1. How To Become Financially Successful in New
Urban Rail Development
5 May 2010
Jonathan H. Klein
Harral – Winner – Thompson – Sharp – Klein

2. How To Be Financially Successful
at a New Urban Rail Development
“A Railways Master Plan must establish a framework for the
realistic evaluation of sector development choices at the
sub-national level, as well as for core national programs.
It must assure that scarce resources are not wasted on
unsustainable ventures and that the respective risks of
project implementation and operation are allocated to the
parties who are best positioned to control or manage
each.”
Source: Draft National Railway Master Plan
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3. Introduction & Agenda
1. Topic of Meeting: Urban-Rail: Financial Planning
Before Investing
How To Be Financially Successful at a New Urban
Rail Development!
What are Common Mistakes You Can Avoid?
2. General Introductions
3. Viewpoint of Jonathan H Klein
4. Why Worry? What Can Go Wrong?
5. How to Make it Happen Right: Practical Financial
Rules
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4. 3. Viewpoints of Jonathan H. Klein:
a. Supplier: commissioned 725 EMUs, 7 locomotives, 35 coaches when an
employee of manufacturers
b. Buyer: purchased 268 EMUs, 10 locomotives, 55 coaches, 20 complete
high-speed trainsets from suppliers
c. Consultant: wrote specifications for and consulting engineering on
several thousand more EMUs, locomotives, coaches, wagons, coal
railways in 12 nations
d. Financial: due-diligence studies for several billion dollars (US) of
leases, coal railways, wagons, BOT, PPP, and DBOM of urban and
intercity passenger trains
e. Construction: Designed and managed the construction of 5 major
workshops and depots
f. Accountant : Ernst & Young, SEPTA, Southern Pacific
g. Maintenance: What happens after the commissioning? Managed 5,100
employees engineering, depot, and workshop department.
h. Government Employee: ten years as a manager and executive of mass
transit and long-distance train operations.
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5. 4. Why Worry? What Can Go Wrong?
This Project is as Big as the RMS Titanic!
The Shipbuilder Has Built Many Successful Ships!
The Shipbuilder Assured Us the Project Is Unsinkable!”
Examples
A. World Cup: South Africa: Gautrain
B. Olympics: London Underground: Victoria Line Upgrade
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6. 4. A. Gautrain: South Africa’s World Cup
Estimated Price: Gauteng
40
35 35
35
30
25 25,2 25,2
Billions of Rand
25
20
20
15
10 7 7
3,5
5
0
2002 2003 2004 2005 2006 2007 2008 2009 2010
Years
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7. 4.B. Victoria Line Upgrade for Olympics
London Underground
• PPP: “Metronet Rail”
• Bombardier as EMU is depot
partner
• Metronet Rail goes bankrupt
• Why?
• Does Bombardier worry?
• Who did the “due diligence?”
• Photo taken by my associate: Delivery of first 09 Tube Stock
EMU
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8. 5. How to Make it Happen Successfully:
Practical Financial Rules
A. Successful Financial Investment:
• “Sureties”: Insurance to Complete
• Due-Diligence
• Good Design is the Best Surety
• Avoid Complexity
B. Income:
• Successful Income:
• Fares and Tickets
• Best Types of PSO and Taxes
C. Working Capital:
• Spare Parts, Training, Spare Parts, Training
D. Can The Asset Be Leased to Another Railway?
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9. 5.A. How to Make it Happen Successfully:
Risk Mitigation & Sureties
The financial risk is that your local project
becomes insolvent or becomes bankrupt.
What are good strategies and tactics to prevent
bankruptcy?
This is the topic of “Risk Mitigation”.
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10. 5.A Insolvency & Risk Mitigation Strategy:
“Sureties”
“Sureties” are insurance. The contractor or PPP private
sector partners buy some type of insurance to finish
construction and commissioning.
Sureties insure there is enough money to finish
construction and commissioning.
But no one will sell insurance to protect you against
future operating losses.
Only you can build the project the correct way to protect
yourself from operating losses.
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11. 5.A Insolvency & Risk Mitigation Strategy:
“Sureties”
Sureties may be construction bonds or Irrevocable
Letters of Credit.
