Media Backgrounder – Crown Tranz Rail Proposal

The following is a simplified description of how Tranz Rail’s access charge would be set if Tranz Rail shareholders accept the Crown offer. It is pitched at the level of retail investors and is not a full technical description. The Crown will be providing a full briefing for the major institutional shareholders next week.

The overall Track Access Charge (TAC) would be set, on a forward looking basis every three years, at a level that should enable Tranz Rail to be commercially viable. Commercial viability is defined as making an economic return, which in turn is defined as providing an appropriate return on the capital invested.

The “appropriate” return will be calculated using financial industry standard methods. These methods allow for a return on capital proportional to the risk of an investment. Specifically it allows a margin to cover the higher risk of investments in the sharemarket and the rail industry relative to, say, government bonds.

In technical terms this means that the TAC will be set so that Tranz Rail is expected to have a Net Operating Profit after Tax (NOPAT) equal to its Weighted Average Cost of Capital or “WACC”. The WACC is the cost of capital including both debt and shareholders’ equity.

The exact margin for risk and fine details of the WACC calculation are still being agreed between Tranz Rail and the government.

The TAC is also capped at the level of TrackCo costs, so rail users will never pay access charges in excess of the costs of owning and maintaining the rail network.

If Tranz Rail performs to budget the return to Tranz Rail shareholders will be as calculated. However, it is not a guaranteed or capped return as performance worse than budget will result in a lower return and better performance will achieve a greater return.

Overall the TAC calculation is very favourable to Tranz Rail shareholders as it assumes a level of shareholder risk based on sharemarket and industry averages, but then removes components of that risk.

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