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APPENDIX C
To
Financial Aspects of California’s
Proposed High- Speed Rail Project
Prepared by Alan Bushell ( MBA, Harvard)
Preface: As an experienced operating executive having worked in Silicon Valley for
more than twenty years starting, restarting, rescuing and running technology based
companies I know what makes an acceptable operating plan for a new business. I know
what thoroughness is needed in building such a plan. I also have deep experience in
standing up for the content of an operating plan and defending the plan as it is challenged
by potential investors in both the venture capital community and institutional investors
and bankers on Wall Street. I have successfully raised private equity capital from both
venture capital and institutional investors and have also raised about $ 300 million of high
yield debt. The qualifications that afforded me the platform to assume such
responsibilities are stated in Appendix 1.
I have devoted close attention to the Operating Section ( pages 64 to 91) of the CHSRA
December 2009 Report to the Legislature and the associated Addendum dated April 8,
2010 ( page 70).
On CHSRA’s Assumptions About Operating Expenses: Above all, I have serious
reservations as to the methodology employed in developing operating costs and hence the
reliability of the reported expectations. This review will first provide structural
observations and then discuss selected referenced elements from the report.
The plan is driven from a ridership forecast and that is its major flaw. It says that it
knows what ridership at one given price point will be and it seeks to perfectly match
operations to that chosen revenue profile. Those of us that start up businesses know that
the real world is not like this. You have costs before you have revenue. You have to
differentiate between fixed cost and variable cost and look at every aspect of your cost
structure in that light. There is not one word in this section of the document that
acknowledges fixed versus variable cost. Fixed cost is by nature rigid. You have too
much of it before you need it, too much that you can’t offset if plans don’t materialize
and not enough if demand surprises you ( insufficient on- train bicycle capacity for
CalTrain). Variable cost does not vary in a straight line and every item of cost needs to
be carefully understood.
Step back from the train for a minute. Apple was able to deliver 1 million iPads in the
first thirty days following launch in 1Q 2010. That is downright impressive, but what if
they had only built 500,000? On the 24th of June they had taken 600,000 pre- orders for
4th generation iPhones in two weeks and customers without pre- orders camped outside
stores for nights hoping there might be an odd few units for them. On that first day of
release there were reports within the first few hours of reception/ antenna issues – do you
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stop the factories or do you charge ahead? Do you stop deliveries to those champing at
the bit to be first amongst their friends to have one, or do you keep taking the money and
hope that you have got it right? Have you got sufficient customer service capacity to
handle the uncertainty and possible fall out?
Potential investors will drill you every which way to make sure that you understand the
dynamics of your business and your plan shows them that before they will part with a
dollar. They expect you to lay out Risk Factors that show that you are fully prepared for
all exigencies and have the ability and resources to respond to them. They want you to
show that you understand that there can be a range of possible outcomes and that you are
operationally and financially able to deal with them. This report does not even touch on
this important aspect.
Potential investors expect you to be intimately knowledgeable regarding your
competition and their potential responses to your participation in the marketplace. No
discussion is offered of how the assumption of a HSR fare of 83% of a presumed airfare
of $ 125 might be countered by the airlines that already offer many variable fare options
well below $ 105. Where is the discussion of the impact of service disruption? Why is
there no acknowledgement of the fact that trains travel one behind the other with little if
any spontaneous overtaking opportunity/ capability? One in- route disruption generally
disrupts all trains. Auto wrecks can be reacted to by detours on alternate roads.
Airplanes are least impactful upon the ability of other airplanes to maintain operations to
schedule. Hundreds of miles of track, tunnels and bridges, combined with trains filed
with passengers carrying luggage are a security target beyond thorough policing. What is
the range of possible outcomes of scenarios such as these that what impact might they
have on both the revenue as well as the cost sides of the income statement?
