KEY POINTS:
The nationalisation of the country's rail system, which is yet another Government pre-election flip-flop, is a sad indictment of our political decision-making process.
Not only are we throwing nearly $4 billion at a failed company but we have also transferred huge wealth to overseas investors while showing little
concern for domestic investors and companies.
The story begins on October 28, 1990, when the core rail business of the old New Zealand Railways Corporation was transferred into the new limited liability company, New Zealand Rail Limited. As part of this process the Crown wrote off $1087 million of debt and injected $360 million of equity.
The new company was created with no debt because its directors and investment bank Fay, Richwhite, the company's main financial advisers, believed NZ Rail had a better future with minimal gearing.
A scoping report by the Treasury, dated September 25, 1992, concluded that "there were no apparent public policy reasons for continued Government ownership of NZ Rail".
It believed that between $217 million and $315 million could be realised from a negotiated trade sale compared with $165 million to $175 million from a sharemarket float.
Bankers Trust, adviser to the Treasury, was concerned a suitable buyer wouldn't be found. But Sir Michael Fay and David Richwhite spotted a chance to repeat their windfall Telecom profit and convinced the highly regarded Wisconsin Central to join their consortium.
The Treasury was apprehensive that Fay, Richwhite would have an unfair advantage because it had been NZ Rail's financial adviser, but the consortium's $328 million offer was accepted in 1993.
Tranz Rail, the purchasing vehicle, borrowed $223 million to fund the acquisition with the consortium contributing only $105 million of equity. This was a classic private-equity structure with the rail company borrowing to fund the consortium's purchase cost instead of using the new debt to invest in rolling stock and track.
In June 1995, Tranz Rail made a capital repayment of $100 million that reduced the equity contribution of the original investors to just $16 million after taking additional shares issued to management into account.
In mid-1996 Tranz Rail issued 31 million shares - 25 per cent of the company - to the public at $6.19 a share compared with the consortium's average cost of less than 20c a share.
The share price rose to $9 by mid-1997 and many consortium members took advantage of heady share prices to sell out at a handsome profit.
The four main original investors - Fay, Richwhite, Wisconsin Central, Berkshire Fund and Alex van Heeren - realised profits of $370 million, mainly tax free, from the sale of their Tranz Rail shares.
Some of these share sales were the subject of an insider trading inquiry by the Securities Commission and settlement was reached with a number of parties. These included parties associated with David Richwhite and Sir Michael Fay, which paid $20 million, while Berkshire Fund and one of its executives paid $7.4 million.
In 2003 Melbourne-based Toll Group made an offer for Tranz Rail at $0.75 a share, later raised to $1.10 a share that valued the company at $231 million.
Toll acquired nearly 84 per cent of Tranz Rail under this offer.
Shareholders who bought shares in the IPO at $6.19, took up their entitlement to the 2002 five-for-seven rights issue at 75c a share and accepted the directors' recommendation to sell at $1.10 a share received only $28 for every $100 invested.
Immediately after the bid the track infrastructure was sold back to the Crown for $1 with several other assets for $33.5 million. This followed the sale of the Auckland track to the Government for $81 million in December 2001.
Since acquiring the track the Government has committed more than $1.5 billion to improving the network, more than $1 billion of it in the Auckland region. In the past two years Ontrack, a division of the New Zealand Railways Corporation that owns and manages the rail network on behalf of the Crown, received $167 million in Government grants and now values the track at an unbelievable $10,648 million.
Ontrack's latest annual report reveals that Labour Party president Mike Williams and former Labour MP Clive Matthewson are directors.
Finally last year Toll made a successful offer for the Tranz Rail shares and Grant Samuel valued the company between $2.89 and $3.32 a share. The main beneficiary of this $3-a-share offer was the United States investor Third Avenue Management, which had bought 10.1 per cent in 2003 to stymie Toll's ability to move to compulsory acquisition under the $1.10 a share offer.
Although Toll had finally achieved its 100 per cent shareholding objective there were major disagreements with the Crown over track access charges.
Originally Toll was meant to pay Ontrack's cash operating costs for the first five years and Ontrack's cash operating cost plus capital costs after that. But Toll dug its toes in and refused to sign a long-term deal on the basis that the proposed agreement would lead to substantial losses or would encourage its customers to transfer to road.
Finance Minister Michael Cullen dropped a bombshell on Monday when he revealed the Government would buy Toll's rail and ferry business for $665 million. There are several reasons why the renationalisation was greeted with dismay by the business and investment community:
The purchase price of $665 million is extremely generous, particularly as Toll is keeping the highly successful freight forwarding and road transport operation, with nearly 200 trucks.
The Crown will give Toll a six-year, rent-free period on the property used by these operations. This could be an effective subsidy by New Zealand taxpayers to the Australian company of more than $70 million over the six-year period.
In addition, Toll's rail operations have charged below-market rates to its freight-forwarding business and this is expected to continue under the new regime. This makes it extremely attractive for Toll to buy new businesses as any new companies it acquires should also be able to obtain below-market rail freight rates.
Why do our politicians continue to offer fantastic deals to overseas investors while treating domestic companies and investors with near contempt?
Most of the privatised companies have delivered great returns for overseas investors while domestic investors have experienced more losses than gains.
Auckland International Airport shareholders were deprived of an attractive offer from the Canada Pension Plan Investment Board while Toll's ASX share price rose strongly this week as Mainfreight's share price fell.
There is a reasonable amount of public support for the renationalisation of rail, mainly based on the premise that a strong railway will take freight off the roads.
But the most important question is, does rail have a viable future in NZ?
Since 1990 the taxpayer has spent or committed nearly $4 billion on rail if the debt write-offs, equity injections, asset buy-backs, subsidies, grants and planned track expenditure are added.
This is before any future expenditure on rolling stock or any past spending by the company is taken into account.
Cullen's only strategy seems to be to throw more money at the mess, yet how can we spend $4 billion on rail when Air New Zealand generates 5 times more revenue, is far better managed and has a sharemarket value of only $1.2 billion?
Surely it would have been far more rational to have spent the $4 billion-plus on improving our road network.
* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.
gaynor@milfordasset.com
