Whose Line is it Anyway?
A lender's dream client and a ludicrously safe bet for shareholders
? Railtrack was privatisation with all the positive trappings of
nationalisation. And although Railtrack's dismal failures have
finally started hitting its shareholders in the wallet (rightly so
many would argue), its credit rating stands firm ? backed as it is
by monopoly status and implicit government backing.
How much money Railtrack needs to create a functional UK rail infrastructure should be a secondary issue. The answer ? accepted in most other European states where rail infrastructure has been commercialised rather than privatised ? is whatever it takes as long as the cash is used efficiently. The real questions are whether Railtrack can manage funds competently, where the cash will come from and at what rate it will be lent ? and answers to those questions are becoming more unclear with every train delayed.
Moreover, if the private sector does lend should it accept Railtrack's A1 rating given the horrendous fines the company has amassed, its record of project mismanagement and growing calls for restructuring (even re-nationalisation). In simple terms ? is Railtrack still a viable borrower if government bailouts dry up?
Railtrack managed to arm-twist another £1.5 billion out of the taxpayer in April this year but still faces a yawning gap between the funds it has and what it needs to do. There is no doubt that Railtrack inherited a rail infrastructure that was in far worse shape than most in the industry fully realised, but it has long-since exhausted any residual sympathy among the government and public for the extent of the task it faces.
The Hatfield train crash in October 2000 had a devastating effect on Railtrack's performance. When the final results for the year to March 31, 2001 were released in May they showed that exceptional items relating to disruption to the network following Hatfield amounted to £561 million in compensation payments to the train operating companies (TOCs), £26 million operating costs and £57 million additional depreciation arising from the crash. The company also faced a bill of £591 million for failing to meet its performance targets. Railtrack chalked up a pre-tax loss of £534 million for 2001 after having made pre-tax profits of £360 million the previous year.
The WCML drain
But while 2001 has been a disastrous year for the company, not all its problems can be laid at the door of Hatfield. The majority of Railtrack's funding problem stems from one project: The West Coast Main Line (WCML). The cost of upgrading this stretch of track ? one of the worst in the entire network ? has been repeatedly ratcheted upwards. The line links London to Birmingham, Liverpool, Manchester and Glasgow and was originally projected to cost £2.1 billion to upgrade. By April this year that cost had risen to £5.8 billion when yet another overspend was announced ? this time to the tune of £500 million. The cost therefore now stands at £6.3 billion, but many analysts believe that it will hit £7 billion. To date it is running five months behind schedule and counting.
This project was meant to be Railtrack's chance to demonstrate that it could manage a large infrastructure upgrade and give the financial community confidence to lend to further projects. Almost the exact reverse has been the case. ?WCML is not exactly showering Railtrack in glory as an example of project management,? observes Jonathan Manley, associate director at Standard and Poor's in London. The cost of the final stage of the upgrade, which is essential to allow the train operator Virgin Trains' tilting trains to run at maximum speed, has ballooned from £1 billion to £2.5 billion. This has prompted an exasperated Sir Richard Branson, Virgin's chairman, to announce in early July that he is ready to assemble a consortium to complete the upgrade himself. ?The upgrade remains a good deal for us but how good a one it is now for Railtrack is not so clear,? he says. Railtrack refused to speak to Project Finance for this article.
John Robinson, who as incoming Railtrack chairman is probably the least-envied man in Britain (with the possible exception of would-be London Underground saviour Bob Kiley), is well aware of the importance to Railtrack of being seen to be able to finish the job on WCML. ?Our first priority is to carry out the enhancement on the WCML. If we can demonstrate that then the finance will follow,? he says.
But will it? According to industry estimates, Railtrack has a funding shortfall of £3.6 billion over the next five years. And given that it faces claims for compensation from Virgin over the WCML delays, and penalties from an increasingly vociferous rail regulator for failing to reach performance targets, that figure could be much higher. ?The true amount that Railtrack needs is unfathomable,? declares one London-based transport analyst. Railtrack announced in early June that it plans to spend £14.8 billion on maintenance and renewal of the network over the next five years. But as its bills mount up, Railtrack's choices are going down.