Investors in new businesses expect to be presented with detailed line item operating
statements on a quarterly basis for five years forward and annual statements for
subsequent years. They want to see impacts of seasonality, variability, ramp up rates and
relative amounts being spent on discretionary elements. Some of these categories would
include: Recruiting/ Hiring; Education/ Training ( is this front end loaded and perhaps
contracted); Legal Expenses; Government Relations and Lobbying; Union Relations; IT
Services and Software Licenses; External Professional Services/ Consultants and of
course Travel and Entertainment. These operating statements need to be worked into
cash flow statements to ensure that the cash needs of the business are understood and that
if there are operating losses, it is understood how such losses are going to be funded.
The above comments relate to what should, but is not presented in the business plan.
What follows are extracts from the plan that are shown in Italics followed by comments
in regular typeface.
P. 64
Ridership, Revenue and Operations
Overview of Forecasts and Operations Planning
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Ridership, of course, is a determining factor, along with the cost of operations and maintenance of the
system, in developing revenue. These figures will be critical in developing interest from private investors
in the California high­speed
train project. Being highly interdependent, the operations plans and the revenue forecast have been repeatedly
r efined to ensure consistency of assumptions and workability of the high­speed
train service. P age 65 Forecasts for the programmatic EIR/ EIS work used fares based on an LA– SF fare at half ( 50 percent) of
the 2005 air fare, and varied proportionally with distance for other trips. This “ 50 percent” fare level
g enerates relatively large passenger flows without requiring operating subsidy The fare is calculated in the same manner as the 50 percent, but is anchored by an LA­SF
HST fare at 83
percent of the air fare, or in 2009 dollars a high­speed
train fare of $ 105 vs. a $ 125 air fare, and a $ 118
c ost to drive. P age 68 Between 2000 and 2030, population is forecast to grow by 42 percent to 48 million, and employment
will grow by about 51 percent. This growth will increase total interregional travel by 65 percent to 911
million trips a year, with auto keeping its lion’s share, but with a nearly five­fold
increase in
c onventional rail trips. For the purposes of this plan these are unsubstantiated forecasts that have a dramatic
impact in favor of rail trips. To the experienced operating mind there are serious
questions to be asked. How does employment increase twenty percent faster than
population – are we to assume that this is the great employment opportunity for the
presently unemployed? Why would interregional travel grow at a rate more than 50%
faster ( 65%/ 42%) than population growth? Whose determination is it that despite auto
maintaining its market share, rail trips will increase share of market by 500%? This is a
meaningless statement if rail starts from an insignificant share. In addressing
demographics no mention is made of the potential impact of telecommuting, tele-presence,
video conferencing, Internet document sharing and other emerging technologies
which are already starting to reduce the number of business trips taken by air. The
impact of these new technologies is already being reported in the Corporate Social
Responsibility Reports for 2007 and 2008 of corporations such as Cisco, Symantec, Intel
and Nike to name a few. Corporations are investing to see significant reductions in
corporate travel in the immediate future. Without considerations of these trends the
b usiness plan can only be seen to be selectively self serving at best. P age 69 The forecasts assume that high­speed
train travelers will not face airport­style
security checks and
processing time, in line with practice in the Washington­New
York­Boston
150­mph
Acela train services,
and all but one of the high­speed
train services overseas.. If the operator of HSR chooses to omit equivalent security measures over its entire
system ( track, tunnels, bridges, viaducts, signaling systems, locomotives, carriages and
power sources) in the interests of time and cost savings then the business plan needs to go
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into depth on the risk factors associated with such a decision and the impact on future
system economics and viability in the event of an attack of the proportions experienced in
London and Madrid. Page 70 The 83 percent level is in the middle of a wide range of experience in similar­length
markets outside of
California, based on prices examined in 200721. At the top end, weekend Acela fares in the New York to
Washington market were higher than air fares, and the Japanese Shinkansen fares were 108 percent of
air fares for Tokyo­Osaka
( 322 miles) and 114 percent Tokyo­Hakata
( 722 miles). London – Paris
Eurostar HST fares were 80 percent of air fares, both peak and off­peak.
Madrid – Sevilla ( 333 miles)
AVE fares were 71 percent of air, and Paris Lyon ( 244 miles) 71 percent of air. In the Paris Brussels
market ( 191 miles) where HST has 95 percent of the air/ rail market, and airlines are primarily
connecting to long­distance
flights, ( similar to Central Valley service to San Francisco or San Diego­Los
Angeles flights) air fares are very high, and HST fares were only 39 percent of air fares.
