In the world of merger arbitrage, some stocks are always on the watchlist. MTR Corporation is one of them.
The Hong Kong government has faced almost constant calls to buy back the 25% of the city’s mass transit railway operator that it sold in 1999.
And those voices have only grown louder in recent weeks after MTR found itself at the centre of a scandal around construction flaws on parts of the city's most expensive rail project.
For investors, this may present a fresh opportunity to build up a position in the stock in anticipation of a possible buyout.
In what could be the worst crisis in the company’s history, MTR admitted providing the government with incorrect information on construction flaws at Hung Hom Station, an interchange at the HK$97.1 billion ($12.4 billion) Sha Tin-Central Link.
Four members of the senior management, including Sha Tin-Central Link project director Philco Wong Nai-keung, resigned after government investigations revealed workers cut steel bars to hide the fact that they were not installed correctly, raising serious concern over the safety of the project.
To make matter worse, MTR was forced to suspend construction of the future Exhibition Station, also on the Sha Tin-Central Link, after investigations revealed subsidence in 14 areas of the Wan Chai district had exceeded safety limits.
At the same time, MTR is preparing to finally begin services on the high-speed railway to China next month — putting the lid on a project that was completed three years late and at a much higher cost than originally anticipated.
Besides the construction scandal, the embattled rail operator has been criticised for a growing number of service disruptions caused by aging infrastructure and inefficient management. It has also angered passengers by hiking fares despite booking huge profits.
And while it struggles at home, MTR has been investing in rail projects as far away as Britain, Sweden and Australia, leading to questions on whether it is losing focus.
SHOULD RAILWAY BE LISTED?
That debate over whether mass transit operators should be publicly listed is highly controversial and will likely never come up to a conclusion.
Supporters say a listed metro operator runs more efficiently and transparently with private owners, while skeptics argue public transport should be treated as a public utility and therefore should be operated and fully subsidised by the government.
In Asia’s major cities, there are both government-owned and privately-run metro systems.
Tokyo Metro and Bangkok’s Skytrain system are operated by private companies. Seoul has a subway system that is largely operated by the government, while Kuala Lumpur’s nine metro train lines are operated by two government-owned companies.
However, these cities many not be directly comparable to Hong Kong — some of them have multiple subway systems, for example. As with many other things, Singapore is undeniably the closest comparable to Hong Kong since the two cities both run on a major mass transit system.
Intriguingly, Singapore’s SMRT Corporation also shares some of MTR’s troubles like train delays and falsification of maintenance records. In 2016, the Singapore government took the company off the stock market for S$1.2 billion ($884 million) through Temasek, effectively turning the city’s metro system into a government-owned entity.
Hong Kong's government might be well advised to do the same.
CORPORATE PRINCIPLE
The underlying problem over the MTR debate lies in the unshakable fact a company’s corporate principles will change after it goes public.
A public company needs to maximise value for its shareholders. However, some government entities operate for the benefit of the public, and therefore rank social and environmental responsibility higher than profit-making in many cases.
MTR was never intended to operate under a non-profit model. However, after turning into a public company in 1999, it has inevitably put profit-making as an even higher priority over serving the public.
There are parallels with Link Real Estate Investment Trust — previously the publicly-owned operator of malls, wet markets and car parks at Hong Kong's public housing estates. The company has become a punchbag for politicians who accuse it of gentrfying shops at the expense of mom-and-pop operators.
Link Reit openly admitted maximising shareholder value was a priority and that it would sacrifice public interest when it goes against those of its shareholders. It is the same for MTR.
And the harsh truth is social responsibility and profit maximisation are always in conflict.
PUBLIC CRITICISM
MTR has been criticised for neglecting public interest with its fare hikes through the years. Despite being profitable for seven consecutive years between 2010 and 2016, the railway operator raised overall ticket prices by 25.2% during the period with fare hikes every single year.
While the fare hike was largely in line with the city’s inflation rate during the period, critics have argued that factors such as profit levels, service performance, and MTR’s monopoly status were not considered under a controversial fare setting mechanism.
And yet, MTR was criticised most for receiving unfair treatment with its unique status as both a public-listed company and a public utility.
Intriguingly, the railway operator generated less than one-third of its revenue last year from its transport operations in Hong Kong. Over 60% of revenue came from developing and managing properties in Hong Kong and China.
Over the years MTR has operated under a so-called “rail plus property” business model by developing residential and commercial properties along its rail lines.
The Hong Kong government grants MTR development rights for land around stations and depots, allowing it to make money both from building homes and shopping malls on top of railway stations, and also from the incremental value that came along with the city’s ever-surging property prices.
EFFICIENCY AND INTEGRITY
When the SAR government listed MTR in 1999, financial secretary Donald Tsang said privatisation would bring about further improvements in efficiency, productivity and flexibility.
At that time, few would have criticised the move to bring in private investors since it was necessary for MTR to improve its operational standards when it was rapidly building out infrastructure and expanding Hong Kong’s railway network.
However, it is hard to tell how much impact being a public company has on improving MTR's operational efficiency, which has been declining of late as shown by frequent train delays and disruptions.
Besides, the recent construction scandal shows that when it comes to an integrity issue, a government-owned entity may take more responsibilities than a listed company.
As in the case of MTR, senior management can choose to leave the firm and leave the responsibility behind. But if it is fully owned by the government, it is impossible for the government to shed the responsibility or blame it on a private company's failings.
DETERMINATION
After all, MTR’s troubles have their roots in a highly-bureaucratic government, as well as structural problems such as the fare setting mechanism and the “rail plus property” model. As such, it is unrealistic to expect a drastic improvement in the short term even if the government takes back control.
Still, the government can show its determination to restore the quality of the city’s railway network and ease public concerns over MTR’s integrity by taking it back into its own hands.
MTR has a market value of HK$245 billion ($31.2 billion) based on Friday’s closing price. For the government to purchase the 25% stake it does not already own, it would cost about $7.5 billion – an easily affordable sum with the city’s $140 billion fiscal reserves.
As the railway is the main form of public transport in Hong Kong, it is time for the government to reconsider MTR’s social responsibility and take the asset back under control.
