Traffic Trouble for RiverCity
Traffic Trouble for RiverCity
Australia’s newest tollroad opened on 16 March. The Clem Jones Tunnel, named after Brisbane’s longest serving Lord Mayor, looks like it’s going to be another infrastructure disaster for investors.
The tunnel, owned by ASX-listed RiverCity Motorway (ASX code RCY), runs 6.8km north to south and bypasses some of Brisbane’s most congested traffic areas. There’s no doubt it’s going to be a useful piece of infrastructure. But it’s not going to go anywhere near justifying the $1 per security initial investors stumped up to get the tunnel built.
The tunnel is toll-free for the first three weeks. In the opening six days, an average of 67,000 vehicles used the tunnel. That’s not bad for a city of Brisbane’s size. But it’s not enough to pay the interest on RiverCity’s $1.336bn* of debt. Based on my rough calculations, they’re going to need an average of 80,000 paying vehicles per day to meet the interest bill, and more to deliver a return to securityholders.
Of course, it’s only early days and traffic numbers typically grow between 40% and 60% in the first 18-24 months (known as the ramp-up period). Drivers take time to change their habits and get used to the idea of handing over $4 per day. But if only 67,000 vehicles are using the tunnel when it’s free, they’re not going to get anywhere near the prospectus forecasts once they start charging full tolls.
Toll free periods are a relatively new initiative but we do have a couple of recent case studies. Melbourne’s Eastlink (owned by ConnectEast) and Sydney’s M7 (50% owned by Transurban) were both, like the Clem Jones Tunnel, finished early, enabling the owners to offer a toll free period without upsetting the banks. In both cases, traffic halved once tolling resumed. The M7 opened in December 2005 and an average of 156,439 vehicles used it during the first six toll-free days. In the first week of tolling, traffic dropped to an average of 79,033 per day, a decline of 49%. Even four years later, the average daily traffic was less than it was during the toll free period (an average of 128,669 vehicles per day used the road in the December 2009 quarter). EastLink’s average daily traffic was 270,868 vehicles in July 2008, the toll-free month after it was opened. As soon as tolls were charged, however, traffic numbers fell 50% to 135,555. Today, more than 18 months later, an average of 176,497 vehicles use the road per day, still some 35% below the toll-free traffic numbers.
As an aside, while I indicated above that the ‘ramp-up’ period can result in an increase of between 40% and 60% in traffic, it is interesting to note that Eastlink’s ramp-up has only been 30% in the first 18 months. This seems to be a direct result of offering a toll-free period – people become aware of the road and accustomed to using it earlier than they would have without a toll-free period. It’s a great initiative, but it doesn’t auger well for RiverCity.
Let’s assume the same trends play out (I’m astonished at how similar the drop off was on the M7 and EastLink). The 67,000 vehicles that used the road in the toll-free period will drop to 33,500 once tolls are charged (the road will be toll free until 5 April, and then a 30% discount will apply for the next five weeks). Then we’ll optimistically assume that this number grows 50% over the next 18 months, meaning that in November 2011, an average of 50,250 vehicles will be using the road daily. Using the initial weighted average toll of $4.43 (ex GST), annualised revenue would be $81.2m. Subtract the operating expenses of $31m (the assumption used in the prospectus) and the owners will be left with about $50m of cash with which to service the interest on $1.366bn of debt. Assuming an average interest rate of 7.1% (70% of the debt is hedged at an interest rate of approximately 7.5%, the unhedged portion would currently be a bit cheaper), the interest bill alone will be more than $90m, $40m more than the operating cashflow.
I’ll keep a close eye on the traffic numbers and update these figures as the numbers come out. But the chances of securityholders ending up with another cent out of RiverCity are slim. In fact, the banks look like they’re in for a haircut.
*The original post stated $1.366bn, $1.336bn is the correct number. Change the blue assumptions below to see the impact on RiverCity's cashflow
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Now I need to know where to short the stock. :-)
Great analysis Steve.So much for infrastructure plays...
Steve, given that the tunnel has very regular cash flows, why does it pay over 7% in interest? Couldn't they secure anything less than that? I would have thought they could make a reasonable case that they were a pretty good risk.
The margin on the facility is 1.4% and I'd guess the banks are wishing they'd charged a lot more (the deal was done at the height of the credit bubble).
These toll roads do provide extremely stable cashflows once they are open - but forecasting what that cashflow will be before it's built is extremely difficult (just ask the former owners of the Cross City Tunnel and Lane Cove Tunnel in Sydney).
So, if you're borrowing against an established traffic flow, you'll get low interest rates. If you're borrowing for a road that is yet to be built, you'll pay substantially more.
I just recently checked out BrisConnections now that the third $1 payment has been made and the market value of the stock is around $1.15, and reached a very similar conclusion (albeit with a greater fudge factor owing to the fact that the BrisCon toll road is still two years from completion). With BrisCon there is over $3bn in debt supported by just over $1bn in equity and the average interest rate was largely hedged into place at around 8.76%. The tolls don't seem to offer particularly good value (to be around $4.85 for a 10-15 minute reduction in journey time), and on my figures, the question of whether the shares have any value at all is simply too close to call.
