Supplementary note from the Secretary
of State for Transport, Local Government and the Regions
At my appearance before the Transport Select
Committee on Wednesday, 10 April, I agreed to provide the Committee
with a written note setting out the reasons behind the offer of
a grant to Network Rail to secure the benefits of an earlier exit
of Railtrack Plc from administration than would otherwise be the
I shall write in due course on the other Railway
related matters promised during my evidence.
The grant offer
The Department informed Network Rail, during
the week before Network Rail made its bid to Railtrack Group Plc
on 24 March, that it was potentially willing to offer a £300
million grant on the basis of Network Rail's proposal.
The grant offer is conditional upon Network
Rail securing an earlier exit from administration than would otherwise
have been the case and reflects the benefits available from this
earlier exit. The payment would not be available if Network Rail
was unable to deliver an early exit.
Financial support of a type similar to that
negotiated by Network Rail could be available to other bidders.
The Government and the SRA are willing to discuss proposals advanced
by any serious bidder for Railtrack plc. The guidelines issued
by myself on 31 October 2001 (Official Report, cols 669-671W)
make clear that any proposal should address the basis, extent
and nature of support that will be required from Government. Any
support would be subject to negotiation and agreement. Contrary
to the assertions made by the Shadow Secretary of State for Transport
(Official Report, 25 March col 583), no other detailed proposals
have been received.
The £300 million grant
The grant payment reflects the available benefits
from an earlier exit from administration than would otherwise
be the case. The time difference is based on a comparison between
the administrator's process for removing Railtrack from administration
(the Schedule 7 transfer) and the process for the Network Rail
bid (a share purchase) rather than on specific dates.
A share purchase is expected to lead to an earlier
exit from administration than would be possible under a schedule
7 process of at least six to nine months.
The premium the Government is prepared to pay
is not compensation to Railtrack shareholders. It reflects
an assessment of the value to the Government, the taxpayer and
rail users in terms of the benefits and savings that would result
from an earlier exit from administration.
Consequently, the grant payment to secure an
earlier exit from administration can help to deliver offsetting
savings in Government support requirements to Railtrack's successor
over the medium and longer term compared to what would otherwise
be the case.
The £300 million amount represents a reasonable
sum based upon a range of possible scenarios. It has been tested
and agreed within Government and is consistent with advice on
potential benefits provided by external advisers.
The benefits of an earlier exit
The value of the payment reflects an estimate
of the wider benefits to passengers and the general public based
upon an earlier exit from administration. These economic benefits
are obtained through:
An earlier realisation of efficiency
Railtrack has made welcome progress during Administration
under the guidance of John Armitt though, as to be expected, focus
has been upon addressing immediate concerns. An early exit from
Administration will help to focus the new management upon the
challenging tasks ahead and to identify and implement efficiency
improvements. Specifically, it allows an earlier introduction
of a new improved incentive framework for management, where performance
is aligned with key public interests such as track availability,
punctuality and safety rather than profits. These incentives will
draw out improved efficiency as the successor delivers better
By way of illustration of the potential benefits,
the Regulator had set Railtrack a profile of efficiency improvements
in Control Period 2, beginning with net efficiency targets of
2 per cent in 2001-02 and 3 per cent in 2002-03. No progress towards
these targets had been made by Railtrack, and the situation had
probably worsened though appears to have stabilised during administration.
If an earlier exit from administration could secure an earlier
delivery of these first two targets alone it would save around
£50 million for every £1 billion of expenditure
than would otherwise be the case.
Reduced performance penalties.
Earlier improvements in the punctuality and
reliability of services not only provide upfront benefits for
rail users but would also be reflected in lower penalty payments.
The current penalty payments reflect the societal costs of rail
delays, costs which would be greatly reduced through improvements
in network performance. Performance penalty payments are currently
running at about £370 million per annum.
Projects and schemes in the 10 Year
Plan proceeding more quickly than may otherwise have been the
Several investment schemes have continued to
be developed while Railtrack plc is in Administration. However,
it is clear that an early transfer to a successor that would improve
its knowledge and management of its assets helps to provide greater
certainty and confidence for taking forward further investment
in SRA Strategic Plan projects than would otherwise be the case.
In addition to the benefits mentioned above,
additional benefits arise from the Network Rail bid through the
earlier implementation of a Company Limited by Guarantee structure.
Such a structure offers the following benefits in comparision
to the Railtrack equity model:
A greater alignment of the operations
of the infrastructure manager with the wider public interest ie,
no more "profit before safety".
Decision making based on long-term
analysis of whole-life asset costs not deferring much needed investment
expenditure for short-term economic gain.
A re-investment of surpluses earned
on operations back into rail industry rather than shareholder
dividends. Railtrack Group Plc paid £709 million in cash,
or equivalent, dividends to its shareholders between May 1996
and October 2001.
More efficient financing through
a strong capital structure, offering a potentially lower cost
of capital through a debt-financed company, rather than one having
to pay higher returns to equity.
By way of illustration of this last point, we
can refer to the Rail Regulator's October 2000 Periodic Review.
In determining the 8 per cent real cost of capital return for
Control Period 2, the Regulator estimated that the real cost of
debt for Railtrack Plc was of the range 4.5-4.75 per cent while
the real cost of its equity was of the range 9.3-11.7 per cent.
On this comparison, using the midpoint of both ranges, each £1
billion of finance raised though debt would be around £58
million cheaper in real cost of capital annual repayment terms
than raising an equivalent £1 billion through equity.
Funding of the £300 million
As I said in my evidence, the £300 million
payment will not be a cost to the overall 10 Year Plan for Transport.
The benefits from an earlier exit outlined above will deliver
greater savings in future Government support levels than would
otherwise be the case over the 10 Year Plan period.
30 April 2002