Option one is trying to get more money from the government. The chances of this are slim. There is no re-opener on discussion for a further government grant until 2002 and there is growing evidence that the rail regulator, Tom Winsor, is losing his patience. ?[Railtrack] needs to put away the begging bowl and stop spending valuable management time hawking themselves unwanted around Whitehall,? he declared in June ? not much scope for misunderstanding there. Railtrack has approached the government for a further £2.6 billion following the £1.5 billion it received in April. But incoming transport secretary Stephen Byers may be more sympathetic to Railtrack's plight.
Option two is a rights issue. The mere suggestion raises many a wry smile. Railtrack's share price has tanked spectacularly since the Hatfield train crash in October last year and in June this year the company faced the ignominy of its share price falling below the 380p level at which it was listed in 1996 and being ejected from the FTSE 100. ?It is interesting that they have paid a dividend this year,? says one transport analyst. ?It looks as if they want to keep their options open to raise equity.? In real terms, the only way that Railtrack managed to meet its dividend was to send £138 million of the £1.5 billion grant it received in April straight back to shareholders: not something that weary commuters probably feel was the best use of their hard-earned tax contributions.
But the likelihood of Railtrack attempting a rights issue in current market conditions is all but zero. Investors have probably had enough excitement for the time being: a negative research report published by Phil Oakley and Christian Cowley at ABN Amro in June prompted the share price to fall 20% in two days. The company has said that it will raise £250 million preferred equity by March 31, 2002 ?subject to market conditions and shareholders' approval?.
Next stop: debt. The company put in place committed bank facilities amounting to £1.5 billion in 2000 and has launched a programme to raise between £2 billion and £3 billion in the bond markets via dollar, euro and sterling issues. These will be the first bond issues by the company since May 1999. What is crucial for the company's success in this market is maintenance of its rating. Railtrack is rated A2 long-term by Moody's and A long-term by Standard & Poor's. Manley at Standard and Poor's emphasises that continuing pressure on Railtrack's share price currently has no impact on its rating. ?The company has an above-average business position as the monopoly provider of rail infrastructure in the UK,? he says. ?Their financial profile is improved by the grant settlement in April, but there is only so much borrowing they can do,? he warns.
The crucial question as far as Manley is concerned is whether Railtrack's debt increasing and its interest coverage therefore decreasing will be enough to trigger a downgrade. ?The financial risk is increasing partly because of the amount of borrowing they will have to do,? he says. ?They may look at off-balance sheet solutions to mitigate this.?
Which raises the interesting question of securitisation. Rumours that Railtrack is planning such an issue have been circulating in the market for years. The company has an ideal portfolio of assets suited to this type of financing structure ? not only the rail assets themselves but a huge real estate portfolio as well. One slight problem that does raise its head is the fact that Railtrack does not know exactly what it owns. The inventory comprises 20,000 miles of track, 2,500 stations, 750 tunnels, 9.000 level crossings and 40,000 bridges and viaducts, but the company does not have a comprehensive asset register. Railtrack's assets were valued at £7.2 billion on a historical cost basis and £12.9 billion on a current cost basis at March 2000.
It beggars belief that a company that has been in existence since 1996 has not got around to drawing up an accurate asset register. A full list of what it owns ? which the company has now been told to produce ? will not be available until 2003. While this is not an insurmountable problem for securitisation ? it could be one more warning sign for anyone asked to take a piece of a future deal.
Leasing
Railtrack has suddenly become active in another financing option ? the single-investor lease. This year Railtrack has already signed up for £500 million worth of deals. Dresdner Kleinwort Wasserstein (DKW) arranged Railtrack's first such lease in March this year, financing £250 million-worth of track, signalling and station equipment. Investor in the lease was HSBC. Richard Birch, director of structured asset finance at Dresdner Kleinwort Wasserstein explains that the leases are essentially unsecured corporate facilities for Railtrack as it retains title to the equipment.
Railtrack has done two further leases (both advised on by DKW), one with Barclays Structured Asset Finance and one with Royal Bank of Scotland subsidiary Lombard. Both are valued at £125 million. ?These assets are suited to leasing as they have a very long life,? explains Julian Bishop at Lombard. ?Lease finance is a relatively cheap option for Railtrack and we expect them to lease everything that they can going forward.? Track equipment has a life of anything up to 40 years and the electrification and signalling equipment financed via these leases has a life of around 15 years. All three leases arranged run for 15 years.
