For those used to a diet of Camino related blogs this one might come as a bit of a shock. For those that know me and my interest in governance, economics, and business – not so much.
This was intended as an opinion piece for the the local paper in Christchurch, The Press. Alas, no word was heard :-).
I am very interested in responses to this piece as the line of reasoning has far wider application than the example it has been applied to. I for one think that the way society wastes its resources is a scandal, particularly when done in the name of good intentions. So many people are missing out on help that we could be delivering if we were a little more sensible.
Initially written: 13/2/2017
All appearances suggest that asset sales are no longer being considered by the Christchurch City Council (CCC). This will please many people as there are good reasons for keeping publicly owned assets. However, supporting this should not prevent sensible discussions about asset allocation.
Simply put, are the assets the CCC has performing well, or should they swap them for something else? If we are going to keep the family silver, shouldn’t we make sure what we have is in fact silver!
For example, consider Red Bus. Is it worth the CCC owning this asset, or could it do better?
The annual report for Red Bus is freely available so we can get significant insight into this company’s performance. So what does this reveal?
First, with publicly owned companies it is inadequate to just focus on financial performance. Care needs to be taken to consider important, but more intangible, reasons for public ownership. They may be a monopoly provider, or they may provide some form of public good that the private sector would not deliver.
When considering businesses like this it is worth performing a thought experiment and ask, “what would happen if this company ceased to exist?” What would be lost that the numbers do not show?
With Red Bus the answer is pretty clear, not much! Despite appearances, Red Bus is not responsible for providing public transport in Christchurch. ECAN is. Red Bus simply tenders to provide bus routes along with other companies. And they often lose. Currently only 30% of routes are performed by Red Bus with private firms like Go Bus delivering the rest.
If Red Bus stopped providing bus services your average bus user wouldn’t notice the slightest difference.
So why does Red Bus exist? It exists because the CCC believes it can operate a bus company profitably and receive a healthy dividend. Therefore, we can largely ignore any intangible benefits and focus primarily on its financial performance.
So how did they do?
Last year Red Bus declared an operational profit of $132,000 on turnover of just over $19 million. Better than last year but still a very skinny margin of 0.7%. Probably the simplest way to describe this is “running to stand still”.
Of more concern is that a lot of resources were used to get this small profit. The accounts list net assets at a shade under $38 million, implying a return on assets of 0.3%.
If Red Bus was sold, and different assets purchased, what return could we expect from $38 million? As a comparison we could:
- Put the money into a bank deposit. With interest rates currently around 3.6% this is worth $1.4 million per year.
- Buy some industrial property. A 7% return should be possible so this is worth $2.6 million per year.
- Attempt to mimic the performance of Ngai Tahu’s commercial arm which made around 15% a year since settlement. This is around $5.5 million a year.
None of these options would compromise the provision of a public bus service. ECAN would simply contract to another company. In each case we would get the bus service PLUS the extra money.
A 7% return via option 2 is not an unreasonable expectation. What does Red Bus aim for? According to its report it has a profit target of $400k, or a 1% return on assets. This is hardly a heroic goal and they have failed to achieve even that. With far less effort they should be able to achieve 7 times this!
So what do I conclude?
- Red Bus is operationally inefficient as even with its thin margin it can’t keep other private providers (who tend to be very rational about profit) at bay.
- Red Bus is very asset rich but makes virtually no return on those assets.
- If the council wishes to receive a dividend from its assets there are far easier options than owning this bus service.
- By owning this company the council is effectively wasting around $10 per ratepayer annually.
My response? Sell the assets in this company, let others provide the bus service, and buy other assets which will deliver a decent return.
Red Bus is a tiny component of the CCC asset portfolio. However, even reallocating these resources could significantly improve the life of ratepayers. Even if only used for transport in the city an extra $2.6 million per year could be used to:
- Give away 1 million free bus tickets to encourage more users.
- Give 7000 bikes away.
- Give 1500 E-bikes away.
- Provide 86,000, $30 taxi trips.
- An additional 3% more bus routes could be provided
These are just some options available, and they would be additional to the existing bus system.
Get creative. What would you do?
It is not unreasonably that all the companies owned by the CCC should receive the same attention. As ratepayers we should ensure that they are achieving even a basic level of performance so we are able to enjoy the benefits. As demonstrated with Red Bus, not doing so could be leaving our community significantly worse off than it could be.
Rough against rough 
I guess one question is, if you got rid of Red Bus, would the cost of riding the bus increase? Are the fares fixed by ECAN or by the provider? Is the presence of Red Bus pushing down the tenders that the private companies have to make?
