Department of Transport. Research Study into the financial and other implications of a proposed restructuring of the CIE companies

Transcription

1 Department of Transport Research Study into the financial and other implications of a proposed restructuring of the CIE companies 22 August 2002

2 Department of Transport Research Study into the financial and other implications of a proposed restructuring of the CIE companies 22 August /08/ 02

3 TABLE OF CONTENTS Page EXECUTIVE SUMMARY 3-14 DEFINITIONS 15 1 Introduction Existing Business Structure Introduction History of and background to CIE Existing industry structure Historic financial performance Historical financial review of operating companies Summary 30 3 Restructuring context Introduction Drivers of change The model for restructuring Financial Support for Public Service Obligation Introduction Capital grants Operational subvention Conclusion Property Introduction Description Issues Options Conclusion Claims Introduction Issues Options Conclusion 61 7 Debt Description Issues Options Conclusion 70 22/08/02 Page 1

4 TABLE OF CONTENTS Page 8 Pensions Description Options Conclusion 73 9 Other Financial Issues CIE shareholding in operating companies Taxation Central Services Introduction Generic restructuring issues Change management Operational & management requirements Resource allocation Cost of restructuring Generic functional plans Group IT and Telecoms Claims management Solicitors department Property services Group finance and treasury Internal Audit Group human resources and personnel Group Secretary Group marketing, media and PR Programmes and Projects Ancillary Services CIE Tours Commuter Advertising Network Phasing issues for implementation Introduction Overall approach to implementation Stage 1 - Initial restructuring Stage 2 Intermediate restructuring Stage 3 Final restructuring Restructuring Summary /08/02 Page 2

5 Executive summary Introduction This report has been written by PricewaterhouseCoopers for the Department of Transport in response to the evolving policy for the development of public transport in Ireland. It seeks to identify issues and set out options for a restructuring of the CIE Group into component operating companies, owned directly by the Minister for Transport (the Minister ), considering in particular: the financial implications of restructuring; the allocation of assets, debt and pensions, and provision of central group services; and the making of recommendations for phasing and implementation of restructuring. The uncertainty surrounding the future development of policy and evolving regulatory framework has immediate impact on the restructuring of CIE. This report assumes a model for restructuring which complies with the broad objectives of Government public transport policy as set out in the Red Book. The model for restructuring achieves independent commercial semi-state operating companies capable of sustained State ownership but with the capability of meeting future policy objectives. While many of the issues may be addressed initially on restructuring there will remain a number that will require greater clarity concerning the regulatory framework and long term policy objectives. Accordingly, we make recommendations for the phasing and implementation of the restructuring process. Existing business structure The CIE Group is currently structured as set out in Figure 1 below. Government (Department (Department of Public of Transport) Enterprise) DPE DoT CIE Group CIE Coras Iompair Eireann ( CIE parent company ) Bus Eireann Bus Atha Cliath Dublin Bus Iarnrod Eireann Irish Rail CIE Tours International Incorporated CIET Tours Rosslare Harbour Dubel Limited Source: Note 32, Group Annual Report and Financial Statements /08/02 Page 3

6 Figure 1: Existing CIE Group Structure In addition to holding all of the share capitals of the subsidiary operating companies, CIE parent company currently provides and performs certain functions for CIE Group. It: provides a group management function; owns the property assets; holds group debt; negotiates and allocates subvention; and provides certain central management, administrative and business support services. Over the past 10 years CIE Group has operated in an environment where services have increased and single fares have benefited from infrequent price increases. These increases were not related to extensions of service or cost inflation. As a result of this and operating cost inflation, operating losses before operating subvention has grown from 96m in 1997 to 248m in In the period since 1999 there has been a significant increase in passenger services available but for many of these services direct operating costs exceed fare box revenues. There has also been extensive investment in fixed assets over the past five years. The existing balance sheet is funded largely with capital grants, debt and claims reserves. Unamortised capital grants have increased from 69m in 1997 to 428m at 31 December The debt is of a historic nature with net debt of 250m at 31 December 2001 compared to net debt of 278m fourteen years earlier. The cash flow of the CIE Group is not adequate to retire debt and there is no capacity to support debt which is not State guaranteed. In addition, unfunded claims reserves have increased from 116m in 1997 to 157m at 31 December As a consequence of the factors described above, a restructuring of CIE Group will be driven, amongst other things, by the treatment of the key areas of property, debt, claims and subvention. Accordingly, the options and consequential impact on the operating companies of restructuring each of these are addressed separately in this report. The operational model is not efficient since the public service obligation is provided at a high level of commitment without detailed specification and lacks performance measurement or incentivisation. In combination with the absence of benchmarked financial objectives there is no tangible process for measurement of value for money for the taxpayer. This is not in accordance with the objective of public transport policy which is to ensure the provision of a defined standard of public transport at reasonable cost to the customer and the taxpayer. The process of restructuring must address these issues. Measurement of financial performance must be considered in an integrated way which addresses: the extent of services provided; farebox policy; operating subvention; and capital expenditure plans and available capital grants. 22/08/02 Page 4

