We have been printing sections of the Reason Foundation Due Diligence Report recently,
and here is another section from that report. To remind you, this report of 185 pages was released in September of 2008, prior to the Proposition 1A bond issue on the November ballot.
The rail authority was required, by statute, to issue a business report and have it reviewed by a peer review committee prior to that election. They failed to do so. Nonetheless, the bond issue remained on the ballot and was passed by the voters.
This year, an appellate court in Sacramento found that the language of that ballot, written by the Legislature, was rigged in favor of bond passage, with much promotional and marketing hype embedded in what is required to be very neutral language. The court ruled against this process, citing the Proposition 1A language as prima facie evidence.
Had this Due Diligence Report been picked up by the media and the truth about the HSR project revealed to the voters before the election, they might have made a much wiser decision and turned the project down. Well, we know what happened and where we stand now.
We've presented the Executive Summary and the Introduction to this major paper, and here is the fundamental rationale; that is, why the paper needed to be written.
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http://reason.org/files/1b544eba6f1d5f9e8012a8c36676ea7e.pdf
The Necessity for Due Diligence
A California Senate Committee observed that the public
deserves a full accounting of the project’s risks and
benefits because the project has been portrayed as
a future commercial success. This study relies on
empirical data, historical trends and other data to
apply a due diligence process to this proposal.
The Authority has spent $58 million in public funding
to promote and plan for high-speed rail links among
the state’s major population centers. Due to the magnitude
of the project and because the project has been portrayed
as a future commercial success, there is a need for a due
diligence examination of this plan.
To this end, this work is based on a methodical analysis
of the rail proposal—the type that would be conducted
by potential investors prior to advancing capital in support
of a business proposal, project, venture or transaction.
In the business world, due diligence means undertaking
sufficient independent analysis to ensure that an acquisition
is worth the proposed price.
Addressing Investment Risk
The state Senate Transportation and Housing Committee
recently set the precedent for addressing taxpayers as
investors and helps set the stage for everything that follows
in this Due Diligence Report. Hence, the logic as it appeared
in a June 2008 report from the Senate Committee deserves
to appear at the onset of this study and is summarized as
follows:
The California High-Speed Rail Authority has embarked
upon a $33 billion program to provide high-speed rail service
between Anaheim, Los Angeles, and San Francisco. An
additional $7 billion will be required to extend service
to San Diego and Sacramento.
The project is not being developed as a conventional
public works project to be built with pay-as-you-go funding,
or by relying on public debt financing. Instead, the Authority
is offering California’s voters a business proposition.
Should the voters approve the $9.95 billion measure on
November’s ballot, the Authority is anticipating using the
bond revenues and future federal funds to attract a
substantial amount of private capital. The Authority’s
underlying assumption is that the demand for high-speed rail
is so strong that it will attract a private consortium to design,
construct, finance, and operate the high-speed system,
one that will generate sufficient revenue to repay the
consortium’s investment, cover the annual cost of operations,
and provide a profit. The Authority assumes that the rail
service will not require any future operating subsidy
from the State of California. This will be a large and
complex task given the uncertainty regarding federal
funding and the limited state funding allocated to t
he project. Voters are being asked to make a major
commitment. It is, therefore, imperative that voters
and policy makers have a full accounting of the
project’s risks and benefits.9
While the Senate Committee review is ground-breaking
in presenting a serious discussion of investment risk
associated with the project, it does not provide a level
of detailed analysis. This report will perform that task.
Moreover, the emphasis on risk in this document is
justified because the CHSRA business plan is advocacy
in nature and perils appear to be understated.10
In preparation for this study, thousands of pages
of CHSRA’s documentation spanning approximately
a ten-year period have been reviewed. Also, reports
from other state and federal agencies and documents
from overseas high-speed rail systems have been
examined. This report attempts to clarify material
facts and outline foreseeable risks that have received
insufficient public attention. Hence, it is a
Due Diligence Report designed to help policy
makers make informed decisions with respect
to public funding. The Senate Committee report
insists on the value of a prospectus in stating:
The Authority must update its business plan in a format
consistent with a standard financial prospectus of the
type that is required to be prepared for investors in
new stock or bonding offerings. A prospectus discusses
the investment opportunity, its financial strategy,
its benefits to the investors, as well as the types
and level of risk the investors are assuming. It is
essential that voters be provided with adequate f
inancial information concerning the project.11
Californians are being asked to be investors in a project
being portrayed as a future commercial success, but
the CHSRA’s documentation often relies on theoretical
capabilities or reflects advocacy positions. This study
relies on empirical data, historical trends and other
data to evaluate key issues related to the program, namely:
•• Ridership and marketability
•• Demographics
•• Costs and overall financing
•• Operational issues including safety
•• Train Speeds
•• Technological developments and limitations
•• Greenhouse gas emissions
•• Community factors
•• Possible line truncations or route substitutions
•• High-speed rail experience elsewhere
•• Highway and airport alternative scenarios
•• Adequacy of planning
Moreover, this Due Diligence Report follows the
admonition of the U.S. Securities and Exchange
Commission (SEC) that disclosure documents should
“speak to investors in words they can understand.
Tell them plainly what they need to know to make
intelligent investment decisions.” 12
Indeed, policy makers and private parties will be
making investment decisions regarding the high-speed
system when they make decisions about public funds
or commit their own private investments.
Limitations to Review
The following challenges were encountered in this
due diligence analysis, as a result of difficulties and
inconsistencies in the CHSRA documentation.
