Minister supported MTRC fare autonomy
31 August 2007
New Secretary for Financial Services and the Treasury Professor Ceajar Chan Ka-keung (Professor Chan), appointed on 1-Jul-07, has inherited a seat on the board of Government-controlled MTR Corporation Ltd (MTRC, 0066).
As readers will know, MTRC will soon post a circular to independent shareholders seeking their approval for a transaction which the Government is calling a "rail merger", but is in fact a combination of leasing and acquisition of property assets from the Government-owned Kowloon-Canton Railway Corporation (KCRC). We recommend shareholders vote against that transaction and will write more about it when the circular comes out.
Bundled into the transaction, and in return for no payment, the Government wants MTRC to surrender its commercial autonomy to set its own fares according to free market forces, and agree to an inflation-linked "direct drive" mechanism for overall fare levels, based on the average of wage inflation and consumer price inflation, minus a productivity factor.
However, Professor Chan's views are opposed to this. Here is what he had to say about fare autonomy:
"I believe that as a business, MTRCL should be allowed to set fares, as any business should be able to set prices of its products. Without the autonomy in setting fares, it will be difficult for the company to develop its business strategy and to make investment decisions...
it is not a good idea to take away the fare setting power of the company. To do so will inject uncertainty to business planning, making it difficult for the management to create economic values...
Without the fare setting ability, the new company will not be attractive to the market...
I do not favour adopting a formula that explicitly specifies the allowable level of future fare increases, such as specifying that future fare increases be lower than general inflation... Any explicit rule specified cannot anticipate the changes in the economics of providing railway services. Its adoption is unnecessarily restrictive to the company and adding uncertainty to the company's prospects."
We agree. He expressed that opinion as Professor of Finance at Hong Kong University of Science and Technology in 2000, in his submission to the Legislative Council prior to the flotation of MTRC. At the time, he was an independent academic. There has been no revolution in financial or economic theory that would change those views. Indeed, they accorded with the submissions of other experts and with what the Government itself said at the time:
"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 and frustrate the plan for privatization." - HKSAR Transport Bureau, 24-Sep-99
Professor Chan is now, of course, under the antiquated duty of ministerial "collective responsibility" to support the new and reversed Government policy of withdrawing commercial autonomy from the railways. We sympathise with his situation. One the one hand, as a learned academic with a PhD from Chicago, he knows that what he said in 2000 is right. On the other hand, he is now told that he is wrong by a bunch of over-promoted civil servants who, for political reasons, wish to thrust socialist central planning down the throats of shareholders who were promised a commercial company when they bought it.
If the transaction is approved by shareholders, then the combined regulated revenues of the MTR (excluding Airport Express, which will not be capped) and KCR systems, based on 2006 figures, would be about $10.6bn (including $4.7bn from KCRC), before the fare cuts which are being imposed as part of the deal. Yes, that inflation-mechanism will start from a lower base of about $10bn, with fare reductions of $600m more than off-setting the eventual $450m per year of synergies, which in any case, according to MTRC, will take 3 years to achieve. As we previously explained, future fare adjustments will exclude the eventual inflation figure for 2007, since the mechanism doesn't start until after 30-Jun-09.
So each 1% of lost revenue from adjustments prohibited by the new fare cap would be about $100m per year at current prices. Since that would flow straight to the bottom line after taxes of 17.5% (a rate which is likely to be cut next year), that 1% is worth $82.5m in after-tax profit per year. Capitalise that at a 6% discount rate (a P/E of 16.7) and that 1% loses you shareholder value of HK$1.4bn. If the deal is rejected, then under continuing fare autonomy, each 1% increase in MTRC's fare revenues of $5.9bn is worth about $0.8bn in valuation.
Just giving up this year's underlying consumer price inflation, which could turn out at 5%, takes about HK$7bn off the valuation of the combined entity. The official inflation figures this year are understated because of one-off Government domestic rates rebates which have nothing to do with the cost of running a railway. As for the other half of the proposed formula, a closer guide to wage inflation would be the recent civil service pay rise of 5%.
Ironically, MTRC has, by its own claim, in the last quarter of 2006 achieved the number 1 position in an independent survey of public views of value-for-money in public transport, beating even the Star Ferry and the Tram. That's something it has only achieved twice in 27 years. So contrary to the proposed fare cuts, after 10 years without increases there is actually a lot of scope for fare increases while still remaining good value for money.
Professor Chan was right. Let the railways respond to market forces in setting their fares, and they will optimise their returns to minimise dependency on Government subsidies from property development. Furthermore, if you remove Government subsidies from road transport, then those market forces will push up the cost of road transport to more market-based levels, and allow railways to charge a higher price for their service in competition.
Those road transport subsidies include the exemption of franchised buses from diesel duty, the exemption of LPG from hydrocarbon fuel duty, the low rate of diesel duty on other vehicles, and the huge tracts of land which go into roads, including land reclaimed from the harbour. The charges for use of those roads bear no relation to the opportunity cost of providing them.
Removing or reducing subsidies from both road and rail transport would enhance the Government's revenues and allow for tax cuts in other areas.
© Webb-site.com, 2007
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