Investment: Track record costly to public

By BRIAN GAYNOR

Tranz Rail's colourful history took another turn last week when the company announced it was closing its passenger operations.

The decision is particularly important for the Auckland area because the local authorities are trying to buy the region's rail corridors for $65 million. These will form the basis of a new multimillion-dollar transport system.

Fay, Richwhite, one of Tranz Rail's controlling shareholders, has never been on the wrong end of a transaction with the public sector and the sale of the corridors to the local authorities is not expected to break this trend.

Tranz Rail can be traced back to the original railway network established by the Government in the late 1870s.

The network became hopelessly overstaffed and inefficient, and in 1982 the Railways Department was reorganised into a wholly owned Government organisation called New Zealand Railways Corporation.

In 1990, the company was restructured again and incorporated as a limited liability company called New Zealand Rail.

As part of this process the Government wrote off $1.2 billion of debt and contributed $360 million of new equity.

Fay, Richwhite was the main financial adviser to NZ Rail between 1990 and 1993.

In September 1993, NZ Rail was privatised and sold to Tranz Rail for $328.3 million. Tranz Rail had six main shareholders:

*Fay, Richwhite, a New Zealand-listed company, 31.8 per cent.

*Wisconsin Central, a United States rail company, 27.3 per cent.

*Berkshire Fund, a US investment group, 27.3 per cent.

*Alex van Heeren, 9.1 per cent.

*Richwhite family interests, 4.5 per cent.

In an extremely clever move, Tranz Rail borrowed $220.9 million to buy NZ Rail, and Tranz Rail's shareholders contributed just $107.4 million of equity to the purchase price.

NZ Rail's strong balance sheet allowed the private-sector shareholders to effectively extract $220.9 million of equity that the taxpayer had contributed just three years earlier.

In 1995, Tranz Rail made a capital repayment of $100 million. As $90.6 million of this went to Tranz Rail's original shareholders it effectively reduced their investment in the group from $107.4 to $16.8 million.

This $16.8 million represents a net cost of only 16c a share for the original Tranz Rail shareholders.

In mid-1996, Tranz Rail issued 31 million new shares - representing 25 per cent of the group - to the public at $6.19 each.

A substantial proportion of new equity was used to repay the borrowings associated with the $100 million capital repayment in 1995.

The shares were listed on the Stock Exchange on June 14, 1996 and were keenly sought by investors. By the end of the year Tranz Rail's share price had reached $8.60 and it peaked at $9 in mid-1997.

A number of the original shareholders took advantage of the high share price to sell all or most of their holdings. Berkshire Fund sold 16.3 million shares in November 1996 and March 1997 at an average price of more than $8 each.

In 1998, Alex van Heeren, the owner of Huka Lodge, sold 7.4 million shares at an average price of $5.99. This compared with his original cost of 16c a share.

Mr van Heeren's profit, which exceeded $42 million, was particularly attractive because New Zealand has no capital gains tax.

In recent years Tranz Rail's operating performance has been fairly dismal. Since 1995-96 there has been a huge increase in capital expenditure and long-term debt.

Over the same period revenue has been relatively static and operating profit has fallen from $111 to $71 million.

The group's share price has responded to the poor performance and it reached an all-time low of $2.60 in 1998. At yesterday's closing price of $3.60, it is still well below the public issue price of $6.19 a share.

The recent history of Tranz Rail contradicts the theory that success is rewarded and failure is punished in the business world.

Francis Small, the group's managing director until May, has received large pay increases in each of the past three years and he was paid $1.8 million, including a retirement allowance, in the year to last June. Dr Small remains a director even though the group has performed poorly in recent years under his stewardship.

The huge returns received by Tranz Rail's original investors has had nothing to do with good governance as the group's operating profit is now lower than its last two years under Government ownership.

Those profits are mainly due to Fay, Richwhite's intimate knowledge of the group's financial structure and the new shareholders' ability to take advantage of the Government's $1.2 billion debt writeoff and $360 million equity injection in 1990.

But the poor operating performance of the group has finally stirred the directors into action. Michael Beard has replaced Dr Small as managing director and he told last week's annual meeting that Tranz Rail would be substantially restructured.

The group will concentrate on freight. Its other businesses, including passenger services, will be sold, leased or closed. Staff numbers will be reduced from 4000 to just 600 as part of the process.

A number of lines, including the Napier to Gisborne route, may be permanently shut.

This will put enormous pressure on roads, particularly in regions where there is expected to be a huge increase in logging activity over the next few decades.

Tranz Rail's main shareholders, who were responsible for stripping out $220.9 million of equity in 1993 and $100 million in 1995, are now suggesting that the Government may wish to subsidise uneconomic lines if it wants them kept open.

The obvious conclusion from last week's announcement is that Wisconsin Central, Fay, Richwhite, Berkshire and Richwhite family interests who still own 45 per cent of Tranz Rail believe that they can maximise shareholder value by downsizing the group to its profitable freight operations.

Last year, the Fay and Richwhite interests sold 6.2 million Tranz Rail shares at an average price of $3.62 each and their original $34 million investment is now worth nearly $130 million, most of it unrealised.

The big shareholders have probably decided that they have too many shares to sell on the market and the best way to realise value is through further capital repayments.

In this regard the country's taxpayers and Auckland's ratepayers are about to assist them.

Tranz Rail is in the process of selling part of its long-term lease over the railway lines in the greater Auckland region for $65 million plus an annual fee of $2.25 million. This will probably be funded by a combination of taxpayer and ratepayer money.

The money will be a bonanza for Tranz Rail shareholders and will probably be returned to them in the form of a capital repayment.

It is difficult to understand why the Auckland region is prepared to pay $65 million to part-lease the railway corridors when the whole of NZ Rail was effectively bought for $107.4 million in 1993 - or $16.8 million after the 1995 capital repayment.

Who will run the Auckland system if Tranz Rail closes its passenger services?

If Tranz Rail sells the passenger activities, will the new owner have any interest in running a commuter train service in Auckland?

The proposed $65 million purchase indicates that Auckland region councillors have no better grasp of economic reality than the Wellington politicians seven years ago.

*Disclosure of interest: none.