7 Existing funding, subvention and fare box arrangements are not an appropriate basis for sustainable commercial enterprises. Detailed 5 year financial plans are required for each operating entity based on clearly stated assumptions acceptable to the operating companies and DoT. Restructuring context An optimal restructuring of the CIE Group in accordance with the broad objectives of public transport policy, should permit the public transport industry to move forward in a manner which will ensure that a defined standard of public transport can be operated efficiently, and performance reported in a manner capable of measuring value for money for the taxpayer. In addition, the restructuring process must maintain sufficient flexibility to be able to accommodate future developments in regulation and policy. A model for the creation of independent sustainable commercial semi-state operating companies (Irish Rail, Bus Éireann and Dublin Bus) should include, amongst other things: 1. a board of directors with an appropriate balance of executive, non-executive and worker directors, responsible to the shareholder, which in future would be the Minister for Transport and not CIE parent company; 2. an independent management team with the depth of resources to address all of the necessary business functions of an independent entity; 3. a detailed definition of the services to be provided; 4. a detailed definition, in the first instance by the operating companies, of the asset base required to provide those services; 5. the creation by DoT of an efficient funding structure; 6. an independent fares policy which is linked to operating subventions; 7. the setting of financial targets by the DoT with the support of agreed levels of subvention; and 8. arms-length agreements to be negotiated between the operating companies to deal with access to and use of property, group purchasing and other services provided. Each of the above items is essential to the creation of stable and sustainable commercial enterprises. It is unlikely that a restructuring of the CIE Group could endeavour to achieve all of the above immediately. The extent to which areas can or should be restructured at each stage is discussed more fully under each of the following sections. Items 1 and 2 need to be addressed in phase 1 while items 3 to 8 must be addressed in phases 2 and 3. Our more detailed recommendations concerning the phasing of implementation are set out in Section 12. Additional personnel resources will be required in the operating companies and in DoT to implement and operate the new regime. Chief Executive appointments in each of the bus companies will be required as the term of employment of the current incumbents expire under the existing appointments in /08/02 Page 5

8 Financial Support for Public Service Obligation The existing regime for capital grants and revenue subvention is determined through annual budgeting rounds. This constrains long term planning. Increased operational costs resulting from capital projects are not adequately addressed in the determination of operating subvention levels. A review of this process indicates that the following items are required : 1. the development and implementation of a detailed service specification including monitoring and incentivisation mechanisms; 2. the development of an independent fares policy so that the basis of increasing fares annually provides some commercial freedom to the operating companies and is independent of the Minister of Transport; 3. the introduction of an appropriate legislative and regulatory regime; and 4. the further development of a capital projects evaluation methodology so that cost benefit analysis takes full account of long term operating costs. Commensurate with item 1 is a commitment from Government to greater certainty concerning future levels of subvention and fares policy to permit longer term planning by the operating companies. Whilst an optimal restructuring would address all of these, as a minimum it should address options 1, 2 and 4, the implementation of which will be in part dependent on addressing option 3. This would permit an initial drive towards assessment of value for money. Property The CIE property portfolio is currently held by the CIE parent company which does not charge the operating subsidiaries for use of freehold property. Lease costs are charged on to the operating companies. The depreciated historic cost of this portfolio amounts to 139m at 31 December Under any scenario for restructuring the operating companies will require the continued use of operational property. As independent management entities they should be provided with flexibility and incentives to use property in the most efficient manner. The usage, ownership and financing of property should be viewed as separate matters. There are broadly two options concerning the redeployment of the CIE property portfolio: Option 1: transfer the ownership of the operational property from the CIE parent company to where it is required in each operating company. This may include transfer to an independent entity of property requiring common access, such as bus stops/stations, where ownership may better reside with an independent authority. Any necessary transfers to an independent authority need not happen initially but could 22/08/02 Page 6