?Given the company's anticipated UK tax profile and planned enhancement expenditure it appears a natural fit for Railtrack to use UK tax-based lease finance as one source of funding for long-term infrastructure enhancements,? says Birch at DKW.
?Despite this, not all expenditure is suitable for UK lease finance as a large portion of Railtrack's expenditure is on replacement, and renewal and does not qualify for capital allowances. The company's large expenditure programme does not automatically mean therefore that new leasable assets are available. Enhancement expenditure qualifying for 25% allowances is the most suitable,? says Birch.
?In reality, replacing a worn out rail is enhancing the network, but for tax purposes it is treated as replacement. Railtrack will therefore have to carefully identify which equipment is suitable for lease financing going forward,? says Birch. Railtrack has committed to spend £5.3 billion on enhancement projects over the next five years.
Although Railtrack's funding requirement is vast, it is not as big as it might have been. Following the Railtrack's woeful performance on the WCML project, the government attached certain conditions to its April grant of £1.5 billion to the company, one of which was that it give up its option to finance the second stage of the Channel Tunnel Rail Link (CTRL) project. Railtrack managers must have secretly breathed a sigh of relief, but this is just the latest in a string of projects that Railtrack has had to relinquish.
At the beginning of the year Railtrack had over £9 billion worth of projects underway, including the WCML, modernisation of the East Coast line, the delayed Thameslink 2000 project, CTRL and an extension to the Tyne & Wear Metro system. The £4.3 billion CTRL phase two will now be built by Bechtel and London & Continental Railways and the Strategic Rail Authority will announce a joint venture to manage the East Coast line upgrade. Railtrack has also pulled out of the Thameslink 2000 project to build a link connecting north and south London. This project ? the cost of which has escalated from £650 million in 1996 to £830 million in 1999 ? is now unlikely to get the go-ahead until 2003. Railtrack was given £200 million when it was privatised specifically to fund the Thameslink project.
The first phase of the CTRL is due to transfer to Railtrack in 2003 for a purchase price of £1.7 billion. Indications are that the company will have to consider some form of off-balance sheet structure to address this commitment. ?They want to do it on a non-recourse basis,? says Manley at Standard and Poors. ?It is feasible that they might try some sort of securitisation structure. There is a strong appetite for investment grade debt.? The company has raised money for this project in the past via a bond issue through a special purpose vehicle.
While most involved must welcome Railtrack's withdrawal from the project management arena, it is an indication of a chipping away at Railtrack's remit ? a process that has gathered speed with recent moves by the country's train operating companies (TOCs) to take the situation in to their own hands. Three of the largest TOCs in the industry ? National Express, Virgin Rail and Stagecoach ? are in talks with the Association of Train Operating Companies to take over track maintenance and signalling activities on their parts of the network from Railtrack. The track and signalling equipment would be leased by Railtrack to the TOC, guaranteeing a regular income stream for Railtrack and giving the TOC more control over the state of the track it is operating on. Such proposals have the support of many in the industry, including the regulator Tom Winsor, and indicate a groundswell of support for a complete restructuring of Railtrack itself.
?There will have to be a government turnaround in the form of a complete restructuring [of Railtrack],? says one London-based transport analyst. ?The company needs to be split into regional divisions. Anything is better than what they face now. There will come a crunch point where there is a complete change of direction.? There is growing pressure for the adversarial nature of the relationship between the TOCs and Railtrack to be addressed and even for the government to buy back a stake in the company. But if all of Railtrack's operational activities are gradually removed, what is the company left with? A large pool of assets that it will lease to other people.
?The fact that Railtrack has been relieved of responsibility for all enhancements is good from a debt perspective in reducing the company's risk exposure.? says Manley. However, that may also mean shareholders do not get the returns they are looking for.
And how would a wholesale restructuring of Railtrack affect its existing lenders? Bishop at Lombard dismisses the idea that there is implicit political risk in the leases that the bank has written with Railtrack. ?Rail infrastructure is always going to be there,? he says. But Birch at DKW admits that the potential for future restructuring is an issue. ?The extent to which any deal would be affected depends on the terms of the facility,? he points out. Bankers and investors take note ? ?The subject was discussed.?
