The hatchet job

By Frances Martin

Sunday 1st September 2002

The people who do those surveys that find New Zealand is an ethical place to do business should go talk to Michael Beard. The Tranz Rail managing director has just been the target of a very nasty piece of attempted corporate sabotage.

Tranz Rail, you'll remember, got slammed in the media during July with stories suggesting it had been cooking its books using the kind of dodgy accounting exposed at US phone company WorldCom. The articles all quoted an anonymous report claiming the rail operator had been capitalising routine maintenance to inflate its profits. The upshot was that its track was supposedly overvalued by a whopping $308 million - equal to $2.55 on each Tranz Rail share - and its reported profits were higher than they should have been.

Sound bad? It would be if it were true.

You can't blame the media for its interest. The timing of those behind the report was superb. It popped up during a meltdown in the US share market, amid accounting scams that were making investors jumpy.

Tranz Rail was vulnerable to investor sentiment: it had just issued a profit warning after its own share price started to nosedive. Assets were going to be written-down in value, the company warned, though not the track.

The public had good reason to be interested, too. Since former controlling shareholders Wisconsin Central Transportation, Sir Michael Fay and David Richwhite sold out, institutions - many of them investing pension funds - have become Tranz Rail's biggest shareholders. The rail company also controls an asset crucial to the functioning of New Zealand's economy and acts as a lifeline for our exporters.

In fact, the dubious accounting claims didn't hold up to closer scrutiny. Under New Zealand Accounting Standard 28, repairs are classed as a cost that should be deducted from profit each year. Money spent improving assets, however, can be capitalised - which basically means it gets added to the asset's value. The spending can then be written off as depreciation (wear and tear) over several years instead of one.

Before Tranz Rail was privatised in 1993, it expensed all track renewals. But since then, about half the $50 million spent each year on the track has been expensed. The rest - about $183 million - has been capitalised, with about $45 million of depreciation charged against profit. Tranz Rail says the capitalised track spending reflects improvements in the asset. In 1993 four-wheeled wagons could only run at about 55km/h, it says. Track improvements now mean bigger wagons can travel at 80km/h. The network is worth more because it can cope with bigger, faster trains.

This treatment of track spending has been scrutinised and accepted by its auditors, KPMG, as being within the accounting rules. Tranz Rail's been quite open about it, and share market analysts also knew track spending was being capitalised because the amount of depreciation charged has been a hotly debated topic in research reports. "Of course we knew," one analyst says, pointing out that the gradual rise in the track's value showed up in Tranz Rail's annual reports.

Analysts' relaxed attitude to the treatment of track spending was also evident in the fact the anonymous report had almost no impact on the company's share price. Sure, it dived in July, but the fall began several days before the report was leaked and was largely due to analysts realising Tranz Rail wasn't going to achieve expected profits.

But the anonymous report did have a big impact on Tranz Rail's reputation with the wider public. As well as claiming the company was cooking its books, it suggested the rail operator's financial state was so weak that users of its services should be worried. Written in March, it was quoted in several newspapers within a short space of time in July, suggesting someone systematically leaked the document. Why leak it then?

The rail company was in what can only be described as fierce price negotiations with big customers such as state-owned coal company Solid Energy. The track's value had been a big issue in these talks. The higher the value placed on it, the more Tranz Rail could claim it must charge customers to cover its capital costs. A report saying the track was worth $308 million less than claimed could substantially weaken the company's bargaining power.

Even more importantly, the report's release coincided with ever-so-sensitive talks Tranz Rail had been having with the government about renationalising the track. Arguably, selling the network fits in with Beard's vision of Tranz Rail as a freight company that doesn't necessarily own the assets it uses. He's already flogged off part of the network in Auckland and has outsourced engineering services.

A bigger issue for the company is whether it would be allowed to keep its monopoly on running rail freight services after the network moved into state hands. A report suggesting the track was overvalued might seriously undermine Tranz Rail's bargaining power over price. Suggestions it was financially unstable might also damage its arguments for remaining the only freight operator allowed to use the lines.

Now, who would want to deliberately sabotage Beard and his gang?

Tranz Rail declined to talk about the report's pedigree. That isn't surprising as Unlimited understands the initial prime suspect was one of the company's biggest customers, Solid Energy. However, the state-owned miner's chief executive, Don Elder, categorically denies he had anything to do with writing or leaking the document. "It was not commissioned by Solid Energy [and we're] not in a position to have had any responsibility for any use made of it." Elder's seen the document and knows the author's identity, but says the person has no connection with his company. "I've said the same to Tranz Rail."

The finger's also been pointed at the Rail Freight Action Group, a lobby group spearheaded by Auckland public relations consultant Cedric Allan of Porter Novelli. However, Allan says he hasn't seen the report and neither he nor the group had anything to do with commissioning or leaking it. That's not to say the group - whose members include Tranz Rail customers such as Solid Energy, Fonterra and Fletchers - hasn't had a well-timed go at the rail operator.

It aired its concerns about Tranz Rail's performance in a press release on July 22, the day after the company bared its soul to analysts during a seminar aimed at winning back market confidence after the profit warning. This was the first journalists had heard from the group, which Allan says was formed about a month earlier. The group is not anti-Tranz Rail, he says, but it wants to make sure the government doesn't pay too much if it does buy back the track as a high price would be eventually be passed onto customers.

Allan dismisses suggestions the main impetus behind the lobby group is Solid Energy, saying all members have played an equal role. However, other group members told Unlimited Allan is a driving force, as is Sara Lunam, a former Tranz Rail employee who now works as a consultant for Solid Energy. Solid Energy's representative within the lobby group, Lunam says she's seen the anonymous report and knows who wrote it but she had nothing to do with commissioning or leaking it. In fact, she was out of the country at the time.

As for Beard, he's tried to ignore the sabotage attempt - publicly at least - and has instead gone all out to win back market confidence in his Tranz Rail restructuring plans. He and chief financial officer Wayne Collins have taken the extreme step of issuing profit forecasts for the next three years, almost unheard of in the New Zealand share market.

In doing so they've taken a huge gamble. Beard and Collins know what happens to companies that don't meet analysts' profit expectations: their share price gets crushed, just as Tranz Rail's did in July. If they disappoint the market again without good reason they should probably start looking for new jobs. They've essentially put their heads on the block in what can only be described as a determined attempt to show analysts just how serious they are about meeting them.

Investors seem to have been impressed. Tranz Rail's share price firmed just after the forecasts were unveiled, though it's since been weighed down by a drop in the wider market and by credit ratings agencies Standard and Poor's and Moody's putting the company on negative credit watch.

But, with luck, Beard and Collins will have bought themselves enough breathing space to turn the company around and restore profits to an acceptable level. Of course, that's assuming they aren't ambushed by any more sabotage attempts.

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