9 happen as and when the regulatory model evolves. We understand that this is the preferred option of operating company management and consistent with recommendations made in the Yellow Book in respect of Iarnrod Éireann s property. Option 2: continue to hold the property in a central property holding entity, which would offer potential to retain central management, ownership and control. Access to operational property would then be permitted using arms-length lease contracts, incorporating economic rents. Either of these options can provide a pragmatic solution for property. There are a number of important issues that are required to be resolved before a final decision on property ownership in each operating company is arrived at. These include: the nature of the development of a competitive market; a legal review of EU regulations; the nature of regulation for the Irish market place; and a legal review of property titles. Under either option certain constraints should be placed on the use of property to assure preservation of the asset base for public transport use. Clawback arrangements should be put in place to capture any subsequent realisation of surplus value. Whilst constraints might be placed on the primary use of property, consideration should be given to incentivising operators to develop the environment for their customers, including development of peripheral services, such as retail franchises and commercial development. Introduction of an agreed measure for return on capital would provide a driver for further commercial development and exploitation of property assets. Charges should be implemented for use of property by an entity which is not the owner and principal occupier. Claims The CIE Group currently self-insures for all third party and employers liability risk, other than catastrophe. Unfunded claims reserves amount to 157m at 31 December The issues that arise on restructuring are: substantial initial funding implications of transferring to third party insurance arrangement and related impact on annual cost; legal viability of continuing with self-insurance arrangements in the context of private investment; and the continuation of effective in-house management of the function. 22/08/02 Page 7

10 The options on restructuring are: Option 1: continue with self insurance; Option 2: establish a direct writing captive insurance company; or Option 3: seek third party underwriting. To enable a restructuring to commence the pragmatic solution is to continue as is with Option 1. This would result in little change to the capital requirements of the CIE Group companies. The companies would continue to avail of the cashflow benefits but equally would be exposed to the risks of under-reserving. The potential would exist to move to either Option 2 or 3 over time if necessary but with very substantial funding requirements. Debt The CIE Group had net debt of 246m at 31 December CIE parent company is the holder of all group debt and provider of treasury management functions. The group borrowings are guaranteed by the State which permits optimal costs of borrowing. The existing debt funding structure is of a historic nature. The primary objectives of financial restructuring are two fold being: to refinance the CIE Group at sustainable debt levels in the context of its ongoing cashflows and its financing requirements for development and renewals; and to establish the operating companies with funding structures that achieve the lowest weighted average cost of capital. The issues concerning borrowings on restructuring are: there has been no substantial reduction in debt levels since the restructuring in 1987; any re-allocation of the existing debt to the operating companies on restructuring will maintain the same level of global borrowings and, assuming continuation of the State guarantee, result in broadly the same global interest charge; in advance of a full understanding of the eventual operating environments it is not possible to determine appropriate levels of gearing for the individual operating companies; the ability to service debt will be determined by future cash flows which will be a function of fares, subvention, service requirements and costs within the evolving regulatory framework; the restructuring will lead to an increased cash funding requirement for the CIE Group; and recent losses have further pressurised the debt structure. 22/08/02 Page 8

11 Prima facie there is no benefit from attempting to re-allocate the existing borrowings. Any desire to have some borrowings allocated to the operating companies in the early phases of restructuring is more closely related to the focus it would provide for management and DoT for operating companies to manage and generate cash. Accordingly consideration should be given to a capital injection to retire a significant portion of the debt. The debt retirement should be initially focused on Irish Rail where the debt levels have been constant with no reduction in debt levels since the 1987 restructuring. This debt amounted to 171m at 31 December We recommend full retirement of this debt given there are no current prospects of repaying the debt through operating cash flows. The bus companies are currently debt free. Consideration should be given to allocating a portion of the debt to the bus companies in conjunction with any transfer of property into these companies. This would effectively force the bus companies to show an economic return on the property transferred into the companies in as much as they would be required to fund the debt. These financing costs would effectively have to be settled either by increased revenues, likely to be fare increases, or through increased operating subvention. This would provide an efficient capital structure and a more transparent financial model but will not necessarily affect group operating performance. The quantum of debt transfer will depend on the 5 year financial forecasts which should be prepared. It will also be essential that the companies be allowed capacity to borrow further amounts to fund ongoing capital expenditure requirements. The residue of debt is at the CIE parent company level. This should be reduced by: (i) (ii) the settlement of the LUAS debtor of 47m - this is a timing issue; the transfer of debt to the bus companies; and (iii) the State retiring the balance. Pensions CIE has two final salary pension schemes both of which are well funded. On restructuring there are broadly two options: Option 1: creation and administration of separate pension schemes; or Option 2: continued shared participation in the existing schemes. Whilst the operating entities remain in public ownership the advantages of continued shared participation are likely to result in Option 2 being the preferred route for initial restructuring. The advantages of Option 2 are that it will minimise changes for employees; save in administration costs; and avoid splitting up of the funds. 22/08/02 Page 9