How much money Railtrack needs to create a functional UK rail infrastructure should be a secondary issue. The answer ? accepted in most other European states where rail infrastructure has been commercialised rather than privatised ? is whatever it takes as long as the cash is used efficiently. The real questions are whether Railtrack can manage funds competently, where the cash will come from and at what rate it will be lent ? and answers to those questions are becoming more unclear with every train delayed.
Moreover, if the private sector does lend should it accept Railtrack's A1 rating given the horrendous fines the company has amassed, its record of project mismanagement and growing calls for restructuring (even re-nationalisation). In simple terms ? is Railtrack still a viable borrower if government bailouts dry up?
Railtrack managed to arm-twist another £1.5 billion out of the taxpayer in April this year but still faces a yawning gap between the funds it has and what it needs to do. There is no doubt that Railtrack inherited a rail infrastructure that was in far worse shape than most in the industry fully realised, but it has long-since exhausted any residual sympathy among the government and public for the extent of the task it faces.
The Hatfield train crash in October 2000 had a devastating effect on Railtrack's performance. When the final results for the year to March 31, 2001 were released in May they showed that exceptional items relating to disruption to the network following Hatfield amounted to £561 million in compensation payments to the train operating companies (TOCs), £26 million operating costs and £57 million additional depreciation arising from the crash. The company also faced a bill of £591 million for failing to meet its performance targets. Railtrack chalked up a pre-tax loss of £534 million for 2001 after having made pre-tax profits of £360 million the previous year.
The WCML drain
But while 2001 has been a disastrous year for the company, not all its problems can be laid at the door of Hatfield. The majority of Railtrack's funding problem stems from one project: The West Coast Main Line (WCML). The cost of upgrading this stretch of track ? one of the worst in the entire network ? has been repeatedly ratcheted upwards. The line links London to Birmingham, Liverpool, Manchester and Glasgow and was originally projected to cost £2.1 billion to upgrade. By April this year that cost had risen to £5.8 billion when yet another overspend was announced ? this time to the tune of £500 million. The cost therefore now stands at £6.3 billion, but many analysts believe that it will hit £7 billion. To date it is running five months behind schedule and counting.
This project was meant to be Railtrack's chance to demonstrate that it could manage a large infrastructure upgrade and give the financial community confidence to lend to further projects. Almost the exact reverse has been the case. ?WCML is not exactly showering Railtrack in glory as an example of project management,? observes Jonathan Manley, associate director at Standard and Poor's in London. The cost of the final stage of the upgrade, which is essential to allow the train operator Virgin Trains' tilting trains to run at maximum speed, has ballooned from £1 billion to £2.5 billion. This has prompted an exasperated Sir Richard Branson, Virgin's chairman, to announce in early July that he is ready to assemble a consortium to complete the upgrade himself. ?The upgrade remains a good deal for us but how good a one it is now for Railtrack is not so clear,? he says. Railtrack refused to speak to Project Finance for this article.
John Robinson, who as incoming Railtrack chairman is probably the least-envied man in Britain (with the possible exception of would-be London Underground saviour Bob Kiley), is well aware of the importance to Railtrack of being seen to be able to finish the job on WCML. ?Our first priority is to carry out the enhancement on the WCML. If we can demonstrate that then the finance will follow,? he says.
But will it? According to industry estimates, Railtrack has a funding shortfall of £3.6 billion over the next five years. And given that it faces claims for compensation from Virgin over the WCML delays, and penalties from an increasingly vociferous rail regulator for failing to reach performance targets, that figure could be much higher. ?The true amount that Railtrack needs is unfathomable,? declares one London-based transport analyst. Railtrack announced in early June that it plans to spend £14.8 billion on maintenance and renewal of the network over the next five years. But as its bills mount up, Railtrack's choices are going down.
Option one is trying to get more money from the government. The chances of this are slim. There is no re-opener on discussion for a further government grant until 2002 and there is growing evidence that the rail regulator, Tom Winsor, is losing his patience. ?[Railtrack] needs to put away the begging bowl and stop spending valuable management time hawking themselves unwanted around Whitehall,? he declared in June ? not much scope for misunderstanding there. Railtrack has approached the government for a further £2.6 billion following the £1.5 billion it received in April. But incoming transport secretary Stephen Byers may be more sympathetic to Railtrack's plight.
