Rail infrastructure projects: too risky for private investors?
TAIWAN High Speed Rail Corporation (THSRC) is on the brink of financial collapse because its operating profits are insufficient to meet preferred share redemption obligations and Taiwan's Legislative Yuan has unanimously rejected a financial restructuring plan drawn up by the Ministry of Transport and Communications. While nationalisation of THSRC appears the most likely outcome, this is likely to be a messy affair with taxpayers having to foot a very large bill.
Nationalisation of THSRC could cost at least $NT 700bn ($US 22.1bn) which includes $NT 300bn compensation to THSRC for past damages. However, THSRC says it will push for up to $NT 400bn in damages if it is nationalised. THSRC's calculations include $NT 10.4bn from providing discounts on fares, $NT 152bn from actions beyond its control such as an earthquake in 1999, and $NT 235bn in losses incurred due to economic fluctuations.
The irony of the situation is that the Taiwanese government originally planned to use public funds to build the 345km high-speed line linking Taipei with Kaohsiung, but like many governments it was faced with growing demands on its limited resources and so decided to use a build, operate, transfer (BOT) model to construct the railway.
This was a bold decision considering the price tag of $US 18bn for the scheme, which made it the world's largest privately-funded BOT project. Nevertheless the government pressed ahead and THSRC was granted a 35-year operating concession and a 50-year concession to develop the area around the new stations.
The 1999 earthquake caused a setback for the project as civil works contracts were cancelled due to concerns over whether the designs and construction methods were sufficiently robust to withstand seismic events. Revised contracts were awarded the following year and the line opened in January 2007.
But the delay cost THSRC dearly and forced it to raise another $NT 65.5bn on top of its original syndicated loan of $NT 323.3bn, some of which had been borrowed at interest rates of 8%.
The high-speed line got off to a dismal start, carrying an average of only 43,000 passengers a day during its first year of operation compared with a forecast of 180,000. But since then traffic has climbed each year rising from 32.4 million journeys in 2009 to 47.5 million in 2013. Operationally, THSRC has been a great success, with punctuality continually exceeding 99%.
In 2010-11 THSRC successfully carried out a restructuring of its long-term debt and loans, and in 2011 declared its first profit recording a net income of $NT 5.78bn. THSRC's financial performance has continued to improve and it has remained in profit ever since. Revenue grew by 6.24% in 2013 to $NT 36.1bn resulting in an Ebitda of $NT 26.5bn and a pre-tax profit of $NT 2.7bn. While THSRC's 2014 results have not been announced yet, it was expecting to do even better last year.
THSRC's financial crisis was brought to a head through 39 lawsuits filed by its original shareholders over the redemption of preference shares. Taiwan's Supreme Court is expected to pass judgement on this in March. If the shareholders win, THSRC will be given 80 days to come up with a plan to resolve the crisis. As this seems unlikely, THSRC will be declared bankrupt in May and the government will have to nationalise it by January 2016, with a new organisation in place to run the company by March 2016.
One solution could be for THSRC to become a fully state-owned company, with its debts written off. Another option would be to retain the infrastructure in state ownership and to privatise the operation of the railway through either outright sale or a concession. The government could also sell off land around the stations to help recover its investment.
THSRC is not the first BOT project to go bust and it certainly won't be the last. The problem with trying to fund major railway projects privately is that the capital outlay is very high, implementation usually takes four to five years if everything goes according to plan, and the railway is unlikely to make its first profit until it has been operating for several years. This means the risk is very high as the project is highly vulnerable to construction delays, interest rate and economic fluctuations, and changes in government policy, all of which can wreak havoc with the financial plan.
Traffic, and therefore revenue forecasting, over such a long period is also very difficult to get right, especially as there is a tendency to inflate traffic forecasts at the outset to a point where the project becomes financially and economically viable. Sometimes traffic exceeds the forecast, but usually it takes time to build, as in the case of THSRC. But this means revenue will grow slowly resulting in losses during the first years of operation which add to the overall debt, making it even harder to pay back the lenders.
All too often politicians have a dreamy-eyed view of the private sector and its ability to fund major projects, and fail to understand the basics of private enterprise, and then complain bitterly when a privately-funded project fails. Private companies are in business to make a profit and can only survive if they do so, whereas governments have wider responsibilities including investing in projects for the national good and providing the means for private enterprise to flourish. Politicians would do well to remember this or face the consequences if they do not.