If your partner cannot obtain this insurance, then
your partner has a financial disease.
Insurance costs money.
Another surety is the legal right to your land if the
project fails.
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12. Minimum requirements for sureties are as follows:
• A surety should cover likely cost-overruns. The amount of a surety should be not less than
120% or more than 200% of original budget.
• The surety amount should be increased for change orders, variations, and additions to the
project’s budget.
• No surety will cover what happened to Gauteng Province, the London PPP, the Taiwan High
Speed Train, or New York City’s East Side Access tunnels.
• Sureties should always be required for passenger railways’ prime contractors, whether the
railways is publicly or privately funded, and for any railway relying on a specific, advanced
technology that has not been successfully and repeatedly used before.
• Sureties should not be required of all cargo railway projects unless (i) an advanced
technology is employed and/or (b) the contractor receives milestone payments or advance
payments. However, the land must always be returned to the public if the project is not
completed.
• Sureties should not be required of special-purpose, sub-national cargo railroads constructed
primarily for transport of minerals and related cargo if, and only if, no public funds other
than land grants, are involved in the project.
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13. Minimum requirements for sureties are as follows:
(continued)
• Only Irrevocable Letters of Credit should be acceptable sureties for advance and
milestone payments. Raw material, advances to other parties, and work-in-process shall
not be accounted as earned-value when calculating the net value of advance payments,
and only substantially complete and commissionable assets should be counted.
• Sureties are not acceptable when issued by banks or other institutions headquartered or
based in the same nation as the party purchasing the surety. Sureties should be
obtained from a firm or other entity that is clearly independent of the party required to
purchase the surety. Protect yourself from yourself.
• Sureties should be payable to the national government only. Sureties should not be
payable to local governments. The reason is that sub-national governments often are
the partner that causes the insolvency. Sometimes, it is necessary to protect yourself
from yourself.
• Sureties should contain a provision that the surety shall “step-in” and finish the project,
then, operate it and/or sell it, and that title and all other rights belong to the surety in
the form of a lease or lease-hold, until the project is commissioned and licensed to
operate.
• The project should contain a legal right for land to “revert” back to the public if the
project is not completed.
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14. 5.A Insolvency & Risk Mitigation Strategy:
“Due Diligence”
• Due-diligence focus is about the cash-flow.
• Due-diligence is not identical to a conventional
costs-and-benefits analysis: Not about benefits to
society.
• Due-diligence is about Financial Sustainability
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15. 5.A Insolvency & Risk Mitigation Strategy:
Due Diligence & Financial Sustainability
Financial Sustainability
Financial due-diligence determines if there is an automatic,
independent, immediate method to provide a enough cash in
each and every time period.
The due-diligence tells you if the cash-flow is enough for:
construction costs,
beginning working capital,
continuing operating costs, and
capital replacement costs
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16. 5.A Insolvency & Risk Mitigation Strategy:
Due Diligence & Financial Sustainability
• Financial Sustainability is a major problem in urban
transport:
• Bappenas & IndII: “RECENT LEGISLATION
MANDATES that mid and large-size Indonesian cities
implement … Bus Rapid Transit (BRT) systems. Local
officials in these cities face serious constraints as they
attempt to design effective systems. They are
hampered by a lack of training on the principles of
mass transit, … an inability to estimate patronage,
service costs, and revenue streams. Thus, the bus
services that now exist are often poorly planned,
unattractive to passengers and financially
unsustainable.”
• Source: IndII Blast #4, May 2010, front page
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17. 5.A Insolvency Risk Mitigation Strategy:
Due Diligence
Cash Flow Link
• Do the riders, shippers, miners, real-estate developers, local governments,
and other beneficiaries have a regular, prompt method of paying cash to
your metro or railroad for the benefits they receive?
• The regular, prompt payment may be through cargo tariffs, TAC, PSO,
passenger tickets, and special real-estate tax assessments near a project’s
stations, ports, or terminals.
• The routine payment may be indirect; for example, the payment may be
granting monopoly privileges to the project’s sponsors.
• Financial sustainability requires the routine payments are directly linked
from specific beneficiaries to the operators and owners of the sub-national
project.
