Rail firm plans route unaided by state funds

Date: 29/02/1996

By Tim Jones

AS Europe's biggest building firms bid for huge transport contracts and complain about the lack of public-sector help, three men in a central London office are piecing together their very own 3.6-billion-ecu

Trans-European Network (TEN).

At Central Railway plc, chairman Andrew Gritten and his small team are seeking parliamentary approval for a project to own, design, build and operate a specialised freight railway from northern England through the Channel Tunnel into France.

What is more, they plan to do it alone, without any financial subsidy.

“It may well be said that this kind of thing is not possible, particularly to finance the front-end of the project,” says Gritten, “but we are living proof that this is not true.”

While the fledgling company's experience shows how an imaginative approach can raise 'seed finance' for a major project, it also provides ample evidence of the financial system's weaknesses in coping with such a high-risk venture.

If and when it wins approval, Central Railway will be a typical project-financing proposition - with a lot of bank debt, balancing this with shareholder equity and sufficient income to cover interest. But, for now, it is a venture capital idea and needs seed finance to get it started.

It all began in the late Eighties when Gritten published a pamphlet for a think-tank on how to attract private capital into the railway system.

Bored with being told how wrong he was, 43-year-old Gritten decided to put his money where his mouth was.

In 1991, he founded Central Railway as a limited company and brought on board as finance director Alan Stevens, a 34-year-old project finance specialist from Schroders merchant bank.

Their central idea was to design a 'supergauge' railway, making extensive use of underused or dismantled track or railway corridors, capable of carrying lorry trailers from northern England into France.

“We are proposing a service which is intended to be essentially another ferry that you can get on earlier and which is faster and more reliable than getting on a ferry or driving all the way down to the Channel Tunnel,” says Stevens.

Together with the French state railway, SNCF, Central Railway calculated that its line could capture 15&percent; of the total UK-continental freight market.

“The Channel Tunnel was obviously an extremely large opportunity for anyone who could figure out how it should be used in a freight sense,” says Stevens.

“We are simply aiming to get another share out of what is a very rapidly growing market. It is a very big market and it would seem from our research that it is large enough to support this project.”

Freight is the key to making enough money out of operations to recoup the estimated 3.6 billion ecu to be spent on construction and commissioning the line.

When the railways were first created, they were designed to move heavy freight like coal and steel, and it was a mere historical accident that an operator found it could sell tickets to people on their trains.

“The experience of Eurostar ought to indicate that there is something fundamentally unattractive about basing a railway on a passenger operation,” argues Stevens.

A system designed to cope with approximately 15 million passengers a year is moving less than five million.

“We are not asserting that all railways can be made to make money, but simply that a single railway could form part of a useful freight system. Having said that, we obviously had to go on and try to prove it,” says Stevens.

This they have done. Working together with engineers Mott MacDonald and US project manager The Ralph M. Parsons Company, Central Railway drew up a prospectus and a formal share offer document.

After two failed attempts to attract institutional investors through unquoted stock offerings, the company made a public offer of 1.5 million shares at £1 each. Central Railway is now quoted on the Ofex exchange and is capitalised at around 9.5 million ecu.

During this time, Gritten and Stevens learned a lot about the difficulties of finding high-risk venture capital - the kind of problems that usually mean such projects have to have state backing.

Central to the problem of finding start-up finance is the fact that the company must win parliamentary approval and planning permission before it can lay a single track. This gives an advantage to state-run companies or projects with government backing because the state also runs the approval mechanism.

“There's a lack of understanding that you can't raise huge amounts of money on the basis of putting a project through an approval process that might fail,” says Stevens.

“As a private company without public funds, we decided that the only possible thing we could do was form a company and raise equity. If you are seeking money for something which could lose all its value if approval is not given, then you obviously have an equity proposition rather than a debt one, and you are forced to try to attract amounts of higher-risk equity.”

The company would have liked to present a proposition to potential shareholders by going straight to the stock market. However, non-trading companies cannot seek a listing without offering stock of more than 120 million ecu for subscription.

At the same time, the company found that the UK venture capital industry had become obsessed with financing management buy-outs of existing firms, rather than providing support for truly new ventures.

But, having raised equity and put together a detailed plan, Central Railway believe they are only weeks away from filing a formal application for government approval.

If everything goes according to plan, construction and commissioning will take four and a half years.

And if, several years from now, Central Railway is up and running, it should be the kind of safe, low-growth utility stock that pension funds love.

But getting to there from here is another matter, one of many lessons these entrepreneurs have learned in the past five years.