My analysis also ignored the effects of Steve's earlier post on the success of short vs long toll roads, which would be another negative.
What started as a valuation, ended in perverse voyeurism as I was genuinely very impressed by the promoters' ability to pull off such an audacious rip-off in floating the BrisCon equity securities when the world was already well into the credit crunch!
Hey Steve,
Very interesting. Potential real life example of becoming anchored to the free trial period price of FREE and then not much liking paying once the price rises.
This is talked about in the book Predictably Irrational. The New York Times will be facing a similar problem shortly when they move from the free content model to the paid content model...
Your cashflow model has failed to take account of debt repayments. In fact the debt amortization profile in the PDS is a fabrication. The present value of debt repayments so far in the future are only a small fraction of what is implied by the profile.
The debt repayment is mostly irrelevant. If they can generate enough cash to cover the interest, they'll be able to refinance the debt when it comes due (most toll roads have been able to increase the amount of debt as traffic grows).
It's a 45 year concession. If everything went to plan, they wouldn't repay any debt until the last 10 years of ownership (as we've seen with the M4, which has just been handed back to the NSW Government).
Possibly. But I actually like the toll free period because people who wouldn't previously have paid for the road use it and come to understand the benefits.
I just think it flattens the ramp-up profile - where traffic used to start low and take up to 24 months to reach normal traffic levels, it probably starts higher and only takes six months because drivers became aware of it in the toll-free period.
Yep. There's probably a price (around 10 cents perhaps) where you get some interesting optionality.
I do think the Brisconnect road will perform better. I'd like to hear some locals' thoughts on this, but in my experience there aren't as many attractive alternatives from the airport as their are to Clem Jones. I've been in some horrible traffic coming in along the river from the airport - but I've never had a problem over the Story Bridge. It's a relatively small sample size though.
Yeh I see your point. I'm not sure which effect dominates but you may be right...
This is correct. The prospectus shows debt level rising, with each rollover, for about 25 years. Inflation and rising fuel costs as well as congestion due to population explosion will make this tunnel viable in a very short time.
'most toll roads have been able to increase the amont of debt as traffic grows".
You claim that the debt is largely irrelevant I do not agree for the following reasons.
The cash flow to debt ratio is the criterion that would be used by bankers in setting up a refinancing arrangement. If the debt is large the required criterion may not be met. Traffic growth may not necessarily imply that the desired increase in cash flow will occur to the extent required. Level of service deteriorates as the traffic increases, causing an aversion to paying a toll. This is visible on the M2 particularly during the AM peak period. Incidentally, the M4 debt was relatively small. I believe it is erroneous to deal with toll road financials without considering the future cash flows in relation to debt.One would expect that a prudent banker would look at the present value of the future cash flows and see if they equate to the debt which has been drawn down to construct the facility. This is the real test of financial viability: neither the Clem Jones tunnel nor Brisconnections exhibit it despite the grossly inflated traffic forecasts.
Obviously cashflow to debt is a very important ratio when it comes to lending money. They need to ensure there's enough cash to at least cover the interest, otherwise the debt is going to grow exponentially - which is why I think investors in this road are in trouble.
But, assuming there is enough cash to cover the interest, they don't need to worry about repaying debt for the first 20 years at least. Future growth would enable the road to easily repay the outstanding debt in the last 10-15 years of the concession. You can bank on inflation growth in tolls + 2% traffic growth at least, giving you 5% nominal revenue growth. Over 45 years, that's going to result in a nine-fold increase in revenue and mean today's debt obligations could easily be repaid.
Obviously the debt needs to be paid off eventually and the banks will lend less than the PV of cashflows, which is why the banks would only lend, say, 7 years cashflow once there is 10 years to run on the concession.
But RiverCity's big hurdle right now is to get somewhere near covering the interest bill.
As a brisbane resident i dont personally see the benefit of the tunnel. For someone who lives near the south east freeway the problem getting to the airport has always been along Kingsford Smith Drive and the Gateway and that is exactly where the tunnel finishes. The tunnel simply gets you past the easy bit (although peak hour might be a different story).
I'm also a Brisbane resident, living on the south side, and I've seen serious improvements in traffic flow at morning rush times. It might change after the free period, but so far it's had a measurable impact. I must say I didn't think it was going to do anything, but I've been impressed - so far! (touches wood)
The cost-benefit analyses underpinning these projects are of course usually predicated on a relatively small travel time savings per vehicle multiplied by a large number of vehicles. The interesting claim for this project was "avoiding 24 sets of traffic lights", yes that might be true if traversing the inner city / CBD but follow the SE Freeway to the ICB to Kingsford Smith Drive there is not a single set of traffic lights and it's essentially the same route (parts of which are also 80kmh).
All this argument is fine for the stock at $1, what about value for the price now at $0.15 ?
Reading the half year results released to the ASX, the debt is $1.336bn. The II specified it at $1.366bn. What is the correct figure?
