Corporate Profile: Railtrack faces a turning point

After three years, Railtrack has reached a critical junction: either it behaves like a cost-cutting utility and has its profits capped or it invests heavily in the rail network with all the risks that would entail. For the company's shareholders, taking the wrong turning would prove disastrous

LOOKING OUT from the boardroom on the 13th floor of Railtrack's headquarters, Gerald Corbett believes he can see the future. Under the chief executive's gaze stretches the main line out of Euston to Glasgow - the worst line in the country.

By 2005 it should be the finest in Europe under an innovative revenue-sharing deal with Virgin Trains, that will provide track to carry Richard Branson's hi-tech tilting trains at 140mph.

Mr Corbett believes that the deal points the way forward for a company that is facing a major junction less than three years after privatisation. The wrong decision will have a huge impact on Railtrack profits and shares.

It has been given a stark choice - behave like a cost-cutting utility and have its profits capped or start taking risky decisions to invest actively in the network. It has to learn to live with a new regulatory system and three new regulators, and will find itself without the advice of its experienced chairman, Sir Bob Horton, from August.

Railtrack had an idyllic childhood but faces a painful adolescence. Privatised on 20 May 1996 at a share price of 380p, shares had soared in value to pounds 17.68 within just two years as investors realised its cashflow potential.

Railtrack has a guaranteed income, earning 91 per cent of revenue from track access charges paid by passengers and freight operators. This has allowed it to achieve efficiency savings against the background of stable revenue, and profits have risen accordingly, from pounds 190m in 1996 to pounds 388m for the 12 months to March 1998.

Railtrack has been told it cannot continue to make these sorts of returns without changing its entire corporate strategy. Behind the threat stands the industry's new "Fat Controller", Sir Alastair Morton, who last Thursday took over as chairman-designate of the new Strategic Rail Authority (SRA).

His reputation precedes him from his days at Eurotunnel, where his no- nonsense approach with the construction companies and banks was credited with achieving the completion of the pounds 10bn Channel Tunnel.

Alongside him is the rail regulator, Tom Winsor, who sets the level of track access charges that train operators pay to Railtrack and monitors its investment. His views are also well-known (see panel).

When Mr Winsor starts work on 5 July he will inherit the proposal of his predecessor, Chris Bolt, to gave Railtrack that stark choice. If it behaved like a dull utility, it would be allowed to make a return of between 5-6 per cent on its assets rather than its current 10 per cent. If it entered into innovative revenue-sharing deals with train operators and took a greater risk, then it could earn more money.

Mr Corbett said that Railtrack had responded to the challenge laid down by the regulator but defends its investment record. "When the rail industry was privatised, the assumption was there would be little or no growth. The biggest problem that was then envisaged was how we would go about taking capacity out of the system."

He said that there had been 25 per cent growth in passenger numbers since privatisation, with increases of 7 per cent and 8 per cent in the past two years alone.

Railtrack outlined pounds 27bn of investment in its annual Network Management Statement (NMS) - an increase of pounds 10bn from 1998 - of which pounds 3.56bn involved partnership schemes. "What Railtrack is now faced with is the change of going from being a dull utility with a cost-cutting mentality to a growth company in an expanding market. It's what the engineers who run this place have been waiting 80 years for, and they can't get cracking soon enough," Mr Corbett said.

Mr Corbett said Railtrack's investment plan could not be funded if Mr Winsor cut Railtrack's rate of return to 5 per cent. Railtrack wants to move from the current system of guaranteed track access charges to a new model, where as much as 30 per cent of its income is dependent on revenue-sharing, risk-bearing joint ventures with train operators. Railtrack sees its deal with Virgin for the second phase of the West Coast main line upgrade as a model, and believes that the pounds 3.6bn of partnership schemes outlined in the NMS shows it is prepared to take risks. These include a pounds 450m new rail link to Heathrow, a pounds 400m third freight route to Scotland and a pounds 95m upgrade of Brunel's Great Western Railway. These schemes should attract a return of up to 13 per cent, it believes.

Giles Fearnley, acting chairman of the Association of Train Operating Companies, said that the jury was out on whether Railtrack was investing where it was needed. Passengers blame the operators for poor performance, even if Railtrack can be responsible for up to 70 per cent of delays.

"In the early days of privatisation there was significant frustration that Railtrack was not providing sufficient investment to meet what we were saying was an increasing demand and the widening opportunity for rail travel," Mr Fearnley said.

"We warmly welcome the approach they have taken in the NMS. We need to see them deliver that - and quickly." One train operator looking for a change of direction is Chiltern Railways, which became the first to invest in infrastructure after losing patience with Railtrack. It invested pounds 600,000 in a new platform at a station, to remove a bottleneck that was harming punctuality.

The managing director, Adrian Shooter, said that he applauded Railtrack's NMS for spelling out plans for growth, but added: "It has taken them three years to realise that maybe they have to invest in something that is expanding and that privatisation was not all about falling demand."

Mr Fearnley said that if Mr Winsor decided to cut Railtrack's rate of return then the money ought to be ploughed back into the industry rather than to the Treasury.

But analysts think this is unlikely. Railtrack's share price jumped 2 per cent after the decision not to appoint Mr Bolt as regulator. Richard Hannah, a transport analyst, said: "The big picture for the rail industry now is to catch up on the investment backlog and not to worry about the details of rates of return available to investors, which is what previous regulators seemed to do."