Option two is a rights issue. The mere suggestion raises many a wry smile. Railtrack's share price has tanked spectacularly since the Hatfield train crash in October last year and in June this year the company faced the ignominy of its share price falling below the 380p level at which it was listed in 1996 and being ejected from the FTSE 100. ?It is interesting that they have paid a dividend this year,? says one transport analyst. ?It looks as if they want to keep their options open to raise equity.? In real terms, the only way that Railtrack managed to meet its dividend was to send £138 million of the £1.5 billion grant it received in April straight back to shareholders: not something that weary commuters probably feel was the best use of their hard-earned tax contributions.
But the likelihood of Railtrack attempting a rights issue in current market conditions is all but zero. Investors have probably had enough excitement for the time being: a negative research report published by Phil Oakley and Christian Cowley at ABN Amro in June prompted the share price to fall 20% in two days. The company has said that it will raise £250 million preferred equity by March 31, 2002 ?subject to market conditions and shareholders' approval?.
Next stop: debt. The company put in place committed bank facilities amounting to £1.5 billion in 2000 and has launched a programme to raise between £2 billion and £3 billion in the bond markets via dollar, euro and sterling issues. These will be the first bond issues by the company since May 1999. What is crucial for the company's success in this market is maintenance of its rating. Railtrack is rated A2 long-term by Moody's and A long-term by Standard & Poor's. Manley at Standard and Poor's emphasises that continuing pressure on Railtrack's share price currently has no impact on its rating. ?The company has an above-average business position as the monopoly provider of rail infrastructure in the UK,? he says. ?Their financial profile is improved by the grant settlement in April, but there is only so much borrowing they can do,? he warns.
The crucial question as far as Manley is concerned is whether Railtrack's debt increasing and its interest coverage therefore decreasing will be enough to trigger a downgrade. ?The financial risk is increasing partly because of the amount of borrowing they will have to do,? he says. ?They may look at off-balance sheet solutions to mitigate this.?
Which raises the interesting question of securitisation. Rumours that Railtrack is planning such an issue have been circulating in the market for years. The company has an ideal portfolio of assets suited to this type of financing structure ? not only the rail assets themselves but a huge real estate portfolio as well. One slight problem that does raise its head is the fact that Railtrack does not know exactly what it owns. The inventory comprises 20,000 miles of track, 2,500 stations, 750 tunnels, 9.000 level crossings and 40,000 bridges and viaducts, but the company does not have a comprehensive asset register. Railtrack's assets were valued at £7.2 billion on a historical cost basis and £12.9 billion on a current cost basis at March 2000.
It beggars belief that a company that has been in existence since 1996 has not got around to drawing up an accurate asset register. A full list of what it owns ? which the company has now been told to produce ? will not be available until 2003. While this is not an insurmountable problem for securitisation ? it could be one more warning sign for anyone asked to take a piece of a future deal.
Leasing
Railtrack has suddenly become active in another financing option ? the single-investor lease. This year Railtrack has already signed up for £500 million worth of deals. Dresdner Kleinwort Wasserstein (DKW) arranged Railtrack's first such lease in March this year, financing £250 million-worth of track, signalling and station equipment. Investor in the lease was HSBC. Richard Birch, director of structured asset finance at Dresdner Kleinwort Wasserstein explains that the leases are essentially unsecured corporate facilities for Railtrack as it retains title to the equipment.
Railtrack has done two further leases (both advised on by DKW), one with Barclays Structured Asset Finance and one with Royal Bank of Scotland subsidiary Lombard. Both are valued at £125 million. ?These assets are suited to leasing as they have a very long life,? explains Julian Bishop at Lombard. ?Lease finance is a relatively cheap option for Railtrack and we expect them to lease everything that they can going forward.? Track equipment has a life of anything up to 40 years and the electrification and signalling equipment financed via these leases has a life of around 15 years. All three leases arranged run for 15 years.
?Given the company's anticipated UK tax profile and planned enhancement expenditure it appears a natural fit for Railtrack to use UK tax-based lease finance as one source of funding for long-term infrastructure enhancements,? says Birch at DKW.
