The first thing that Phil Pacey, finance director at the Great North-Eastern Railway, does at the start of our interview is reach for a piece of railway memorabilia – a petty cash book for the same line that he now helps run dating back to 1907, which sits is a small display case in his high-ceilinged Victorian office near York station. “We have to remember that this is a business that’s being going for over 100 years and GNER is just the latest guise,” he says. “We do have to look back to history as well as look forward.”
In the railway business, it’s hard not to look back. Ever since the industry began, it’s been hugely romantic, held a position of great national importance, and been something of a nightmare to run from a financial perspective. In rail, people always seem to be harking back to a former golden age, whatever the reality of life on the line was really like.
Pacey, who entered the industry as a fresh-faced management trainee while it was still British Rail, has seen more change in the business over the past five years than any transport finance man would have seen for generations. “BR was a fantastic training ground,” he claims. “Not only financially, but in management, it really was. I came through the ranks, I’m actually one of the few finance directors now in rail who are rail trained.” When privatisation – the biggest shake up since nationalisation almost fifty years previously – was pushed through in the dying days of the last Conservative government, Pacey was naturally part of the management buyout team that bid for the newly created franchise covering the east coast mainline.
“I prepared GNER for privatisation,” he recalls. “I was also bidding at the same time, so I was part of the team that was running, selling and trying to buy the business -which was hell. We got a bid together that was fully financed, but we got beaten by Sea Containers, so in effect we were taken over, but I survived it.” In fact, even the successful bid by Sea Containers has a strange symmetry with Pacey’s past in BR.
The current owner, despite its name, is far from being simply an ocean-going bulk freight transport company. A majority of its business is now in leisure, hotels and passenger transport operations (including the Orient Express, a business which inspires Pacey), and in that respect it shares some heritage with Pacey’s previous experiences. “British Rail twenty years ago was a super place to learn one’s trade, because it ran railways, hotels, ships, ports and engineering companies – it was a UK conglomerate.”
Of course, that made the privatisation process somewhat more fraught than it had been for other state-owned businesses. The central problem, one which is still being argued over with no little passion, is that the rail network by its nature is hugely interconnected. Pacey still has to deal with this problem, but he has a particularly personal recollection of the rather haphazard way in which parts of the business were sold off.
“I was finance director of the Trains Division of British Rail before I joined the predecessor to GNER in York,” he explains. “That division purchased and maintained all of British Rail’s trains with an investment budget of up to £2bn a year. It spent about £1bn a year maintaining trains nationally. That was broken up into three ROSCOs and that’s interesting in itself: two of the three FDs at the ROSCOs are now millionaires.”
This has become something of a scandal, and Pacey’s first-hand observation of the process is fascinating. “The management teams each bid; I honestly thought they would have no chance,” he says. “Here was a huge series of asset leasing opportunities that were being handed out on a plate. And the main banks and institutions nearly all got frightened off. Part of that was Clare Short’s fault, because she was saying that Labour would re-nationalise things if they got in. But they were sold at a snip – management teams got two, and Nomura got the other one. I would never have called that in a million years. And those management teams were incredibly lucky to be in the right place at the right time, and when realisation dawned they made a lot of money.” And quickly – it was a matter of months before managers sold their interests and walked away wealthy.
Pacey betrays no hint of bitterness that he wasn’t part of one of the winning syndicates – and in any case, the level of complexity which lead to the ROSCOs being sold off so badly is still occupying much of his time. “To deliver enhancement in the product there are so many things which have to be aligned: Railtrack, the other operators, and the rolling stock suppliers,” he points out. “The planning in GNER, from the resource, relations, and finance angles, is hugely complex.”
Railtrack’s most recent report stresses that it has made great strides in improving punctuality.
But it is still facing large fines for failing to keep the infrastructure, which all the train operating companies (TOCs) rely on, up to scratch. Pacey writes out a cheque for £3m every week to the track operator, but if it fails, GNER is the public face that bears the brunt of customer anger. “Railtrack is everything,” the FD stresses. “If Railtrack is not performing, we are nothing.”
