Transmanche Link Case Study

The Eurotunnel Project illustrates the cost overrun risk and economic risk that accompany large, ambitious transportation projects. This is particularly so when there are competing modes of transportation; in this case, ferries whose operators may reduce fares in order to compete. The Eurotunnel Project's experience highlights the financial problems that high leverage can bring. In spite of its financial difficulties, as of the date regular passenger service began, the European financial community generally felt that the Eurotunnel Project would continue to operate. However, it recognizes that Eurotunnel would require a financial restructuring to reduce its debt burden. Subsequent events appear to validate these concerns. Recent positive net profits have helped to justify the restructuring, but they have remained relatively small and unstable. Ultimately, the two governments and the creditor banks have so much at stake that the Eurotunnel Project is probably too big and too visible to be allowed to fail.

This afternoon, Eurotunnel's shareholders will meet in a convention centre near Charles de Gaulle airport in Paris to vote on a radical proposal: to sack the board of directors. It may sound like the sort of idea that never gets beyond the mass voting power of the pension funds and financial institutions, but Eurotunnel is different. Small investors rule at the owner of the Channel tunnel - specifically, French small investors. One million of them account for 65% of the shares and many are angry. Their investment has fallen 90% in value since the peak and they blame the British and French governments for encouraging them to invest in what has become a financial horror story.

Even Eurotunnel's board admits the company will be unable to meet its interest payments from the end of next year. To the rebels, it is time to get tough: let the company slip into insolvency, they argue, and force the British and French governments to sanction state aid. It is brinkmanship - financial madness, argues the current board - but we may soon find out whether it works; last night, with proxy votes already counted, the rebels had a commanding majority.

To outsiders, the drama seems bizarre. The Channel tunnel is perhaps the finest engineering achievement of the 20th century and runs beneath the busiest shipping lane in the world. How can its owner be in perpetual financial |crisis? The answer - a combination of ideological stubborness and wild optimism about the tunnel's popularity - starts at the moment the project was born.

The stage was a summit meeting in Paris in November 1984, during an era when Britain's contribution to the EEC budget was a source of annual complaint. This time, however, the negotiations had been easy, thanks largely to the efforts of President Mitterand. Margaret Thatcher was enjoying a rare moment of Euro-enthusiasm: she spoke of a new "togetherness" in Europe and an era of co-operative projects.

Not that this was expected to extend as far as a Channel tunnel. Mitterrand was keen, but such huge construction projects seemed to fail a basic Thatcherite test: they usually ran massively over-budget and required the taxpayer to guarantee the finances. In a long night of discussion at the British embassy in Paris, the prime minister confounded her fellow cabinet members by slowly swinging behind the idea. Britain, it was announced the next day, would back a feasibility study. The only condition was that the project be financed entirely by the private sector.

At this stage, the talk was not of a tunnel, but of a fixed link. The submission of the consortium led by Sir Nigel Broackes of Trafalgar House envisaged a bridge-plus-tunnel design. In engineering terms, it was the most ambitious and it seemed to be favoured by the French. But at the Department of Transport Nicholas Ridley appeared to encourage the consortium of American entrepreneur James Sherwood, whose ferry business was under threat whichever link was built. Like the Broackes bid, Sherwood's design incorporated a road link, a feature that scored well in opinion polls. Thatcher herself spoke of driving to France.

The eventual winner was the compromise candidate - the Channel Tunnel Group, a consortium of 10 contractors and five banks with a plan for a twin-track rail tunnel. Cost, and the relative simplicity of the design, seemed to be the deciding factors. And so the Treaty of Canterbury was signed in 1986, vowing to use the tunnel to foster better relations between Britain and France, and specifically disallowing state subsidy. All that was needed now was funding - a task that proved as complex as any of the engineering challenges.

Over the next 18 months, the project was almost shelved before a sod of earth had been removed. The first round of fundraising, known as Equity One, amounted to just £45m and was distributed among the original backers of the Channel Tunnel Group. Equity Two was to raise £205m, with the sums coming equally from the big financial institutions in Paris and London. The French institutions - many of them state-owned, but that was allowed - easily found the cash. In London, however, it was a desperate scramble. The Bank of England was called upon to twist arms. After two delays, and amid acute embarrassment, London eventually found its half-share.

But the size of the challenge was obvious. The project required a further £5bn of bank lending, and the lead banks were demanding that another £750m be raised from new shareholders. One result of the near-disaster of Equity Two was the replacement of Lord Pennock as co-chairman of Eurotunnel. In his place came Sir Alastair Morton, veteran of the British National Oil Corporation, an intimidating, sometimes abrasive executive with a reputation as a man who would not take a backward step. He was determined that the thing would be built.

Eurotunnel itself, the body Morton would run with André Bénard, his French co-chair man, was the creation of the banks. They did not want to lend directly to the building contractors; instead, they wanted a single body to stand in between as owner of the tunnel. The 10 contractors, now known as Trans Manche Link (TML), would deliver to Eurotunnel.

Almost immediately there was a problem. The lead bankers - NatWest, Midland, Credit Lyonnais, BNP and Indo Suez - were happy with construction contract, but a tier of secondary banks thought it too favourable to the contractors and insisted on it being rewritten. "The result was that the contractors had to decide whether they wanted to sign a contract that was not so powdered and friendly as the one they had wanted," says Morton. "It was a source of continuing friction thereafter."

The original plan was to float the company in summer 1997. Morton managed to persuade his colleagues that the timetable was far too tight. But even the newly scheduled flotation date of late autumn was not achieved without a major scare. SNCF of France and the then British Rail were being asked to guarantee the sums they would pay to use the tunnel, known as the minimum usage charge. Morton recalls a meeting in Paris, where the railways made a "final offer" that fell short of the mark. "Bénard and I looked at each other and I said, 'Shall I tell them, or will you?' As we were in France, Bénard did it. He lambasted them in French, which for a three-month-old project was quite brave. But it worked." Days later, at a hastily arranged meeting at Heathrow, the railways caved in.