Fares for each trip continued to be expressed as a single average fare. The 83 percent level is in the
middle of a wide range of experience in similar­length
markets outside of California, based on prices
examined in 200721. At the top end, weekend Acela fares in the New York to Washington market were
higher than air fares, and the Japanese Shinkansen fares were 108 percent of air fares for Tokyo­Osaka
( 322 miles) and 114 percent Tokyo­Hakata
( 722 miles). London – Paris Eurostar HST fares were 80
percent of air fares, both peak and off­peak.
Madrid – Sevilla ( 333 miles) AVE fares were 71 percent of
air, and Paris Lyon ( 244 miles) 71 percent of air. In the Paris Brussels market ( 191 miles) where HST
has 95 percent of the air/ rail market, and airlines are primarily connecting to long­distance
flights,
( similar to Central Valley service to San Francisco or San Diego­Los
Angeles flights) air fares are very
high, and HST fares were only 39 percent of air fares.
F ares for each trip continued to be expressed as a single average fare. There is no discussion of the extent to which different fares are subsidized from the tax
base and other sources to reduce face value of rail tickets. Comparison with these stated
examples is therefore meaningless. Similarly certain air travel routes are able to maintain
non market driven fares as a result of being restricted to a monopoly national air carrier
and a reciprocal partner. Knowledgeable investors will by this stage be convinced that
the authors of this business plan are brewing and drinking their own Kool- Aid. P age 71 & 72 Y ear 2020 to 2023 increase. Figure 1 Ridership almost 262% Figure 2 Revenue: 261% The growth forecast over the first for years of operation is dramatic. Experienced
business operators know that there is a limit to how many employees can be recruited,
trained, learn the operating dynamics and chain of command and form a cohesive
effective entity. A ramp rate such as this needs to be substantiated with examples of
other entities that have successfully managed this type of flying start. P age 80 Operations, Costing & Cash Flow Operations cost ( all expressed in 2009 $$) in the third year of reporting ( 2019) is stated as $ 0.20
billion. 2020, the first full year of operations with passengers, is $ 0.68 billion ( 340% year on year
growth). 2021 has 20.6% growth, 2022 has 14.6% and 2023 has 9.8% growth. Thereafter, from 2023
($ 1.01 billion) through 2035 ($ 1.07 billion), a span of 13 years, operating costs are projected to be
essentially flat.
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This scenario is almost impossible to believe. Surely by the 15th year of constant
operation the maintenance cost should be increasing noticeably due to wear and tear.
However it is held constant at approx. 42% of essentially flat total operating costs. One
would only draw the conclusion that the executives that authorized this plan have no
experience relative to the task at hand. Assuming that all costs from 2023 through 2035
will be almost constant when expressed in 2009 $ and all experience the same average
rate of inflation runs counter to past experience. Medical insurance and fuel will be
major cost items for a system such as this. In the past twenty years no business operator
has been able to successfully contain these two expenses to anything like the general rate
of inflation.