This is Pacey’s biggest operational problem. “The way I describe it is that our factory is full,” he explains. “There are no more paths on the track, the trains are full, the travel centres have got queues, telesales is full, the car parks are full – that’s good. We were actually built to a size by British Rail, based on efficiency, and if all the bits of the factory are full, it must have been designed quite well.”
Railtrack can accommodate some additional paths, but not at the peak times and to the key destinations which passengers are demanding. “So it is really a constraining force on the business, we’re really feeling it,” Pacey admits. “We are at times having overcrowding, and it’s starting to get frustrating for this company. You can’t make more money when the factory is full.”
Railtrack has said that it has a menu of infrastructure investments on offer to the TOCs, and that it is waiting to hear what they’d like. But individual elements, such as the ability of the overhead cables to support only a certain number of trains in simultaneous operation on the line, constrain GNER.
The future of the rail network hinges on the renewal of the current operating franchises. In 1996, GNER was one of the first companies to win a franchise. Pacey, incidentally, is keen to point out that in fact the government still owns the railways – it has simply contracted operators to run rail services on the Railtrack network. In GNER’s case, for seven years.
“It was all about operating contracts, the government saying: ‘We’ve invested in GNER, we’ve got some reasonably new trains, here are the assets, the leases, go away for seven years and deliver,'” Pacey recounts. “This time it’s about attracting new investment, and this is a completely different scenario. It’s very exciting, very challenging to get the bid together.”
The big difference this time round is that the Shadow Strategic Rail Authority (SSRA) is offering franchises for 20 years, and the old rolling stock supplied by British Rail is coming to the end of its life. New franchises are only going to go to those who can come up with a realistic investment plan.
“We will have to tie ourselves in to a large increase in assets, and most of those assets have got a life of 25-years-plus,” Pacey says, referring largely to new rolling stock. “So by definition, if you’re buying a large swathe of assets with 25 years life, your profitability is going to go backwards for a while. So there is a structural challenge, which is who pays, and how they pay. The second ingredient is building in a margin for error, given that the whole business is based on passenger demand, and passenger demand ebbs and flows with the economy, especially with a 20-year planning model. The third ingredient is that we’ve got to get a lot of the traditional suppliers on-side: if Railtrack is not on-side with this, we are not going anywhere, and therefore there is a huge effort to communicate, share, challenge, think, innovate – to try and put all the suppliers in place in such a way that they want to do the deals.
“Another ingredient is to try and attract new players into rail,” he continues. “For example, we’re going to buy tilt trains and the financing of those trains is attracting new players into the industry. That’s super, but there’s a huge challenge, and a lot of this is on me personally, which is about getting them confident and comfortable that this is the right place for them to put their money. So turning the City on to rail, and getting them to think of rail as part of their asset portfolio, that’s a pretty big task for all of us. We’re in the vanguard of this new phase, and a lot of the burden of getting people comfortable is going to fall on the first few deals.”
Being a subsidiary of Sea Containers is, in this respect, a double-edged sword. On the one hand, Pacey is approaching institutions with little or no exposure to the parent, which is listed in the US. On the other, that means that he’s having to build new financial relationships between UK-based capital and what, for them, is a relatively unknown quantity. Fortunately, increased competition between capital providers (banks, building societies and hungry European players) and between capital markets is helping the process. “There’s a shortage of UK-based asset deals,” Pacey adds, “so in terms of tax capacity, all the players out there are looking for it, and we’ve got some superb deals that we’re putting on the market.”
The FD is also the first to admit that such deals have to be structured carefully. “The track record is not good,” he confesses. “Eurotunnel, the high speed link – the deputy Prime Minister has had to rescue that. Long-term transport projects are fraught, that is the history. And therefore trying to secure the capital, trying to secure the right level of reward for the risks is a huge challenge, there’s a lot of time and effort going into it. One of the key things in transport projects is to get the most competitive financing. It makes a huge difference to the economics.”