?Despite this, not all expenditure is suitable for UK lease finance as a large portion of Railtrack's expenditure is on replacement, and renewal and does not qualify for capital allowances. The company's large expenditure programme does not automatically mean therefore that new leasable assets are available. Enhancement expenditure qualifying for 25% allowances is the most suitable,? says Birch.
?In reality, replacing a worn out rail is enhancing the network, but for tax purposes it is treated as replacement. Railtrack will therefore have to carefully identify which equipment is suitable for lease financing going forward,? says Birch. Railtrack has committed to spend £5.3 billion on enhancement projects over the next five years.
Although Railtrack's funding requirement is vast, it is not as big as it might have been. Following the Railtrack's woeful performance on the WCML project, the government attached certain conditions to its April grant of £1.5 billion to the company, one of which was that it give up its option to finance the second stage of the Channel Tunnel Rail Link (CTRL) project. Railtrack managers must have secretly breathed a sigh of relief, but this is just the latest in a string of projects that Railtrack has had to relinquish.
At the beginning of the year Railtrack had over £9 billion worth of projects underway, including the WCML, modernisation of the East Coast line, the delayed Thameslink 2000 project, CTRL and an extension to the Tyne & Wear Metro system. The £4.3 billion CTRL phase two will now be built by Bechtel and London & Continental Railways and the Strategic Rail Authority will announce a joint venture to manage the East Coast line upgrade. Railtrack has also pulled out of the Thameslink 2000 project to build a link connecting north and south London. This project ? the cost of which has escalated from £650 million in 1996 to £830 million in 1999 ? is now unlikely to get the go-ahead until 2003. Railtrack was given £200 million when it was privatised specifically to fund the Thameslink project.
The first phase of the CTRL is due to transfer to Railtrack in 2003 for a purchase price of £1.7 billion. Indications are that the company will have to consider some form of off-balance sheet structure to address this commitment. ?They want to do it on a non-recourse basis,? says Manley at Standard and Poors. ?It is feasible that they might try some sort of securitisation structure. There is a strong appetite for investment grade debt.? The company has raised money for this project in the past via a bond issue through a special purpose vehicle.
While most involved must welcome Railtrack's withdrawal from the project management arena, it is an indication of a chipping away at Railtrack's remit ? a process that has gathered speed with recent moves by the country's train operating companies (TOCs) to take the situation in to their own hands. Three of the largest TOCs in the industry ? National Express, Virgin Rail and Stagecoach ? are in talks with the Association of Train Operating Companies to take over track maintenance and signalling activities on their parts of the network from Railtrack. The track and signalling equipment would be leased by Railtrack to the TOC, guaranteeing a regular income stream for Railtrack and giving the TOC more control over the state of the track it is operating on. Such proposals have the support of many in the industry, including the regulator Tom Winsor, and indicate a groundswell of support for a complete restructuring of Railtrack itself.
?There will have to be a government turnaround in the form of a complete restructuring [of Railtrack],? says one London-based transport analyst. ?The company needs to be split into regional divisions. Anything is better than what they face now. There will come a crunch point where there is a complete change of direction.? There is growing pressure for the adversarial nature of the relationship between the TOCs and Railtrack to be addressed and even for the government to buy back a stake in the company. But if all of Railtrack's operational activities are gradually removed, what is the company left with? A large pool of assets that it will lease to other people.
?The fact that Railtrack has been relieved of responsibility for all enhancements is good from a debt perspective in reducing the company's risk exposure.? says Manley. However, that may also mean shareholders do not get the returns they are looking for.
And how would a wholesale restructuring of Railtrack affect its existing lenders? Bishop at Lombard dismisses the idea that there is implicit political risk in the leases that the bank has written with Railtrack. ?Rail infrastructure is always going to be there,? he says. But Birch at DKW admits that the potential for future restructuring is an issue. ?The extent to which any deal would be affected depends on the terms of the facility,? he points out. Bankers and investors take note ? ?The subject was discussed.?
Request a Demo
Interested in IJGlobal? Request a demo to discuss a trial with a member of our team. Talk to the team to explore the value of our asset and transaction databases, our market-leading news, league tables and much more.