12 Management of Change The management of the change process, leading to any reorganisation of CIE group and its operating subsidiaries, will be fundamentally important to achievement of the desired outcomes. Structured and well planned communication with all the relevant stakeholders will be a critical process. Initial discussion of the planned changes with boards of directors, management, staff and unions will shape the ultimate outcomes. In planning for this change process detailed consideration needs to be given to existing terms and conditions of employment throughout the group. Central Services A number of management, administrative and business support functions are undertaken within the CIE parent company which support the day to day running of the operating companies or are required for consolidation and reporting of group performance to the Department of Transport. The restructuring of the CIE Group should ensure that the board and management teams of each of the operators have sufficient functional resource, systems and administrative support to enable them to continue to manage the business efficiently and effectively as independent commercial entities. To facilitate this a change management process will need to be instigated and managed by a dedicated change team. The change team should include senior management of CIE and each of the operators as well as change specialists. This process will: identify the operational and management requirements of the operators; develop a resource allocation process; analyse the cost impact of restructuring; and develop a transition plan for the restructuring process. In developing the restructuring process the CIE Group should seek to retain critical mass efficiencies where possible through shared services arrangements, at least in the short to medium term. This approach is in keeping with best practice adopted by many large national and international businesses. To facilitate the prompt implementation of the restructuring plan we recommend the formation of a Group Services Company to succeed to some of the services currently provided by the parent company. This approach ensures critical mass in certain key areas thus maintaining a value for money approach. The Group Services Company should be proportionately owned by the operating companies. The current functions undertaken by CIE parent company should then either be transferred into the Group Services Company or directly into the operating company as summarised in the table below. We would envisage that the transfer to the operating companies would take place on a phased basis (see description of phasing and Figure 2 on subsequent pages) thus allowing for a smooth transition and ensuring continuity of services to the operating company throughout the period of change. 22/08/02 Page 10

13 Function Initial Stage Intermediate Stage Final Stage Pensions management (inc. pension payroll) Claims management IT Services Internal Audit Services to be provided by group services company. Finance & Treasury HR Programmes & Projects Group Secretary Marketing & PR Solicitors Property management Current CIE function to be devolved to operators. Core functions to be devolved to operators. Retention of shared access to specialist expertise during transition period to be assessed further. Further detailed assessment required to determine allocation of management resources based on allocation of property ownership (see p.8). Strategic review of IT and Internal Audit completed - could be sourced by alternative provider (in-house or outsourced). Pensions and Claims management more likely to be maintained as part of GSC at this stage. Current CIE function to be devolved to operators. All functions devolved to operators. Further assessment required to determine allocation. As industry structure is developed in more detail, strategic management review of all functions completed and optimal provider for services identified. Current CIE function to be devolved to operators. All functions devolved to operators. Further assessment required to determine allocation. The ultimate objective is to ensure that each operating company has direct control over the support functions throughout the phased process. The phasing also recognises that certain functions such as IT, pensions management, claims management etc., rely on a skill set which is more effectively serviced by a central services function which has the critical mass to provide these services. Accordingly, during the initial phase functions that do not require this particular level of critical mass can be transferred directly into the operating companies. The transfer of other functions is phased to allow each operating company sufficient time to assess the quality and value of services and to develop their own strategy in relation to these more complex functions and either continue to use a central services provider or resource the function internally. The reallocation of the services, currently undertaken by the CIE parent company, to the operating companies will clearly give each operating company more control and direct management of its business. It will, however, lead to some duplication and dis-economies of scale where similar functions are undertaken by individual operating companies: This can be minimised by the continued use of the Group Services Company or an equivalent specialist provider particularly in the areas of IT, pensions and claims. Ancillary Services There are ancillary businesses within the CIE parent company, namely, Tours and CAN. There are two options concerning these assets: Two options have been identified for CIE Tours: 22/08/02 Page 11

14 Option 1: maintain within State ownership; or Option 2: divest the assets through either a management buyout or trade sale The divestment of this asset offers the potential to generate cash for the CIE Group although it will be essential that analysis to verify the financial viability of this option be undertaken prior to any decision. Two options have been identified in relation to the advertising contract managed by CAN: - Option 1: Continue with central contract; or - Option 2: Transfer to individual operating company contract. It is recommended that the existing central contract be maintained until completion. This is because the operating companies will need to complete a review of the benefits of collective negotiation against those of individual operating company management before finalising a decision. Phasing and implementation As indicated above, it is unlikely that the full benefits of restructuring can be achieved simultaneously and that a phased approach to implementation will be required. Accordingly, the following 3 stages of restructuring are envisaged: Stage 1: Initial restructuring, initial steps to enable a restructuring to commence, albeit at a sub-optimal level. This should commence prior to the introduction of new legislation, which will be necessary to effect the restructuring of the CIE Group. Stage 2: Intermediate restructuring, which would achieve a sustainable commercial model in public ownership but maintain flexibility to accommodate future developments in regulation and policy. This would happen on enactment of new legislation and vesting of assets/liabilities in operating companies. Stage 3: Final restructuring, over time there will be a need to accommodate future policy developments as envisaged in the Red Book. This would evolve with the implementation of new regulatory regimes. At this stage each of the operating companies would be sustainable commercial enterprises capable of providing a return on a defined asset base. The outline approach that could be adopted for the restructuring process has been summarised in Figure 2 overleaf. The approach comprises the three stages of restructuring, each preceded by a period of planning and implementation. 22/08/02 Page 12

