loan of $22 million, and a subordinated IFC C loan of $10 million.

The borrower is a Mauritius-registered holding company, which carries guarantees from operating subsidiaries located in each country. These subsidiaries are parties to agreements with their respective national rail companies, and while each government has obligations to each operating company, they do not have obligations to the other country's operating company, only the central conceded asset account.

The two host countries are still considered emerging markets, and carry considerable risks for investors, even those with some experience in emerging markets. And by the middle of 2006, despite bringing in KfW and the IFC as direct lenders, Sheltam was faced with a huge equity shortfall. All four of its partners pulled out at various stages, and Grindrod had second thoughts about putting up its share of the equity funding.

The result was a last-minute scramble in the weeks leading up to financial close to bring in suitable equity investors. The first to come in, for $5 million, was ICDC, a Kenyan private equity manager*, and second to come in was Babcock & Brown, which has slowly been undergoing a transformation from shadowy leasing and advisory boutique to listed infrastructure investor. In a sense the structure and risk profile of the asset speaks more to its past, but the investment, at $5 million, is not large.

The final investment, equal to Sheltam's own $9 million, came from Kenya's Trans-Century, which owns interests in telecoms, pipeline and power assets. Thus each shareholder contributes complimentary expertise – Sheltam in operations, B&B in financing, ICDC in cross-border development projects, and Trans-Century Kenyan business experience. The process, a fevered search involving multiple continents and several false starts, allowed the financing to meet lender conditions precedent, and only two months after originally scheduled.

Nevertheless, the task ahead for the new owners is daunting. While the railway's unions have so far acquiesced in some severe job losses, the operator will have to reduce losses to fraud and entice additional passengers onto the line. And Rift Valley will need to persuade some of the shippers that presently use truck routes that it is reliable enough to take on their business.

Rift Valley is no one-off. There have been limited steps towards bringing in private operators elsewhere in Africa, certainly enough for Comazar (the private pan-African rail operator) to exist. Emerging markets rail operations across Latin America and Asia could also benefit from large-scale investment of this type. But the main prize for both sponsors and lenders is the much-mooted privatization of Spoornet, the South African freight operator. Rift Valley, while an impressive achievement, could also be understood as a dress rehearsal for that upcoming sell-off.

Rift Valley Railways
Status: Closed 12 December 2006
Size: $111 million
Location: Kenya and Uganda
Description: Financing for 2,350km passenger and freight rail line
Sponsors: Sheltam, Trans-Century, Babcock & Brown, ICDC Investment Company
Financial adviser and arranger: PricewaterhouseCoopers
Lenders: KfW, IFC
Partial guarantee provider: IDA
Financial adviser to governments: IFC
Borrower legal counsel: Latham & Watkins (US), Hamilton Harrison & Mathews Advocates (Kenya), Kampala Associated Advocates (Uganda), Benoit Chambers (Mauritius)
Sponsor legal counsel: Werksmans Attorneys (South Africa)
Lender legal counsel: Fulbright & Jaworski (US), Walker Kontos Advocates (Kenya), Byenkya, Kihika & Co. Advocates (Uganda)
Kenyan government legal counsel: In-house and Wragge & Co. (UK)

*This sentence originally misidentified ICDC as South African.