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Thanks for the question
It would appear that ECAN set the prices and RED Bus simply tender to deliver the routes for a fixed price. However, someone may be able to add more information to that. It would be interesting to know what incentives are in place to make sure the bus is full as presumably it would be more beneficial to run the bus empty (i.e. less weight) :-).
I would also re emphasise that RED Bus are in a competitive tender with other providers and, at present, lose about 70% of the time. They are presumably a more expensive than the alternative or they would be the dominant provider.
More broadly, this question asks what other benefits are provided by RED Bus that the accounts do not show. There may be many, but it is not clear what they are. If there are any I would like to know what they are, how much they are costing to deliver, and if their may be a better way to deliver these.
For the record, some very rough calculations indicate that if RED Bus used its capital more effectively it could reduce bus ticket prices on its routes by 75c, i.e. 30% of a zone one ticket on a metro card.
Another fun fact. By doing some extrapolation on the figures it looks like ECAN pays around $5.60 per bus trip, or twice what it receives from a zone 1 metro card. Bus usage numbers will have to double if you expect the bus system to break even. However, I may publish something that would argue that subsidising a bus system is potentially a cheaper option than the alternative, despite its very low usage levels.
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My understanding (but I don’t know for sure) is the same as what Justin has said: that fares are fixed (by ECAN?). Competitive bus service providers tender for routes – basically they are competing on cost, but other factors such as historical reliability might be relevant in the tender process.
Justin: I reckon you should focus on operating surplus as a proportion of equity. (Pretty much you have done this, although you mention turnover which is maybe a bit of a distraction?). Essentially there is a heap of book value tied up in this company which, so far, is not delivering a return. I would also be looking at what plans they have to increase operating return. A quick glance at their annual report doesn’t show me any obvious plan.
It’s also worth noting that, just because there is a lot of book value there, it doesn’t mean they could sell the company, or the assets, for that price. An investor would be willing to pay only the NPV of the future net cash flows (assuming we treat it as a going concern). I wonder what CCC would get for selling the company/assets. Possibly a lot less than book value.
My other way of looking at these problems is to imagine, if the CCC didn’t own the company, would it be looking to acquire it? That helps to focus on the strategic reason for owning the company (rather than nostalgia) . I can’t see any strategic reason for owning it. But maybe someone could come up with one…
Luuk asks a good question: “Is the presence of Red Bus pushing down the tenders that the private companies have to make?” Probably to some extent, yes, in practice. But the industry is probably pretty competitive. No-one’s getting rich here. So I can’t imagine that would make a huge difference.
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There was a bit of pressure to keep the word count down and make sure concepts were being understood – hence not using the official official terms. However, point taken.
Regarding what the equity is. It looks like half of the $38mill is buses. Presumably if they stopped operating the new operator would want most of them. Perhaps not at the book value price though so they may take a hit if they sold them. However, the other half is land which they park the buses on. This is likely to be accurately valued as it appears that a bit of financial engineering has gone on here.
Those that are against asset sales should perk up their ears for this next bit.
In the article I was quite careful to distinguish between operating profit and recorded profit. According to the accounts Red Bus declared a profit of $2.4 mill and paid a dividend of $1.35 mill. How did they do this when they only made $130k via their operations? It appears that they had the land value re valued up by $2.3mill and used this re valuation to take out a larger loan in order to pay the dividend. In my opinion this is asset sales by stealth.
Regarding the impact on fares. I think it is highly unlikely that fares will come down anytime soon irrespective of who delivers the bus service. According to the ECAN annual report 60% of bus costs are subsidised to the tune of $65mill a year (around $150 per person in chch). This is a massive expense for ECAN and my guess is that this gives enough incentive to makes sure any tender is competitive, but also that ECAN would like to raise prices given any chance.
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Yeah – I agree good to focus on the underlying operating surplus rather than 1-off land revaluations.
I note the company has very low debt c.f. equity. Operating very “low risk”. Could gear it up: take on more debt, and pay out the excess cash as dividends. That’s a way of producing cash for the CCC without actually selling the assets.
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As it happens I think this may be a good way to get asset sales without scaring the horses. However, I also think that it needs to be identified for what it actually is.
In this case I am not sure I agree that Red Bus can handle much debt. It simply doesn’t have the cashflow to pay for it, especially when that debt is not being used to improve the actual operating performance of the business. If they continue to do this to pay dividends then eventually it will come home to bite.
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