• The link motivates a project to perform its transportation services in a
manner that is directly valued by its users.
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18. 5.A Insolvency Risk Mitigation Strategy:
Financial Sustainability: Cash Flow Link
Automatic
Independent
Immediate
Motivates!
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19. 5.A Insolvency Risk Mitigation Strategy:
Recommendations for a Comprehensive Due-Diligence Analysis
If purely private capital is involved, then the independent firm performing the due-
diligence should not be Indonesian. The office of the firm directing the work, and the
team leader, should be off-shore. This requirement will facilitate confidentiality of the
analysis’ details.
If purely private capital is involved, then the results of the due-diligence must exclude
commercially sensitive and proprietary information. The results should be confined to
statements of adequacy of cash-flows; of financing methods, of technical risks, of
technical and safety compliance, and of areas of concern requiring risk-mitigation.
If significant amounts of public funding are involved, including PSO or other subsidies,
grants of land, creation of special tax districts, granting of tax and customs abatements,
granting of monopolies, then the Government may require fuller disclosure
proportionate with the degree of public funding. In general, “significant amounts of
public funding” may be defined to be funds whose Net Present Value amounts to more
than ten percent of a project’s Net Present Value.
Do not retroactively require fuller disclosure than the level of disclosure required
initially; that is do not create regulations after a developers spent significant cash and
then, afterwards, be require the developer to reveal its proprietary commercial
information, unless there has been a material change in the project’s scope or costs.
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20. 5.A Insolvency Risk Mitigation Strategy:
Recommendations for a Comprehensive Due-Diligence Analysis:
All comprehensive due-diligence and cost-benefit analyses should be performed to avoid
conflicts of interests.
– The work should be paid for by the project’s sponsors. If the project’s sponsors’
cannot afford to pay for their due-diligence, then it is prima facie clear that the
first test of financial sustainability was failed.
– The analysis should be performed by an independent, qualified firm to be
selected by the DGR under competitive tendering procedures.
– The independent firm should not have any national or sub-national ties to the
sponsor’s interests that present a real and present likelihood of bias or conflict of
interest.
– The independent firm should demonstrate its clear and extensive qualifications
in the specific transport mode proposed for development.
The due-diligence must include the period-by-period cash-flow requirements required to
service interest, principal, and eventual dividends.
The due-diligence must include working capital requirements for inventories of
consumable material and for accounts-receivable.
Accounts-receivable analysis should conservatively reflect delays in collections where there
are land-tax, TAC, and PSO income that are paid to the sub-national project only quarterly
or yearly, or where there is a routine delay in monthly payments.
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21. 5.A Insolvency Risk Mitigation Strategy:
Recommendations for a Comprehensive Due-Diligence Analysis
The due-diligence must show what happens when problems occur.
These problems should include:
1. Construction and commissioning cost overruns of up to 100% for passenger
railways and up to 50% for cargo railways. Light rail trams and metros tend to
employ more experimental technologies.
2. Delays in commencing operations of up to twenty-four months.
3. A major recession that affects demand for this transport service, e.g. the demand
for coal, containers, airplane passengers at an airport line, or employee
commuting.
Problems revealed by modeling are not the same as predicting the actual results
upon which decisions should be made.
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22. 5.A Insolvency Risk Mitigation Strategy:
Good Design is the Best Insurance
Key to Financial Success:
A good initial design attracts capital
• Heavier axle loads: 25 tonnes for cargo and for
commuter railways
• Long passing loops for cargo trains, 1500 to
2000 meters
• Long stations for metros and commuter,
regional railways
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23. 5.A Insolvency Risk Mitigation Strategy:
Good Design is the Best Insurance
• Large clearances for double-level commuter railway
coaches and for double-stack containers.
• Big Capacities for Economies of Scale
Passenger => long metro trains ≥ 8 EMU, double-level commuter
railway coaches
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24. 5.A Insolvency Risk Mitigation Strategy:
Good Design is the Best Insurance
Technical Symptoms of
Future Financial Failure
• Light, small or diesel-hydraulic locomotives
• Long, fixed length ranks of EMUs
• Sole-source, closed-architecture technologies
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25. 5.A Insolvency Risk Mitigation Strategy:
Good Design is the Best Insurance
Technical Symptoms of Future Financial Failure
• Local Assembly and manufacturing factories
a) This is a BAPPENAS decision, not a local decision
b) Almost all of these factories fail and close
c) Almost all of these factories never produce a reliable output and
are always, always late
.