•• Reference Years. At the time of this analysis,
the horizon years of the CHSRA source documents
are inconsistent. As one example, in some cases
the latest available projections are for 2020 while
in other cases 2030 projections are available.
•• Data. Important data have varied widely. For
example, various documents differ in the proposed
route structures and estimated seating capacity of
the high-speed trains. These variables could negatively
affect the ridership that can be expected and thus
cause a concomitant decline in projected revenues.
•• Costs. Construction cost estimates are inconsistent.
The Senate Committee report cites $33 billion to build
the first phase (San Francisco–Los Angeles–Anaheim)
and an overall project cost of $40 billion. Presumably,
this information was obtained from CHSRA. Yet, CHSRA
documentation prepared for an investors meeting during
virtually the same timeframe puts the figure at $45.4 billion.13
•• Ridership. Variations in CHSRA’s ridership projections
claims are extensive and in many cases the data presented
appear to be inadequate to support the conclusions reached.
The Authority has acknowledged that it has commissioned
a new ridership and revenue forecast. However,
considering the exceptionally high demand that has
been projected, it will be prudent for future forecasts
to be subject to independent verification if they are
to be considered plausible.14
Another function of a Due Diligence Report is to bring
to attention costs that have been downplayed or overlooked.
•• Risk Minimization. Environmental impact documents
are replete with references to using the Union Pacific
Railroad (UPRR) right-of-way. In 2008 when the UPRR
declared its unwillingness to sell its land, the Authority’s
chairman said he was unconcerned.15
However, land-purchase costs could increase and
re-alignments could affects speeds,
marketability and construction costs. A related issue
is that landowners facing possible eminent domain
proceedings may file legal challenges. Municipalities
have already filed suits to require environmental
impact statements to be redone.16 Consequences
could include construction delays and cost increases.
•• Employee Injury Risks. A franchise operator will
find exceptional risks regarding
worker injuries and payouts. An anachronistic law,
the Federal Employers’ Liability Act
(FELA) passed in 1908, subjects rail operators to
costly, arcane and time-consuming tort based
provisions (all other industries are covered by less
onerous no-fault workers’ compensation laws).17
An attempt to exempt a franchisee from FELA is
certain to be met by opposition from the rail labor
unions and the trial lawyers’ lobby. It cannot be
determined from the CHSRA documentation if
such high-cost provisions have been included in
operating cost projections.
•• Labor Demands. A risk exists that labor organizations
will demand unique provisions in contracts with
high-speed rail operators identical to what they
have with Amtrak, particularly a labor protection
clause that provides generous severance compensation
for up to five years if a job is abolished or moved
more than 30 miles. Amtrak’s protection obligations remain
significantly higher than those of non-railroad
corporations.18 Because of the strength of railway
labor unions, and because it is typical for the
federal government to impose labor protection
regulations on assistance, it is likely that such
provisions would be applied to a California HSR system.
•• Subsidies. Statements about taxpayer obligations
are contradictory. For example, on January 11, 2008,
the CHSRA chairman, Quentin Kopp, said at a state
SenateTransportation and Housing Committee hearing
that another bond measure after the November vote
may be necessary if costs continue to rise.19
Ten days later, on January 21, another CHSRA board
member, Rod Diridon, insisted: “Having the people
of California pay one-third the price of this project
and then never again having to put money into a
program that will expand and expand and expand
is an awfully good deal for California.”20
After ten more days, on January 31, Chairman Kopp
wrote to legislators: “We believe that if additional state
funds appear needed for the remaining segments, it is
the prerogative of the legislature to determine the amount,
source and timing of such funds, similar to its action on
Phase One.”21 By June 22, the chairman stated unequivocally
that the HSR system would operate at a profit “without
taxpayer subsidy.”22
It is unimaginable that such inconsistent statements
would be made by corporate executives seeking investor
financing without running afoul of securities regulators.
The Authority has stated that the proposed high-speed
rail system “is one of the world’s largest public works
projects.”23 Thus it is even more imperative that all in
volved be cautious because “mega-project” financing
has begun to breed mistrust. The leading worldwide
infrastructure study on such projects concluded:
The cost estimates used in public debates, media coverage
and decision making for transport infrastructure
development are highly, systematically and significantly
deceptive. So are the cost-benefit analyses into which
cost estimates are routinely fed to calculate the
viability and ranking of projects. . . . An important
policy implication for this highly expensive and highly
consequential field of public policy is for the public,
politicians, administrators, bankers and media not
to trust the cost estimates presented by infrastructure
promoters and forecasters.24
This report finds that the CHSRA’s documentation and
public statements are indeterminate as to the project’s
commercial viability and indeed suggest that the project
is not feasible. This report finds that the CHSRA’s
documentation and public statements fail to confirm
the project’s commercial viability and the analysis in
this report suggests that the project is not feasible.
Conclusion
The California Senate Transportation and Housing
Committee observed that CHSRA ought to provide
a financial prospectus on the HSR project because
the project has been portrayed as a future commercial
success. This study relies on empirical data, historical
trends and other data to serve in part as a Due
Diligence Report. It finds that conclusions in the
CHSRA documentation are inconsistent, cost
estimates have not been updated, projections appear
to be based on data inadequate to justify the
conclusions reached, risks in several areas
(e.g., rights-of-way, liabilities for exceptional
employee costs) are understated or completely
ignored, and statements about future taxpayer
subsidies are contradictory. The Authority has
yet to balance issuance of its many advocacy
documents with cautionary documents that are
typically issued in an investment environment.
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