15 Announce Restructuring Objectives Enact Initial legislation Introduce regulatory framework Competitive & Regulated environment Stage 1 Initial stage Change Management Function/operation needs Resource allocation, Management & Board planning Financial Restructuring Initial Capital structure Investment & cost impact Debt & property analysis 5 yr plan Policy formulation Subvention process Performance measures Regulation & legislation Outline Regulatory bodies PSO s Legislative framework Stage 2 Intermediate stage Change Management Review central functions Implement resource allocation, management & governance structures Financial Restructuring Develop optimal finance structures Vest assets/liabilities Establish financial targets Policy formulation Develop fare regime Vfm evaluation Regulation & legislation Develop PSC s Fully implement legislation/regulation Stage 3 final stage Change Management Operationally independent entities Review resource & management Financial Restructuring Financially independent entities Policy formulation Review policy objectives within new operating environment Regulation & legislation Complete regulatory & legislative reforms Figure 2: the restructuring route map Preparation for Stage 1 Initial Restructuring In preparation for Stage 1 Initial Restructuring, there are a number of interdependent decisions/approvals required to be taken to enable a detailed restructuring plan to be developed. These are as follows: (a) a decision by Government to proceed with preparation of necessary legislation; (b) the CIE Group and each operating subsidiary should be requested by Government to prepare a detailed implementation plan to effect the necessary restructuring; (c) the appropriate assumptions for a 5 year financial plan which include fares policy, operating subvention, service levels and capital programme should be agreed; (d) the levels of CIE Group debt should be reduced by at least the amount of Irish Rail s core debt of approximately 170m; (e) the most appropriate ownership structure for key operational properties in the CIE Group should be decided - this will involve a legal review of all issues, associated with transfer of operating property within the CIE Group, including title and EU law issues. Following the above decisions/approvals, detailed planning is required: (a) to assess the likely medium term impact of restructuring on the global level of subvention and capital expenditure requirements (which are not grant aided); 22/08/02 Page 13

16 (b) to develop initial fares policy, ahead of a formal regulatory regime, to provide the operating companies with a framework within which to operate; (c) to develop and implement a more detailed service specification which should include monitoring and incentivisation mechanisms. Commensurate with this will be a commitment from Government to greater certainty concerning future levels of subvention to permit longer term planning by the operating companies; (d) to commence a change management process including detailed assessment of each functional area of the CIE Group Services and resource requirements of each operating company; (e) to prepare 5 year financial plans including cashflow projections, so that an initial view may be taken concerning the capacity of each operating entity for debt funding and their requirement for working capital facilities. At the commencement of the initial restructuring the following key steps need to be undertaken: appointment of change managers in CIE parent company and in each of the operating companies; development of an outline restructuring plan for both the holding company and the operating companies. These outline plans will require approval by the respective company executive teams, boards and the Department of Transport; and development of a communication plan of the restructuring to all key stakeholders. 22/08/02 Page 14

17 Definitions CAN CIE Group or CIE CIE operating companies CIE parent company DoT Irish Rail Bus Éireann Dublin Bus CIE Tours Commuter Advertising Network, a division of CIE parent company Córas Iompair Éireann and its subsidiary companies Irish Rail, Bus Éireann and Dublin Bus Córas Iompair Éireann group holding company Department of Transport Iarnród Éireann Bus Éireann Bus Atha Cliath CIE Tours International Incorporated National Development Plan or NDP The National Development Plan The Minister Red Book Yellow Book Blue Book PSC PSO PSR PMS PTFP The Minister for Transport A New Institutional & Regulatory Framework for Public Transport August 2000 Iarnród Éireann, - The Way Forward, A report to the Minister for Transport, July 2001 New Institutional Arrangements for Land Use and Transport in the Greater Dublin Area. March 2001 Public Service Contract Public Service Obligation Public Service Regime Performance Measurement System Public Transport Partnership Forum 22/08/02 Page 15