What was not known at the time was that the railways' predictions of passenger demand - the basis on which they agreed the minimum usage charge - were a sham. Guillaume Pepy, now chairman of Eurostar, the operator of the high-speed service, but a senior official at SNCF at the time, admitted last year that the forecasts were deliberately optimistic in order to make the business case for the tunnel. The original forecast was for the trains to carry 17m passengers in 2003; in the event, the figure was a little over 7m. If accurate forecasts had been made at the time, the tunnel would never have been built.

In 1987, however, optimism reigned. Some 220 banks entered the £5bn lending consortium and small investors, with the inducement of travel perks, subscribed for the shares in droves, even if the French were far more enthusiastic than the Brits. Eurotunnel got its money on December 1 - and the huge boring machines started work under the white cliffs of Dover the following day.

What followed was six years of engineering brilliance - and bitter arguments between Eurotunnel and its contractors. It quickly became clear that the job of building the longest undersea tunnel in the world was harder than the geological surveys had suggested. On the French side, where conditions had always been known to be tougher, just 50m of tunnelling were achieved in the first three months.

The engineering difficulties were eventually overcome; in their place came quarrels about who would pick up the extra costs. "We bid for and won this contract knowing very well that the initial sum would not guarantee us sufficient margins," says one French contractor now. "So we did what is common practice in the public buildings and works sector: as soon as the first pick was swung we began to make financial demands on Eurotunnel, our client. It was out of the question that we would lose money on this difficult site."

On the Eurotunnel side, Morton started from the premise that TML had signed a contract to deliver a finished and fully equipped tunnel, and that is what it should do. Compromises were achieved only because both sides - and the banks - knew a half-dug tunnel was worthless. Meanwhile, beneath the channel, progress became easier. In December 1990 the breakthrough in the small service tunnel was shown live on television. Hopes were high that services could start on schedule in mid-1993. Eurotunnel, on the brink of running out of cash, exploited the moment to call on its shareholders for another £530m and its banks for another £2.1bn.

The optimism did not last long. Equipping the tunnel with a working railway and rolling stock turned out to be the most painful process of all. This was the era of disasters such as Zeebrugge, King's Cross and Hillsborough and the original safety specifications were improved and improved again. In Eurotunnel's view, TML was hopelessly underprepared for the task. For their part, the contractors were critical of their client's decision-making processes.

The tunnel eventually opened late, with a reduced freight service, in June 1994; passenger services followed in December. By then, Eurotunnel was a financial basket-case: the cost of building the tunnel had rocketed from £6bn to over £10bn. The problems were compounded by the high interest rates of the period: some 11%-17% in the early 1990s, compared with 5%-7% at the time the borrowing was agreed. The year's delay in opening equated to an extra £700m in interest charges; the sums were crippling. "It will be remembered as an engineering marvel, but it will also be remembered for having a defective contract and funding structure," says Morton now. "It made life difficult for a lot of people."

Since the tunnel opened, its financial difficulties have only intensified. The ferries, contrary to early forecasts, have not disappeared, and budget airlines have increased competition. Eurotunnel had to be rescued from meltdown for the fourth time in 1998, and now faces a fresh fight for its life. It still has debts of £6.4bn, and last year's underlying operating profit of £170m was more than wiped out by interest charges of £318m. The current chief executive Richard Shirrefs reckons the prices Eurotunnel is obliged to charge operators such as Eurostar are hindering growth, and calls the engineering marvel "an underused piece of kit".

The minimum usage charge - that troublesome, and ultimately fudged, contract from the 1987 - expires next year, triggering the debt-repayment crisis. Shirrefs' solution is Project Galaxie, a plan where the chief proposal is a call for the British government to give him control of the Channel Tunnel Rail Link and for fares to be lowered in return. To many, that sounds like a breach of the Treaty of Canterbury's rule that there be no state-aid to the Channel tunnel; a court challenge would be inevitable.

Yet it is hard to see how the dire state of Eurotunnel's finances cannot eventually become a problem for the governments of both countries: major state-owned assets, like the high-speed rail lines in both countries, are inevitably tied to the success of the tunnel. Victory today for the rebel shareholders may merely ensure that Eurotunnel becomes a political problem earlier. As for Thatcher, who insisted the project was a chance for the private sector to show what it could do, in two volumes of memoirs she didn't once mention the Channel tunnel.

The engine driver

Nicolas Miguet, failed rightwing French presidential candidate turned stockmarket tipster, is the leader of Eurotunnel's rebellious shareholders. He has run his campaign with a talent for publicity - Eurotunnel has been front-page news in France for months - and direct appeals to shareholders via a telephone hotline.

His language is also direct: last week's telephone message, denounced as "morons" and "intellectually deficient" those shareholders who returned blank voting forms, which count as votes for the board.

Richard Shirrefs, Eurotunnel's chief executive, was so infuriated by one of Miguet's more personal rants that he took succesful legal action in the French courts. Miguet, though, says he regards condemnation for defamation as "a badge of honour".

It would be hard to see Miguet's style appealing to small British shareholders, but they are now a rare breed at Eurotunnel. The Brits tended to buy the shares for the free travel perks and then sold.

In any case, most small investors here can also balance their Eurotunnel losses against gains from privatisation sell-offs of 1980s. Privatisations in France, such as the disastrous France Telecom, have been far less profitable for the small punter.

· Frédéric Pons is a journalist on Libération

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