Regulator gets tough on Railtrack

News Analysis: Proposals to restrict returns on the railways to 5-6 per cent will cut state subsidies but threaten necessary investment

NOT BAD for one day's work. Shares in Railtrack dropped 64p to pounds 14.57 after Chris Bolt, the acting rail regulator, produced his new financial straitjacket for the company, following a 49p fall the previous day. More than 7 per cent has been wiped off the stock market value because of a proposal that is still two-and-a-half years from becoming effective.

If Mr Bolt's proposals are enshrined in tablets of stone, Railtrack's regulated business will be restricted to making a return of 5-6 per cent against an asset base of pounds 2.54bn - its value on privatisation.

Railtrack had lobbied for an asset base of about pounds 4bn, or an uplift of 60 per cent. The company's market value is now pounds 8bn, or more than three- times its flotation value. But the new regulator was clear: "There is no obvious case for rewarding shareholders for more than they invested in the company. Initial shareholders and those who subsequently bought Railtrack shares could have made themselves aware of the basis on which the regulator was minded to calculate a return for Railtrack at future reviews of its charges."

Mr Bolt said Railtrack had a choice. It could either continue to behave as a low-risk utility and work within the proposed low rates of return, or it could initiate "innovative" schemes in which Railtrack, rather than the public purse, would take the risk of success or failure, meriting higher rates of return.

Yesterday's announcement by Mr Bolt exposed the curious position that Railtrack is in. Privatised in 1996 and given total freedom to borrow and enter into joint ventures, the amount it can charge domestic train companies for access to the tracks is strictly controlled. Although it is a monopoly utility it is being told that it should behave like a high-risk/high-return growth stock.

Mr Bolt's proposals will mean that Railtrack has to charge less for access to its tracks. Passenger franchise revenue makes up pounds 2.13bn out of an annual turnover of pounds 2.47bn. By cutting its traditional income, the regulator is forcing Railtrack to seek new ways of making money.

The acting regulator has given a clear message to the company. He has taken the toughest possible approach to regulating Railtrack's core business - the politically sensitive job of maintaining and enhancing the domestic track network.

Alastair Gunn, a transport analyst at Credit Lyonnais Securities, said the impact of the new regulatory framework on Railtrack's profitability could be in the order of pounds 100m.

"These are severe proposals. What the regulator is saying is that Railtrack's profits are very high and are not going to be sustainable in the future. The shares have been treated so far as a growth type of stock, not as a regulatory stock like water companies."

Peter Bergius, an ABN Amro analyst, said: "This is a tough approach, with the proposed rate of return at the bottom end of expectations, if not below expectations." A number of brokers are planning to reduce their ratings of Railtrack shares.

Railtrack is furious at Mr Bolt's approach. Gerald Corbett, the chief executive, said: "His approach was one that would be taken with a traditional utility but the world has moved on. Rail isn't water and it isn't electricity. Rail is different - huge growth, huge investment requirements." He said Mr Bolt was exercising his duties under the Railways Act 1993, even though this is due to be superseded by new legislation.

Mr Corbett said the Government needed to build a new "economic architecture" for the railways as part of its plans for a strategic rail authority. This would involve giving train companies incentives to perform well. He said that when the regime was set up "there was no West Coast upgrade, no 'standing-room only' on the London to Edinburgh route or overcrowding from Brighton to Victoria".

He added that Railtrack had delivered investment of pounds 1.4bn a year, a huge growth in passenger numbers, and had cut infrastructure-related delays by 40 per cent. "Every pounds 1m of profit supports pounds 10m of investment," said Mr Corbett, referring to Railtrack's rating in the debt and equity markets.

Yesterday's review comes against a background of increasing pressure on John Prescott, the Secretary of State for Transport, to force rail companies to deliver a better service. References to "excessive" profits and to shareholders having received enough rewards will generally go down well.

But Bernard Jenkin, the Conservative transport spokesman, asked yesterday whether this document showed Mr Prescott wanted to recreate British Rail by the back door.