18 1 Introduction The economic growth and prosperity that Ireland has experienced over the last 10 years has resulted in considerable pressure on many aspects of the publicly provided transport infrastructure and services. Expectations of service quality and performance have also increased. In addition there is strong recognition that the role of public transport should also be to promote sustainable development and social inclusion. In recognition of this, the Government introduced the National Development Plan, which outlines proposals for public transport investment strategy for the period 2000 to This strategy is developed further in A Platform for Change an integrated transportation strategy for the Greater Dublin Area 2000 to 2016 published by Dublin Transportation Office in November 2001 and in other land use and transportation strategies being developed in other major cities In August 2000, DoT issued the Red Book to outline proposals for new public transport policy. This had two purposes: to provide a basis for consultation with interested parties (including the Public Transport Partnership Forum); and to provide a policy framework to guide the DoT in preparing the necessary legislative and other measures to give effect to the proposed reforms Public transport service provision in Ireland is primarily provided by CIE through its operating subsidiaries, Irish Rail, Dublin Bus and Bus Éireann. A number of implementation issues associated with the proposed framework were identified in the Red Book and PricewaterhouseCoopers were commissioned to undertake a technical study to assess these issues Our Terms of Reference require us to: conduct an analysis of the existing and projected financial position of the CIE holding company and its subsidiaries and a description of the financial restructuring required to establish the operating companies as independent entities; evaluate the issues likely to arise on the separation of the operating companies from the existing group structure including, inter alia, the allocation of assets and debt, arrangements for pensions, the future provision of services provided by the holding company at present i.e. CIE Group financial management, IT and legal services, property and insurance/liability management; and make recommendations on how the financial, management and administrative issues identified might best be addressed and the steps required (including possible phasing arrangements) to implement the restructuring process, taking into account the evolving regulatory framework. Source: DoT, Appointment of consultants to carry out a research study into the financial and other implications of a proposed restructuring of the CIE companies, May /08/02 Page 16

19 1.1.5 As referred to above, the National Development Plan and A Platform for Change set out public transport investment strategy and a number of consultative documents have been produced in relation to this (including the Red Book and the Blue Book) concerned with the development of institutional, administrative and regulatory reform. This consultation process will promote the formation of policy. At present there is considerable uncertainty concerning the eventual form of that policy. When determined, the policy will have a direct influence on the regulatory framework and operating environment within which Irish Rail, Dublin Bus and Bus Éireann will provide services Against this background, CIE parent company and its operating companies are currently constrained in determining their long term business strategy and in long term financial planning. Accordingly, in addressing the Terms of Reference for the report we have carried out an analysis of the financial position of CIE Group but our analysis has been confined to the review of historic financial information and review of the budget for The operating companies in the CIE Group are responding in a short term framework to significant increases in demand for services and need for extensive expansionary and replacement investment without an integrated and well founded financial plan. While progress has been made in the short term at an operational level a sustainable funding model must be developed The uncertainty surrounding the future development of policy and evolving regulatory framework also creates added difficulty for key issues relating to restructuring of CIE. In order to write this report we have had to make a number of assumptions based on the broader objectives of Government public transport policy as set out in the Red Book. These assumptions concern the definition of a model for restructuring which achieves independent commercial semi-state operating companies capable of sustained ownership within the public sector but which should be capable of accommodating future policy objectives concerning: the introduction of further competition to markets; State funding; introduction of private sector finance; passing of assets and risk to the private sector; and maximisation of value of assets It will then be possible to make more specific recommendations on how to make further changes to the operating businesses and regulatory framework to achieve them In order to complete the research study we have undertaken a wide ranging analysis of CIE and its subsidiaries. The study has included considerable consultation with the senior management of both the CIE parent company and subsidiary companies. Our approach to the study has been to collate data using meetings and interviews with key personnel to identify issues. PricewaterhouseCoopers has not independently checked or verified this information and we rely on the accuracy and completeness of the information supplied to us. 22/08/02 Page 17

20 For each of the key areas of restructuring, subvention, property, claims, debt, pensions, and central services, we have applied an approach of describing the topic, identifying issues related to restructuring and setting out the options that may be considered. We have indicated how these issues might be best addressed, setting out the consequences of relevant options. Further detailed work will be required to finalise decisions on the most appropriate option for each issue and the programme of work to lead to implementation While many of the issues may be addressed initially on restructuring there will remain a number that will require greater clarity concerning the regulatory framework and long term policy objectives. Accordingly, at the end of the report we make recommendations for the phasing and implementation of the restructuring process. 22/08/02 Page 18

