City relieved as regulator offers £855m to Railtrack

Biggest rail firms likely to benefit most from moves to cut down the number of operators

The City yesterday concluded that Railtrack had got off lightly. Tom Winsor, the regulator who has developed a reputation for playing hardball, gave the company a surprisingly easy ride, analysts said.

The City yesterday concluded that Railtrack had got off lightly. Tom Winsor, the regulator who has developed a reputation for playing hardball, gave the company a surprisingly easy ride, analysts said.

Mr Winsor yesterday published his five-yearly review of Railtrack's finances, to cover the 2001-2006 period. In the wake of the Hatfield train crash, he set out the fees Railtrack is allowed to charge train operating companies, the level of government grant it will receive, the efficiency gains required and the amount of profit it is permitted to make.

On all these counts investors felt relieved, and this showed in the Railtrack share price, which closed up 6 per cent at 1,108.5p. Railtrack's revenue for the next five year term will jump to £14.9bn, from £10bn for the first five years following privatisation in 1996. The review was significantly more generous than the regulator's draft conclusions, published in July, which provided for future revenue of £14.3bn.

Wyn Ellis, an analyst at Commerzbank, said: "Railtrack has received a massive bail-out. It is in such a mess that there is no alternative to simply taking the pressure off. They are the only ones who can deliver the Government's objectives."

For instance, the regulator determined the company's regulated asset base at £5.5bn for the start of the new five-year period. With the rate of return permitted set at 8 per cent, this points to a pre-tax profit figure of £441m, for the year ended 31 March 2002, the first financial year of the new review term.

That compares favourably with City expectation of profits of £340m, for this year, the last of the current review period.

A more profitable future Railtrack, with more money to spend, emerged from the review. So why did the normally tough Tom Winsor come over all soft?

Tellingly, the extra money for Railtrack is all being provided by a £855m increase, compared to July's draft, in the government grant available for the company. This will now reach £4.7bn over five years.

Things have changed since Railtrack was privatised by the Conservatives in 1996. The Labour government, in particular the Deputy Prime Minister John Prescott, has invested huge political capital in promises to improve public transport. The Government has decided, and apparently taken the regulator with it, that carrots, rather than sticks, are needed to bring about a better and safer rail service.

Steven Marshall, Railtrack's finance director, said: "Tom Winsor wants to see investment in the railways and he acknowledges the need for us to raise the finance to do so."

Railtrack yesterday still said that the efficiency gains required by the regulator, of 3.1 per cent a year to 2006, were too harsh. Most independent commentators felt however that, privately, the company was delighted by Mr Winsor's settlement. Even a profits warning yesterday from Railtrack could not dampen investor enthusiasm for the company.

Although the new £15bn expenditure budget was welcomed in the City, analysts did question the ability of the Railtrack management competently to handle this amount of cash. They said that, given its poor record on major projects, especially the delayed and hugely over-budget West Coast Mainline, its ability to cope was in doubt.

The tragedy at Hatfield last week raised obvious concerns over the level of expenditure on safety work. The regulator yesterday duly earmarked £8bn of the revenues for the next five- year review period for maintenance, renewal and replacement of track and signalling.

But the other strong point to emerge in recent days has been the idea that there are simply too many companies involved in the rail industry. This complexity, the argument goes, leads to the sort of breakdown in the chain of command that can cause accidents.

Gerald Corbett, Railtrack's chief executive, raised the issue two days after the accident. More significantly, Mr Prescott, over the weekend, also brought up the problems of fragmentation. Until last week, for example, Railtrack had never held a meeting with the train operators and the track renewal and maintenance contractors, all sitting around the same table.

The views of Mr Corbett and Mr Prescott on fragmentation dovetail nicely with the stated intention of the Shadow Strategic Rail Authority to reduce the number of train operating companies, in the round of franchise renegotiation now under way. It is thought that while the SSRA will cut the number of franchises slightly, from, say, the current 25, to 21, the number of train operating companies could be halved from the current 10.

Licence terms are also expected to be extended, from the seven years typically awarded after privatisation, to 20-year periods this time.

Beyond safety, there is an economic argument for the change. At privatisation, in the mid-90s, the then Tory government argued that the more companies there were in the industry, the greater the competition, and this would drive down prices.

Since then, the industry and the Labour Party has concluded that fragmentation, competition and short licence terms, took away the incentive to invest.

Fewer, larger operators, working with long franchises, would invest more in rolling stock, it is now thought. And newer rolling stock would be more reliable, more comfortable and, above all, safer.

While consolidation, such as the National Express deal to buy Prism Rail, would cut down the number of train operating companies, the figure will automatically be reduced by the SSRA favouring just a few companies in the award of franchises.

It is thought the bigger groups, who can show the greatest investment firepower, will win out. National Express, which already speaks for nine licences, would be an obvious beneficiary of the new approach. Other strong candidates are FirstGroup, which holds three franchises, and the Stagecoach/Virgin partnership, which together have four licences. Foreign companies - especially the French which are already very active here, but also the Swiss, the Swedes and the Dutch - are also seen as contenders likely to remain in the new, slimmed down, rail industry.