Government digs MTRC hole
17 May 2007
The Government and MTR Corporation Ltd (MTRC, 0066), which the government controls, are digging themselves deeper into a hole. Today Secretary for Subsidised Transport Sarah Liao Sau-tung announced to the Legislative Council (during market hours, before MTRC had announced it) that MTRC had agreed to extend a fare freeze by a further 15 months, if the "rail merger", which in reality is a lease of KCR assets, goes ahead.
Under the Government's proposed Fare Adjustment Mechanism (FAM), the average fare adjustment in any year, down or up, would be equal to the average of the changes in the Composite Consumer Price Index and the Nominal Wage Index (Transport Sector) published by the Government, for the previous calendar year.
Tonight's MTRC announcement that it is "prepared to consider" extending its fare freeze from 11-Apr-08 (two years after the proposed deal was announced) until 30-Jun-09 (or until negotiations on the rail merger are terminated, if earlier) means that the FAM would not include any adjustment for inflation in 2007, but only for 2008 onwards.
Year-on-year inflation is currently at 2.4% (Mar-07) and heading upwards. Wage settlements are too - MTRC and KCRC both raised wages by about 2.7% in 2006. So the FAM, if it were applied in 2008 in respect of price and wage inflation up to 31-Dec-07, would likely yield around a 3% fare increase, maybe more. By missing out on 2007's inflation, the fares in 2008 and every year after that would be lower by 3%, taking a permanent bite out of the railways' already-slim profit margin.
The FAM would apply to most of the combined operations with revenue of around $11bn this year. 3% of that is $330m, and after tax that would be about $272m per year in current dollars. At a 6% discount rate (or a P/E of 16.7), that translates to a lost value of about $4.5bn. Lower fares might be slightly compensated by higher passenger volumes, but it is unlikely to make much difference. Furthermore, the Government wants to restrict individual route fare changes to a narrower plus or minus 5% range, reducing the company's flexibility to respond to market demand by balancing increases on busier routes with cuts on lower-load routes.
At a stroke, Government has wiped about HK$4.5bn off the value of the post-deal MTRC, or about $0.81 per share, or 4.2% of its market value. The fact that the share price didn't fall today tells you something - shareholders don't expect the deal to happen. They intend to vote it down if it ever gets as far as the minority shareholder meeting. However, the Government, as majority shareholder, by putting us all through this fiasco is clearly abusing its position, true to the warning in the IPO prospectus:
"The Government can exert significant influence on the Company and could cause it to make decisions, modify the scope of its activities or impose new obligations on it that may not necessarily be in the best interests of the Company or its other shareholders."
Having dug this hole, the Government and MTRC should stop right now and bury the deal. They must either come up with a proper corporate merger on terms acceptable to minority shareholders, including the preservation of fare autonomy, or they should buy out the minority shareholders, thereby returning the whole show to Government, which can then pursue whatever socialist transport policy it wants, at taxpayer expense. Fare autonomy was once considered crucial by Government, as it said in 1999 before the IPO:
"It is important that, after privatization, MTRC should continue to retain fare autonomy which will enable it to invest in the development and maintenance of the railway system. Indeed the loss of fare autonomy may run the risk of rendering MTRC shares unmarketable..."
They were right then, and they are wrong now.
© Webb-site.com, 2007
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