21 2 Existing Business Structure Key Points CIE parent company provides and performs certain functions for the group. It: - provides a group management function; - owns the property assets; - holds group debt; - negotiates and allocates subvention; and - provides certain central management, administrative and business support services. The CIE Group s current funding model is not sustainable due to lack of clarity in key planning assumptions. Clearly stated assumptions acceptable to the operating companies and DoT need to be developed in order that detailed 5 year financial plans can be produced for each operating company. As a consequence of the above, a restructuring of CIE Group will be driven, amongst other things, by the treatment of the key areas of debt, property, claims and subvention. Accordingly, the options and consequential impact on the operating companies of restructuring each of these are addressed in this report. The existing financial model has a debt funding structure based largely on pre 1987 borrowing rather than financial optimisation. The operational model is not efficient since the service obligation is provided at a macro level of commitment without detailed specification and lacks a performance measurement or incentivisation mechanism. In combination with the absence of benchmarked financial objectives there is no tangible process for measurement of value for money for the taxpayer. 2.1 Introduction The purpose of this section is to set out the existing business structure, highlighting certain aspects relevant to this study. These relate specifically to the legal, operational and financial structure, and the way in which the business is currently funded. In the face of a number of choices concerning aspects of restructuring this starting point is fundamental. 2.2 History of and background to CIE CIE is a statutory body providing land based public transport within the Republic of Ireland. It is wholly owned by the Minister for Transport and reports to that Minister. Whilst the operations of CIE were formed over half a century ago, the current structure with three operating companies, was established in 1987 under the terms of the Transport (Re-organisation of Coras Iompair Éireann) Act, Irish Rail, Dublin Bus and Bus Éireann are incorporated, and operate principally in the Republic of Ireland. They are incorporated under the provisions of the Companies Acts, 1963 to 2001, as wholly owned subsidiaries of CIE in accordance with Section 6 of the Transport (Reorganisation of Coras Iompair Éireann) Act, The structure of CIE is indicated in the diagram below. 22/08/02 Page 19

22 Córas Iompair Éireann Group "CIE Group", is organised into the following legal entities: (a) CIE parent company (b) 3 operating companies Bus Éireann, Bus Atha Cliath, Iarnrod Éireann (c) CIE Tours International Inc. (d) Dubel Limited (e) Rosslare Harbour Government (Department of Transport) DPE DoT CIE Group CIE Coras Iompair Eireann Éireann ( CIE parent company ) Bus Eireann Bus Atha Cliath Dublin Bus Iarnrod Eireann Irish Rail CIE Tours International al Incorporated CIET Tours Rosslare Harbour Dubel Limited Source: Note 32, Group Annual Report and Financial Statements 2000 Figure 2.1: CIE Group Existing Structure CIE parent company is governed under the Transport Act, 1950 (as amended). In addition to its role as group holding company with overall responsibility for the direction, performance and reporting of the Group, CIE parent company also performs a number of other functions: (a) owner of the portfolio of operational and other properties used by the operating subsidiaries; (b) holder of the group debt; and (c) responsibility for the negotiation and allocation of subsidy. 22/08/02 Page 20

23 2.2.3 The CIE parent company has some 187 employees whose principal focus is as provider of the following central group services: (a) IT (Section 10.8) (b) Claims management (Section 10.9) (c) Solicitors Department (Section 10.10) (d) Property Services (Section 10.11) (e) Group finance & Treasury (including salary and pensions management) (Section 10.12) (f) Internal Audit (Section 10.13) (g) Group HR and personnel (Section 10.14) (h) Group Secretary (Section 10.15) (i) Group Marketing, media and PR (Section 10.16) (j) Programmes & Projects (Section 10.17) Further detail and issues relating to these functions are dealt with in Section The three key operating companies Irish Rail, Bus Éireann and Dublin Bus and their operating brands, may be summarised as follows: Iarnród Éireann ( Irish Rail ), a corporate entity with 100% of its share capital held by CIE. The principal activities of Irish Rail are the provision of national rail passenger and freight services. These can be subdivided as follows: - InterCity - Suburban - Long Distance Commuter - Rail Freight In addition to these services, Irish Rail also has responsibility for the following activities: - Road Freight - Rosslare Harbour - Network Catering including Dubel Limited a corporate entity with 100% of its share capital held by Irish Rail. (Incorporated in Northern Ireland where it provides catering services for Northern Ireland Railways including their cross-border trains). 22/08/02 Page 21

24 2.2.8 Bus Éireann, a corporate entity with 100% of its share capital held by CIE. The principal activities of Bus Éireann are: - Expressway scheduled inter-urban coach services - Provincial City Services (in Cork, Limerick, Galway and Waterford) - School Bus Services on behalf of the Department of Education and Science - Local stage carriage bus services throughout the country - Commercial Vehicle Testing - Private Hire Bus Atha Cliath ( Dublin Bus ) a corporate entity 100% of its share capital held by CIE. The principal activities of Dublin Bus are provision of a comprehensive bus service for the city and county of Dublin and its hinterland as follows: - City Services - Cityswift - City Speed - City Imp - Nitelink - Airlink - Private Hire CIE parent company has one further subsidiary: - CIE Tours International, a corporate entity with 100% of its share capital held by CIE, incorporated in the USA The responsibilities of the directors of the subsidiary companies are determined by company law and the Transport (Re-organisation of Coras Iompair Éireann) Act, Rosslare Harbour The management of the harbour is undertaken by Irish Rail. The ownership and activities of Rosslare Harbour are governed by statute. A legal review is currently being undertaken modernise the status of legislation governing the port which dates back to the 1890s. Rosslare Harbour has been a significant profit contributor with operating profit of 3.8m on turnover of 10m in A reduction in volumes primarily due to the foot and mouth outbreak in 2001 combined with a competitive market place has reduced operating profit to 2.6m in /08/02 Page 22