Page 81 Insurance Cost shown as $ 0.0
Page 82
Insurance is assumed to be handled by the Authority and the state in the initial phase, through an
o wner­controlled
insurance program ( OCIP). This business is expecting private investors to be attracted. What guarantees will they be
given that their investment is exempt from any insurance expense into the future, or if
not, what is it likely to be? This business has assets that will need to be insured even if
self insured and there are costs associated that need to be revealed. There is also the issue
of liability insurance and no mention is made with respect to whether “ handled” also
means that unlimited cost will be absorbed by some entity other than the HSR system
i tself. Table J
Initial Phase Operating Results T his Table anticipates an Operating Surplus in every year from 2020 through 2035. It is surprising that despite forecasting fifteen consecutive years of substantial operating
s urpluses there is no discussion of any tax provision with respect to such surpluses. W hat is not shown in the costs? Costs that, by omission, will have to be borne by the citizens of California through their
taxes and their portion of the federal subsidies through their portion of the federal taxes
paid by all citizens of the US include: Interest cost of servicing the bonds. Principal repayment of the bonds. Interest and amortization on Federal Debt contributed to capital costs. Page 84 Cost of the System Cost Estimate Summary Page 85 & 86 Tables 1, 2 & 3 This discussion does not address and include costs of eminent domain takings for
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expanded right of way, grade separations and approaches to grade separations nor takings
for construction purposes. It also does not address costs that might be incurred due to loss of business experienced
through disruption by businesses impacted during the construction phase. This discussion has not yet addressed the cost impact of alternative track solutions
ranging from berm, to tressle, to open cut, to cut and cover and to tunnel. The authors appear not to have processed the lessons taught by Flyvberg, Bruzelius and
R othengatter in their book Megaprojects and Risk – an Anatomy of Ambition. In the interests of not overburdening the reader I reserve comment on pages 87 through
9 1 for those more qualified to address engineering matters. ADDENDUM ( April 8, 2010)
to the California High‐ Speed Rail Authority’s
“ Report to the Legislature; December 2009”
Page 70+
REITERATION OF TICKET PRICING IN BUSINESS PLAN REPRESENTING ONLY SCENARIOS AND NOT
POLICY DIRECTION
Ticket Pricing Scenarios
As is indicated in the December 2009 Report to the Legislature, the average high  speed train fares are
scenarios, and no policy decision has yet been made on how much a ticket will cost for the system.
That decision will be made in the future, with input from the Authority’s Board and any private entity
contracted for the system’s operations.
The Authority has looked at two scenarios for potential ticket pricing: one with high  speed train fares
being set at 50 percent of airfare over the same distance and another at 83 percent.
The first scenario shows the broadest ridership, and therefore the largest environmental impacts. And
for that reason, that scenario continues to be used by the Authority for environmental review and
mitigation.
The second scenario is used to illustrate that with this increase in fares, ridership goes down but so do
operations and maintenance costs, such that the revenue surplus actually increases. Since fewer
passengers are carried, fewer long trains need to be operated, reducing operations and maintenance
costs. The result is an increase in the bottom line cash flow projections.
In both scenarios, the system would generate a significant revenue surplus after the initial ramp up and
would not require a government operating subsidy.
It is alarming that, after four months of review and the opportunity to significantly
improve the business plan, the above is the informed opinion of the California High
Speed Rail Authority. I paraphrase: We can make it work at 50% of airfares, we like it
better at 83% of airfares but, no matter what, we will generate a significant operating
surplus that would not require a government operating subsidy!
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Unbelievable
I also refer you to the work of Liam Julian ( with whom I have never had any contact)
referenced below:
http:// www. hoover. org/ publications/ policy- review/ article/ 5296
Hoover Institution
Stanford University
. . . ideas defining a free society
The Trouble with High- Speed Rail
by Liam Julian
Liam Julian, a Hoover Institution research fellow, is managing editor of Policy
Review.
Copyright © 2010 by the Board of Trustees of Leland Stanford Junior University
Phone: 650- 723- 1754
Extract from this article:
Other setbacks came in January, when the California Legislative Analyst's Office,
the legislature's nonpartisan watchdog, issued an evaluation of the High Speed
Rail Authority's most recent business plan. It found the following:
* The rail plan offered an " uninformative timeline" and presented an
" inconsistent order of events."
* The rail plan contained " no risk management strategy." For instance, it
addressed " the risk of incorrectly forecasted ridership with one sentence," murkily
noting that " the risk ' would be mitigated by policies that continue to draw people
to reside in California and encourage high- speed rail as an alternative mode of
transportation.'"
* The rail plan did not " provide any numerical ranges nor confidence intervals
for projections contained in the plan ( such as cost, revenues, or ridership)." Thus,
" the risk of not realizing the forecasted ridership, revenues, or costs is unknown."
These conclusions are simply devastating. Perhaps the most- damaging among
them, even though it's not particularly new, is that the High Speed Rail Authority's
latest business plan contains no realistic outline of how California will pay to build
a high- speed rail system. And so the ridership problems, political problems, route
problems, timeline problems all become secondary - none of them matters if
billions of construction dollars never materialize.
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