• New technologies, especially miracle technologies that:
a) have not built a working commercial model, and the model is
“scalable” upwards in size or
b) have not successfully commissioned at least three systems for
operation in other cities that use similar technologies;
c) Are not only a transport project, and not a project to develop a
manufacturing industry unless funded and approved by BAPPENAS.
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26. 5.B How to Make it Happen Right:
Successful Income & Expenses
• Target For Successful Income
– Farebox Recovery Ratio* should be almost 100% after three
years of operation on a full-accrual accounting
– Mass transit projects should have physical capacity to reach a
break-even volume: Can 100% farebox recovery of your
operating expenses be recovered with your physical capacity?
– Farebox income does not include general PSO, IMO, and general
tax subsidies.
* The farebox recovery ratio is the percent of operating costs paid by a combination of passenger fares, routine
income from rental of real estate, the taking-in contracts for maintenance and construction activities, and by
advertising income. Routine income does not include subsidies or dedicated taxes. Routine income is income that
depends on how many passengers are using the railway or metro
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27. 5.B How to Make it Happen Right:
Successful Income & Expenses
• Fares and Tickets:
Do not subsidize other social benefit agendas.
• Best Types of PSO and Taxes
– PSO and special taxes should be paid by organizations with a
direct benefit from dry port, cargo railroad, metro, light rail, or
commuter railway
– Best type of tax is land tax on only the land near the railway
stations and terminals
– Taxes are politically dangerous: It is better to rely on payments
by mines, shippers, real estate owners.
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28. 5.C How to Make it Happen Successfully :
Working Capital & Parts:
Advance Milestone Payments.
a) Do not become the contractors’ bank. If the contractors need
you to be their bank, then the contractors are too financially
weak to accomplish the work.
b) Do not advance cash based upon the contractors’ expenditures.
c) Pay only for useful, completed work.
d) Do not pay for raw material or incomplete work.
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29. 5.C How to Make it Happen Successfully:
Working Capital & Parts:
Parts.
• A simple test to learn if a passenger operation or an advanced
technology railway will sustain itself… is if it has routine spare
parts and repair material.
• When a railway project is in financial trouble, it shows you this by
reducing spare parts and track material inventories.
• If there are not enough routine parts and material for routine
maintenance and routine repairs, then there are safety
problems.
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30. 5.C How to Make it Happen Successfully:
Working Capital & Parts:
a) As a general rule, routine parts and material should be more than four percent of
the total price of the assets at the time of commissioning. Assets include
track, signals & SCADA, catenary and power sub-stations and transmission, ticket
vending and canceling equipment, building equipment such as lighting and
passenger furniture, rolling stock, and maintenance machines used for repairing
track, catenary, & rolling stock.
b) Major capital spare should not be included in the four percent of routine parts and
material: nonetheless, these assets must be owned and available to the entity
performing routine maintenance.
c) Routine parts and material may include long-term service contracts to update
software and perform systems maintenance on SCADA and other software-driven
assets.
d) Consignment material, Service contracts replacing hard-assets, and “Just In Time”
parts located in other nations should be not accepted as substitutes for actual
inventories of hard assets. The service contractor inventories of routine repair and
maintenance material that are not physically located in the provinces in which the
parts and material are used, should not be included in the sum of the inventories’
values.
e) Perform an independent physical inventory routine parts and material to verify that
the material and parts are actually available when the railway is commissioned.
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31. 5.D How to Make it Happen Successfully :
Can It Be Leased to Another Railway or
Operator?
Ask the Question:
Who else would want these assets?
If the answer is a problem, then there is something
wrong with the design of these assets.
a) Can my coaches, rails, EMUs and locomotives be used in another place?
b) Are my maintenance contract and parts are sole-source and expensive?
c) Is my information technology is unique?
d) Is my track gage is unique?
e) Is my axle gage is very light?
f) Will Indonesians be trained for advanced technical and for management
jobs?
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