In my humble opinion,there are 2 major issues with the tunnel...Number 1 is the peak time congestion on the northern end of the tunnel at Lutwyche Rd...this may get resolved in 2 years time when the new Airport Link is opened...in the meantime, peak time tunnel traffic inflows and outflows at Lutwyche Rd are very slow...the slow outflow then stalls the rest of the traffic in the tunnel trying to get out onto the ICB. Number 2 is the two free alternative river crossing roads (Riverside Expressway and Story Bridge)...Anna Bligh should slap a $2 toll on the river crossing segment of these two roads to encourage people to choose the most time efficient route rather than the the most affordable route...The toll income may mean she does not have to sell as many state assets as she plans.
One last thought of mine to leave you with: Story Bridge - Free and 3 lanes each way, struggles to cope with 110,000 vehicles a day; Clem7 - Toll and 2 lanes each way, usage after 18 months probably a lot closer to 65,000 vehicles a day rather than 100,264 that the expert traffic consultants (Maunsell Australia) forecast in the PDS. Hope I'm wrong!!!
Thanks Bemused, should be $1.336bn.
IMHO, there comes a point where calling such securities "equity" becomes inappropriate, and a more relevant moniker would be "subsidy charitably paid by suckers to other stakeholders".
You're right Steve, there are more options for people to take with RiverCity than BrisConnect. They should have priced the RiverCity tunnel closer to the Gateway Bridge toll ($2.95 for a car). For my journies I'll be taking the bridge.
Good analysis Steve. In my opinion Brisconnect are in even bigger trouble. They have even more inflated traffic forecasts (hoping for 200,000 per day on the Bowen Hills-Kedron leg) and much more debt. The airport is a big traffic generator but the bottleneck was at the airport roundabout, which has been alleviated with the new Gateway upgrade. Kingsford Smith Drive is also being upgraded. In other words, Airport Link will have plenty of competition, much of it toll-free. Another toll tunnel bankruptcy on the way :)
Hi Steve,
Have you factored in the fact that trucks and commercial vehicles pay a higher toll in your figures. What about the cash the company has in reserves to pay the gap between toll revenue and interest payments. Couldnt that keep them going for years until traffic does impove? Thanks for your analysis
I* live at the northern end of the tunnel and would back "Bemused's" comments - the consortium has not spent enough on getting a smooth flow of traffic in/out of the tunnel. During the early days of the free period it was gridlock/near grdlock around teh northern tunnel enrty/exit. Now consider that was for (only) ~50-60K cars/day/ There is NO WAY that many people are going to pay $4+ to queue up....
When the Brisconnections Northern/Airport tunnel (another dud investment) opens the traffic flows will change but that is a couple of years away,
The Clem7 is a much needed piece of infrastructure - but as Steve's analysis shows, a poor investemnt & it ain't getting any better in teh short term....
sounds like a report written by someone who is probably making a mint shorting the stock right now, for all we know this tunnel could end up generating alot of traffic. Who knows what the government will do to encourage people to use the tunnel. At the end of the day people dont like to sit in traffic, that is why people in Sydney use toll roads. I swore Id never use them and I use the eastern distributor all the time. I'd be willing to bet this company have enough cash in the bank to last them long enough to build the traffic volumes to a profitable level. In the meantime cash in on the fear and short away !
I've never shorted a stock in my life Harry. If I do, I can promise you I won't be using my public profile to manipulate the price.
There's no doubt the road will make an operating profit. It's just not going to make enough to service its debt obligations.
I was talked into these shares by a Bn Broker who said it was a marvellous investment giving a high return! I later found out they were the lead broker.Having suffered the massive loss in the share value,is there any possible upside or should I accept the loss and get out?
Percy
It'is not a loss unless you sell.
What if there's nothing left to sell? Like Allco or ABC Learning or Babcock & Brown...
Hi Ben, this logic can be useful. Sometimes the underlying value hasn't changes but Mr Market's moods have halved the price of your shares. In that situation, it's perfectly reasonable to expect to realise the 'value'.
But it's also important to rcognise when the underlying value of your investment has been permanently impaired, which it clearly has been here. You can either sell it and crystalise your loss, or wait for the administrator to send you a letter telling you it's worthless.
As a very bruised investor from Victoria, it's interesting reading these comments now that the actual, and significantly lower, traffic figures have come home to roost. How long can RCY last?? Chris S.
Excellent piece of work Steve - and I guess the market has begun to agree with you!
Chatter on-line suggests that like the Sydney tunnels the user forecasts were done in reverse. IE. They divided build and running cost by the number of cars needed to service the debt. That gave them false daily user predictions. The real user numbers came later after completion and they were way off. Then the reverse engineering started. Now they have real user numbers, they project forward to see if the real debt can be serviced. Let the fudging begin. Real profit for investors may yet come after debt is written off and the blood stains have faded.
As an analyst for most of my career I am constantly amazed at the insistence of senior managers in numerous companies and industries to massage forecasts and plans to show a certain result. Then when the actuals don't meet plan they ask for a reason. Most of them don't like it when you tell them the problem is with the plan not the actuals.
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