As if coming up with a twenty year business and financing model wasn’t hard enough, GNER is going up against Virgin for the east coast franchise. There has been talk in the industry that the best outcome for the franchise would be a joint venture between the two, and although Pacey puts on a steely demeanour when discussing the tenders (“It’s a takeover battle, that’s how it is: it’s Virgin against us, head-to-head; we’ve got a worthy foe and we’re determined to win”), he is careful to show respect for the Virgin brand.
That doesn’t stop him being fairly acid about other elements in the rail industry, post-privatisation. “It has saddened us that the bulk of the railway industry was actually let to bus operators, and their credentials, other than access to capital and knowledge of privatisation, were basically cost-efficiency,” he laments. “We felt that was totally inappropriate to inter-city type operations.”
Sea Containers is also bidding for a number of other franchises – Pacey hopes that the GNER share of national rail passenger travel can rise from about 10% to nearly 30% – and plans to roll out its customer service ethos, which sees quality as the key to growth in passenger numbers, rather than cost-cutting, across the country. “We’re bidding for SouthWest Trains, and we’d dearly love to show England what could be done with a commuter railway into London,” he says.
This desire to provide high-quality service dominates Pacey’s talk about the railways. GNER, as an intercity network running services to Scotland via Leeds and Newcastle, is in competition with the airlines (“they’re efficient, they’re predictable, they’re focused, but they’re mechanistic – sort of like the Stepford Wives”) and the car (“where things are going in our favour, with the roads going backwards”). So the company can never lose sight of the fact that people have a choice.
Our interview with Pacey took place just days before the start of the Paddington rail crash inquiry, and these are sensitive times for a finance chief in a rail organisation. Pacey knows that the situation is far from helped by tabloid-style accusations that profits are incompatible with safety, but he takes it a step further. For him, passengers are the priority and safety is obviously key to that.
“This is part of my wider role, to get across to all the people who work at GNER the message that one of the biggest drivers of our revenue stream is actually perception and reputation,” he says. “If one is choosing to use a product, then having the right feel about that organisation and the product is important, and part of that feeling in the case of transport is that it’s safe. But it’s not just safety, it’s also a feeling about how one is going to be treated, it’s the feeling that if you go to the toilet it’s going to be clean – there are so many of those things. It is a complex product, and those feelings and perceptions are everything.”
GNER has invested heavily in staff and in service – the FD goes into great detail about the millions poured into additional staff, pointing out that the company has hired train managers. Previously, the staff on board had been uncoordinated, and the lack of a point of managerial responsibility had cramped the service offering. The chairman of Sea Containers, James Sherwood (a self-made man, and quite an imposing figure at the head of what remains, to all intents and purposes, a family firm), has the final say on any changes to the service offering or branding.In a way this takes us back to history. “We came from something that was under-invested, its safety was under attack, its perception in terms of how it looked after people was one of, at best, a utility, but at worst it treated people with disdain,” he says. “It employed people who weren’t interested in people, and we’re a service business. That was the inheritance, and there was a long way to go.”
Pacey loves the industry, despite the regulatory pressures, and despite (or maybe even because of) the high profile of rail in politics and the media – his list of outside commitments to business and civic bodies in the cities GNER serves is impressive. And his commitment to GNER is admirable: look closely at the picture at the start of the interview, and you’ll see that when we photographed Pacey at Kings Cross, he was wearing a GNER name badge in case passengers or staff had any queries (he also stopped to ask staff at the station how their platform fares collection trial was going).
But he’s not staying put. “I’d like to think that we could be a powerful player in rail. There’s a mission to roll out, and I’d certainly like to have a part to play in that,” he suggests. “Whether it’s as managing director of one of the franchises, or whether it’s a group finance and planning role – I don’t mind. I think my skills are analysis and planning and financial management and that sort of strategic work, but I love management too. I’d really like to have a crack at being managing director. I certainly don’t see myself staying here. Far from it. I’m still on a journey.”
This article first appeared in Financial Director magazine.
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