Replacement of Franchised Bus

From: Pui Man PO [mailto:po_pui_man@td.gov.hk]
Sent: 31 May, 2012 11:41
To: James Middleton
Subject: Re: Fw: Alex Turnbull’s Blog
Dear Mr Middleton,

Thank you for your mail. We would like to provide our responses on your observations made at the end of your mail :

Replacement of Franchised Bus
All franchised bus companies required to operate their franchised bus services with buses under the age of 18, and have been replacing their serving buses accordingly.  This arrangement has taken account of the maintenance, operational and financial capability of the bus operators.

Franchised bus companies have to submit annually to the Transport Department (TD) their Forward Planning Programmes for the next five years, including programmes for purchasing new buses and retirement of old buses.  It is estimated that about 2,300 serving franchised buses of which about 700 belong to CTB, including all pre-Euro and Euro I and some Euro II buses, will retire by 2015.

Given that it would take time for all the Euro II and III buses will be replaced, the Government is looking into various cost-effective options to improve roadside emissions, such as retrofitting diesel particulate filters (to reduce particulate emissions) on Euro II and III buses and to commit a trial on retrofit of Selective Catalytic Reduction devices to reduce the emissions of Euro II and III buses to the emission level of Euro IV buses.  Further, in order to promote wider use of environment friendly buses, the Government has added a requirement in all franchises with the bus companies that when setting specifications for acquisition of new buses, they are required, as far as practicable, to adopt the latest commercially available and proven technologies to reduce exhaust and noise emissions.

Return on Average Net Fixed Assets (ANFA)
For franchised bus operation in Hong Kong, the 9.7% rate of return on ANFA is not a “mandatory” nor “guaranteed” rate of return that the bus operators could enjoy, but is only the triggering point for sharing of return between bus operators and passengers.  If the bus operator achieves a return on ANFA above 9.7%, half of the excess over 9.7% will be shared with passengers by providing fare concession or stabilising bus fare.  On the other hand, if the return of the bus operator falls below 9.7%, the shortfall cannot be offset against the fare concession/fare stabilisation obligation.

Disposal / scrapping of buses
The profits on disposal of buses if any, are included as part of the bus operators’ return.  Moreover, the purchase and disposal of buses, as well as the overall bus fleet size, are monitored by TD in various ways.  The franchised bus operators could not sell buses at artificially low book values and then buy back refurbished buses at prevailing market rates.
Please rest assured that the Government will continue to work with the franchised bus companies to implement appropriate measures with a view to further reducing roadside air pollution.

Regards,
Karen Po
Bus and Railway Branch
Transport Department

Dear Mr Middleton,

Your concern has been well received by Transport Department and we will provide a reply to you.

Thank you for your kind attention.

Regards,
Karen Po,
Bus and Railway Branch
Transport Department

—– Forwarded by Joseph Yee Tak LAI/TD/HKSARG on 04/05/2012 10:31 —–

When can we expect your reply or must we approach the Ombudsman?
James Middleton

From: James Middleton [mailto:dynamco@netvigator.com] 
Sent: 10 March, 2012 22:11
To: ‘josephlai@td.gov.hk‘
Subject: Alex Turnbull’s Blog

Commissioner for Transport

Dear Mr Lai,

please see the link to the attached banker’s blog with information regarding Citybus.
We would welcome your response to these interesting facts.

Yours sincerely,
James Middleton
Chairman
www.cleartheair.org.hk

http://alexbhturnbull.tumblr.com/
Text
March 10, 2012
Excess Rents Hong Kong Style: Citybus

As some of you know I am a bit of greenie and get pretty angried up about air pollution. HK’s air pollution is due to two things: regional air pollution, largely from Guangdong that Hong Kong can arguably do little about (the biodome idea was shot down) and roadside pollution principally caused by buses and trucks about which it could do a lot more. There is a great paper here from 2009 that outlines what HK could do about its air pollution, bus regulation is the best “bang for the buck” thing that HK could do with a 6.3 cost to benefit ratio. Paper here.

As buses are regulated utilities I thought I’d look into the financials of these businesses and the documents governing their concessions to see just what was causing them to be so slow to turn over their bus fleet – maybe fares are too low, or perhaps they face exceedingly high costs of some kind, leaving them limited extra cash to invest in newer, cleaner buses. Crazier things have happened though HK’s other utilities like Power Assets Holdings (formerly Hongkong Electric), CLP and Transport International Holdings (listed entity holding the Kowloon bus franchise) have pretty standard returns on equity that would not look out of place in most jurisdictions though Transport International seemed to be earning some fairly ridiculous returns from 98-03 and again in 04-05.

Well, as you can see here for the bus franchises owned by New World – Citybus in particular – that is most certainly not the case (numbers extracted from here). Citybus’ headline ROA numbers is way higher than their 9.7% mandated level and if you look into their depreciation accounting it is much higher.

You see, when you look at the concession agreement for Citybus (Transport Department link here) a few things jump out. Firstly, the depreciation of the buses is 15 years straight line to $1 – so the buses can be readily written down zero or close to it, which is funny because they are almost there – the bus fleet is about 12.5 years old now on average meaning there are a number of assets older than 15 years that are held at $1. Cute, though under ROA type regulation there is no free lunch: if you haven’t got any assets you aren’t entitled to any returns. That does not seem to be the case here – if you take their depreciation at face value Citybus is earning some major excess rents and the Transport Commissioner should explain why New World gets special treatment.

What is a much better representation of Citybus’ returns is when you ignore depreciation and look at cash capital expenditures net of proceeds from disposals. Net cash capex for these business is pretty close to zero – $4.5mm Hong Kong which is absurd when a new Euro V bus costs $3-4mm Hong Kong. So the cash return on book assets they making is close to 30-40% which is the sort of return you expect on a high risk mining venture, not a regulated utility in Hong Kong.

What is more, these disposals are a source of no doubt significant excess rents for New World. Here is how I would take advantage of the Transport Commissioner being asleep at the switch:

1) Get an ROA way above requirement due to aggressive depreciation accounting that is unassailable because its in the terms of your concession and thus protected by contract. Watch the Transport Commissioner do nothing. (we know this is happening from these accounts)

2) Sell older buses at artificially low book values as your regulated fares don’t take account of this in calculating your asset returns. Use proceeds to fund the bare basement capital expenditure you do. Net result: almost no cash capital expenditures.

3) When the concession comes up, buy back refurbished buses at prevailing market rates to ensure you have an asset base on which to earn fares. Claim that you are making a big investment when bidding for the concession.

4) At every available opportunity cry poor about oil prices.

Net-net: 20-30% cash returns for 10 years on government utility type risk.

What can I say? I’m clearly in the wrong game. The bigger question is why isn’t anyone doing anything about this, and why does Transport International not get to play at this game? Its numbers look pretty aggressive too (depreciation at ~900mm HKD, versus capex that looks lower) but Citybus is taking it to another level.

Tags: hong kong hk citybus new world air pollution