The next step is for Mr Winsor to approve the levels of investment. John Prescott, the Deputy Prime Minister, has warned Railtrack that its plans will be scrutinised by the SRA. "Not all [of the money] is committed, and it is not all Railtrack's money. It includes proposals for government and other third-party-funded schemes," he noted.

"We now need to determine whether the proposed investment is sufficient to meet the needs of Railtrack's customers, the train operators and the travelling public."

Mr Corbett also wants a new "economic architecture" so it can share the benefits of passenger growth. "Last year, the train operators' revenues went up 15 per cent, but ours only increased by 1 per cent. At the moment they gain all the benefits of growth," he said.

Mr Corbett said that the Government had to face the fact that there would only ever be four or five profitable railway companies in the UK. The rest would be social railways that would always be in need of subsidy, leaving the issue as how best to allocate that subsidy.

In the atmosphere of threat and counter-threat that pervades this most political of industries, the Government has said that it is considering paying the pounds 1.5bn annual subsidy direct to Railtrack rather than to the train operating companies, to exert more control.

But Mr Corbett does not want the money channelled in this way. "That would send all the wrong signals to the City. It would smack of the bad old days of nationalisation and state planning." Nor does the Government hold all the cards: Mr Prescott is still grateful to Railtrack for rescuing the Channel Tunnel Rail Link (CTRL) from collapse.

Railtrack gave undertakings to the first rail regulator, John Swift,that there would be no tie-up between the new charging formula and the construction of the link. But Mr Corbett says that CTRL is its "trump card". It does not have to commit itself to building the second stage of the line - into St Pancras - until after the new access-charging formula has been fixed. If the formula is too tough then there will be no second stage.

Railtrack is also the only serious contender to come forward for the private-public partnership of London Underground under which the track will be leased in three parts, with the operation of the services staying in public ownership.

Railtrack has made great play of its plans to bid for the sub-surface Tube lines and link them to existing track to allow an east-west rail line through London.

As part of the move away from the privatised utility model towards an innovative FTSE-100 company, Railtrack is expanding from its core base. Mr Corbett said opportunities could include European acquisitions: "There is no reason why, in the next five to 10 years, we could not expand into Europe. The railways elsewhere in the EC are under the same obligation to split rail networks from passenger train operations. Running or managing a continental railway business would not really amount to diversification for us."

But he needs a chairman to succeed Sir Bob. Bryan Sanderson, the chief executive of BP Amoco's chemicals business, is reported to have spurned the opportunity, as has Sir John Egan, chairman of BAA.

Observers believe that Railtrack's shareholders need a strong-willed replacement to keep a controlling hand on Mr Corbett. The chief executive sees things differently, saying that Sir Bob was the ideal person to take Railtrack into the public sector in the face of stiff political opposition. What is needed now is a more conventional arrangement - a non-executive chairman to manage the board.

Points And Signals

Based: Euston Station, London

Chief executive: Gerald Corbett

Chairman: Sir Robert Horton (retires in August)

Formed: 20 May, 1996

Market capitalisation:

pounds 6.9bn

Pre-tax profit 1997/98: pounds 388m (pounds 346m)

Turnover 1997/98: pounds 2.467bn (pounds 2.437bn)

(of which) Franchise payments: pounds 2.131bn (pounds 2.119bn)

Track: 20,000 miles, of which 10,000 are in commercial use

Stations: 2,500, including 14 major stations that are managed directly by Railtrack

Depots: 90 light maintenance

Bridges and tunnels: 40,000

Level crossings: 9,000

Signal boxes: 1,100

Regulator Sharpens His Teeth

IF GERALD CORBETT (right), the chief executive of Railtrack, was not an avid reader of Modern Railways, the trainspotters' journal, he will be now. In fact, he has probably already ordered a few years' back copies.

The reason? Tom Winsor, the man who could prove to be his nemesis, has entertained the industry every month with a 1,000-word article detailing the powers open to regulators to bring the failing rail industry into line.

Mr Winsor has given up a pounds 400,000-a-year job as head of the railways department at the City law firm Denton Hall, for pounds 160,000 a year as Rail Regulator. This alone speaks volumes about the zeal the Scottish-born lawyer has for the role.

On top of that, as chief legal adviser to the Office of the Rail Regulator between 1993 and 1995, he in effect drafted the rules of the game and knows where the bodies are buried.

Railtrack can be in no doubt about Mr Winsor's views. In what constitutes the longest job application in history, Mr Winsor has made plain that not only does he believe that the regulator needs tougher powers, but also that he has powerful tools at his disposal within the existing legislation.

As John Prescott, the Deputy Prime Minister, said when he appointed Mr Winsor: "The Rail Regulator, particularly with his role in determining the level and structure of Railtrack's access charges and reviewing the company's investment programme, will play a key part in realising this vision."

Mr Winsor comes to the job with a high-minded respect for the role of the regulator. Again, writing in Modern Railways: "Monopolies will tend to wish to abuse their powers, and, if unchecked, that abuse will harm the public interest. The regulators were given powers to control abuses of monopoly."

He gave as his reference point the historic decision by the US government to force the break-up of Standard Oil, John D Rockefeller's petroleum monopoly. The significance of this will not have been lost on Railtrack.