TAIWAN High Speed Rail Corporation (THSRC) is on the brink of financial collapse because its operating profits are insufficient to meet preferred share redemption obligations and Taiwan's Legislative Yuan has unanimously rejected a financial restructuring plan drawn up by the Ministry of Transport and Communications. While nationalisation of THSRC appears the most likely outcome, this is likely to be a messy affair with taxpayers having to foot a very large bill.
Nationalisation of THSRC could cost at least $NT 700bn ($US 22.1bn) which includes $NT 300bn compensation to THSRC for past damages. However, THSRC says it will push for up to $NT 400bn in damages if it is nationalised. THSRC's calculations include $NT 10.4bn from providing discounts on fares, $NT 152bn from actions beyond its control such as an earthquake in 1999, and $NT 235bn in losses incurred due to economic fluctuations.
The irony of the situation is that the Taiwanese government originally planned to use public funds to build the 345km high-speed line linking Taipei with Kaohsiung, but like many governments it was faced with growing demands on its limited resources and so decided to use a build, operate, transfer (BOT) model to construct the railway.
This was a bold decision considering the price tag of $US 18bn for the scheme, which made it the world's largest privately-funded BOT project. Nevertheless the government pressed ahead and THSRC was granted a 35-year operating concession and a 50-year concession to develop the area around the new stations.
The 1999 earthquake caused a setback for the project as civil works contracts were cancelled due to concerns over whether the designs and construction methods were sufficiently robust to withstand seismic events. Revised contracts were awarded the following year and the line opened in January 2007.
But the delay cost THSRC dearly and forced it to raise another $NT 65.5bn on top of its original syndicated loan of $NT 323.3bn, some of which had been borrowed at interest rates of 8%.
The high-speed line got off to a dismal start, carrying an average of only 43,000 passengers a day during its first year of operation compared with a forecast of 180,000. But since then traffic has climbed each year rising from 32.4 million journeys in 2009 to 47.5 million in 2013. Operationally, THSRC has been a great success, with punctuality continually exceeding 99%.
In 2010-11 THSRC successfully carried out a restructuring of its long-term debt and loans, and in 2011 declared its first profit recording a net income of $NT 5.78bn. THSRC's financial performance has continued to improve and it has remained in profit ever since. Revenue grew by 6.24% in 2013 to $NT 36.1bn resulting in an Ebitda of $NT 26.5bn and a pre-tax profit of $NT 2.7bn. While THSRC's 2014 results have not been announced yet, it was expecting to do even better last year.
THSRC's financial crisis was brought to a head through 39 lawsuits filed by its original shareholders over the redemption of preference shares. Taiwan's Supreme Court is expected to pass judgement on this in March. If the shareholders win, THSRC will be given 80 days to come up with a plan to resolve the crisis. As this seems unlikely, THSRC will be declared bankrupt in May and the government will have to nationalise it by January 2016, with a new organisation in place to run the company by March 2016.
One solution could be for THSRC to become a fully state-owned company, with its debts written off. Another option would be to retain the infrastructure in state ownership and to privatise the operation of the railway through either outright sale or a concession. The government could also sell off land around the stations to help recover its investment.
THSRC is not the first BOT project to go bust and it certainly won't be the last. The problem with trying to fund major railway projects privately is that the capital outlay is very high, implementation usually takes four to five years if everything goes according to plan, and the railway is unlikely to make its first profit until it has been operating for several years. This means the risk is very high as the project is highly vulnerable to construction delays, interest rate and economic fluctuations, and changes in government policy, all of which can wreak havoc with the financial plan.
Traffic, and therefore revenue forecasting, over such a long period is also very difficult to get right, especially as there is a tendency to inflate traffic forecasts at the outset to a point where the project becomes financially and economically viable. Sometimes traffic exceeds the forecast, but usually it takes time to build, as in the case of THSRC. But this means revenue will grow slowly resulting in losses during the first years of operation which add to the overall debt, making it even harder to pay back the lenders.
All too often politicians have a dreamy-eyed view of the private sector and its ability to fund major projects, and fail to understand the basics of private enterprise, and then complain bitterly when a privately-funded project fails. Private companies are in business to make a profit and can only survive if they do so, whereas governments have wider responsibilities including investing in projects for the national good and providing the means for private enterprise to flourish. Politicians would do well to remember this or face the consequences if they do not.