25 2.3 Existing industry structure Operational structure The formal line of communication with Government as shareholder is through the DoT directly to CIE parent company. Strategic direction, control and overall co-ordination is provided by the holding company whilst each subsidiary and business unit has a high degree of operating autonomy. Each of the operating companies has a board of directors which includes worker directors and non-executive directors. The obligation on CIE to provide public transport services, is set out in the 1950 Act, Section 15 and the 1986 Act Section 8 (10), and is substantially based on the existing network timetable. There are no public service contracts in place due to legislative constraints. Some progress has been made with DoT in developing key performance indicators for financial, operational and customer service measures. We understand that a formal performance measurement system to measure and incentivise agreed levels of performance is being developed. DoT and the CIE Group are working towards a more modern model of transport delivery based on quantifiable service and quality definition. While a three year multiannual capital budget is used as a planning tool, the annual operational subvention levels are inadequate for current levels of service provided. Financial structure CIE Group receives income/funding from four principal sources: (a) revenue, which is represented substantially by farebox revenue for the provision of bus and rail services but also includes road freight, Rosslare Harbour, catering services etc; (b) contractors revenue from the Department of Education for school bus contracts and the Department of Social Family and Community Affairs; (c) operational subvention payments from Government to fund the shortfall of farebox and contract revenues over operating costs; and (d) capital grants from Government and the EU which are provided in accordance with the relevant EU Regulations governing State Aid to transport undertakings. 22/08/02 Page 23

26 The movement of revenue between Government and CIE Group is shown in Figure 2.2 below. Government Dept Dept of Finance Net assets replacement reserve debt claims grants NB no share capital Dept of of Transport PE Payment of CIE Interest Farebox Revenue Source 2001 Passenger revenues 481m Operating subvention 245m Capital Grants 187m Interest Payment (11)m Figure 2.2: Revenue movement Subvention is negotiated on an annual basis as part of a three year rolling process and paid by DoT to CIE Group with CIE parent company assuming responsibility for the allocation of subsidy between the operating companies. The annual process of subvention negotiation is driven by cashflow requirements to achieve a surplus for the year after State grants. It is not driven by specified levels of return on capital employed nor at a level that could permit a benchmarking of financial returns against other operators. The current subvention process is assessed in more detail in Section 4. DoT are working on developing a model having regard to international practice. 2.4 Historic financial performance Introduction We have completed an analysis of the historical financial position of CIE and the operators and a summary is presented in this section. More detailed analysis on specific elements has been completed in the relevant sections of this report. 22/08/02 Page 24

27 2.4.2 CIE Group Historic Financial Performance CIE Group '000 '000 '000 '000 '000 Operating Revenue 529, , , , ,837 Parent company Revenue 18,589 18,193 17,500 13,952 9,397 Total revenue 548, , , , ,234 Group Operating Cost 796, , , , ,232 Operating Loss before Subvention -247, ,753-93,252-92,049-95,998 Subvention 245, , , , ,196 Operating (Loss)/Profit after Subvention -2,460 33,324 53,428 43,813 37,198 Balance Sheet '000 '000 '000 '000 '000 Fixed Assets 939, , , , ,627 Net Current Assets 62,937 42,267 67,420-52,910-62,914 Long Term Creditors -403, , , ,023-99,310 Debt -245, , , , ,166 Third Party claims/liabilities -157, , , , ,011 Shareholders Funds -195, , , , ,226 The table above shows that, in response to general economic growth, travel demand in Ireland and consequent expansions of services, revenue has been increasing over recent years with minimal price increases. The increased service provision also resulted in a significant increase in operating costs, and in order to maintain a net surplus for the year (after State grants) subvention levels have increased by over 84% over last 5 years In reviewing the financial summaries of both the CIE Group and operating companies below a number of key points can be identified: (a) turnover has grown in each of the operating companies by between 18% and 38% in total over the 5 year period 1997 to This turnover growth is substantially volume related, as there has only been a single fare price increase in 2000; (b) operating costs have increased quicker than revenues (between 45% and 56% over 5 years) resulting in substantial increases in operating loss before subvention. These increases are particularly significant in 2000 and The increases in costs are primarily due to increases in service levels, pay awards and asset depreciation; 22/08/02 Page 25