COMMENT: A clever game of give and take on the railways
Tuesday 16 May 1995
Will the vote-winning games make the railways harder to sell? In theory, all that ought to happen is that bids for passenger franchises will include a higher level of subsidy, to make up for the likely lower revenues.
In practice, the outcome is harder to call. It will depend very much on which franchise is in question. For a commuter service in the South- east, where volumes are not very flexible and prices will be capped, a franchise operator will have to rely exclusively on cutting costs to make money and is likely to worry about the financial risks involved in losing the freedom to raise fares. This will be a serious disincentive.
But other services, such as the Gatwick Express and some of the overpriced InterCity routes that compete with airlines or motorways, might just benefit in total revenue terms from lower prices if they stimulate extra volume. When the Channel Tunnel Rail Link opens high-speed Continental services to provincial cities early in the next century, there could be enormous volume increases from discount pricing. So it is not a foregone conclusion that franchise revenues overall will fall.
As for the Railtrack privatisation, there will be only limited scope for higher income even if the price caps do stimulate extra traffic. The real downside is, however, that if the price caps slow the franchising process, confidence in any of the railway sell-offs will be hit. The likely price for Railtrack is falling every time the rail regulators open their mouths. Soon, it may hardly be worth selling.
The whole rail exercise is really a clever new version of the baby's game of give and take. The trick was last used as recently as a week ago when the Government said it would drop the levy on electricity consumers early, to cut electricity prices 8 per cent in the nuclear privatisation. Where the choice is between using the proceeds of privatisation to cut taxes or buy consumers' favour, the Government seems to be shifting towards the latter.
Yet another cable float
There are many initiatives that can aptly be described as a triumph of hope over experience but few more so than the spectacle of yet another public share offer in a UK cable company. So far there have been six of them; with most trading below their offer price, this new sector hardly qualifies as a rip-roaring investment success. Most investors have had as much UK cable as they would like. Yet they keep coming. Yesterday it was the turn of Nynex to announce details of its forthcoming flotation. The pathfinder prospectus makes a valiant attempt to differentiate the company from previous floats. Nynex is large, blue-chip and, unlike some of the others, it has operational and managerial control of all its franchise interests, enabling it to pool adjacent franchises into a single operating area.
In the end, however, Nynex is just another cable company. The only thing that really seems to change is that the prospectuses get longer and the list of "risk factors" detailed longer still - a record 12 pages in Nynex's case. With so many uncertainties facing this industry, both regulatory and competitive, valuation is still as inexact a science as it always was. The cable companies can no longer expect the free ride they were once hoping for; BT is breathing down their necks with every expectation of being freed from present constraints ahead of the official 2001 target date. The electricity companies too pose an increasingly real threat; some have started installing fibre-optic links into all visited houses, using the excuse that it is needed for remote reading of meters. Even on the discounted cash-flow basis used to value cable stocks, the margin of error could be as high as 50 per cent either way; add in the changing competitive and regulatory environment and the situation could become a good deal worse.
To be fair on Nynex, even at the top end of its 131p to 151p target range for flotation, the shares would still trade at a small discount to Telewest, which is the most comparable UK cable company. The rating, then, is not demanding set against the others. You have to wonder, however, why Nynex's US parent is prepared to accept such a substantial downgrade on the value it was claiming for its UK offshoot little more than a year ago. Clearly the seller's need is greater than that of the investors it hopes will buy.
A U-turn from Labour
The shadow cabinet is getting rather good at U-turns. The windfall profits tax on utilities, an idea pinched from the Conservatives' one-off 1981 bank tax and as bad now as then, is fading into the background in favour of profit-sharing.
This is a new buzzword, which will be explained in some detail today at a conference in London by Jack Cunningham, the shadow trade secretary. The conference is organised by Unison and the Labour-leaning Institute for Public Policy Research, which last week published an earnest volume of papers suggesting a variety utility regulation reforms.
The basis of present utility regulation is a cap on prices linked to a retail price index formula. Most experts agree that this is better than controls on return on capital or setting ceilings on profits, neither of which contains much incentive to efficiency. A windfall tax is just as bad, since if excess profits are likely to be expropriated, a company might as well keep costs high to avoid interference.
Dr Cunningham plans to acknowledge the importance of incentives to managers to raise efficiency. The new proposals will therefore be a hybrid, mixing a price cap with what amounts to a progressive clawback of profits from shareholders. The greater the efficiency gains a management makes, the larger proportion that has to be redistributed to customers in lower prices.
Set out simply and clearly so shareholders know the odds, the Cunningham formula could work, though it will alter utility valuations. The risk is that Labour will muddle it with politics by using a new system to interfere with boardroom pay through the regulator. Utility pay should be dealt with by giving shareholders an obligation to vote on remuneration packages, not by giving the regulators the impossible job of setting a fair level.
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