Title

The merger of two railways in Hong Kong : a case study

Author(s)

Leung, Hon-wai; ho"Z

Citation

Issue Date

2008

URL

http://hdl.handle.net/10722/54613

Rights

unrestricted

THE MERGER OF TWO RAILWAYS IN HONG KONG - A CASE STUDY

LEUNG HON WAI

M.A. IN TRANSPORT POLICY AND PLANNING DISSERTATION

THE UNIVERSITY OF HONG KONG 2008

Abstract of dissertation entitled

The Merger of Two Railways in Hong Kong - A Case Study

Submitted by

Leung Hon Wai

for the degree of Master of Arts in Transport Policy and Planning at The University of Hong Kong in August 2008

Transport is of vital importance to a society to meet its social and economic needs. The economic success of Hong Kong depends largely on the achieving a high level of mobility of both material and people. Hong Kong has a diverse multi-modal public transport system which includes the railways, trams, buses, minibuses, taxis and ferries. About 11 million passenger journeys are made everyday on the public transport system.

The rail merger involves the merger of the rail operations of the Mass Transit Railway Corporation Limited (MTRCL) and the Kowloon Canton Railway Corporation (KCRC) but not the merging of the two companies. KCRC still exists as a legal entity after the merger and solely owned by the HKSAR Government.

The objective of the proposed study is to review whether the Rail Merger between MTRCL and KCRC is successful or not. The study focused on reviewing the merger result with its relevance to the Governments Transport Strategy and impacts to its stakeholders, the community and the public passenger transport systems in Hong Kong. The study reviewed in details the key integration processes before and after the merger but did not touch on the merger deal as it is of commercial sensitivity.

The research findings support that the Rail Merger between MTRCL and KCRC is successful and it will enhance the competitiveness of the railways as a result of enhanced interchanges and fare reduction. The operating efficiency and synergies achieved can be used to fund the fare reduction for the benefits of the travelling public. It will also facilitate the Hong Kong Government towards achieving the objective in using railway as the backbone of public transportation in Hong Kong due to improved connectivity between new and existing lines under an integrated railway operations and planning.

However, it is now only a few months since the Rail Merger implemented on 2 December 2007 and a further assessment at later stage is recommended. How the new merged railway operations further explore untapped synergies arising from the combined railway operations and projects construction, for further efficiency and cost effectiveness and better value creation to services leading to further benefits to the Hong Kong community, would be critical to the success of the Rail Merger in the medium to longer run.

The successful experience of the Rail Merger between MTRCL and KCRC can be taken up as a role model and solid foundation for possible merger among other public transport operators and public utilities e.g. between the public franchised buses or even between the two public power companies China Light & Power and Hong Kong Electric. Of course, a balance between potential monopoly on supplies and benefits of merger must be struck with all relevant perspectives taking into consideration. Other practitioners may make use of findings of this research to undertake further research into possible merger between other public transport operators or public utilities, for the benefits of the Hong Kong community.

The Merger of Two Railways in Hong Kong - A Case Study

by

Leung Hon Wai

A dissertation submitted in partial fulfilment of the requirements for the Degree of Master of Arts in Transport Policy and Planning at the University of Hong Kong

August 2008

DECLARATION

I declare that this dissertation represents my own work, except where due acknowledgement is made, and that it has not been previously included in a thesis, dissertation or report submitted to this University or to any other institution for a degree, diploma or other qualifications.

Signed...................... Leung Hon Wai

ACKNOWLEDGEMENTS

I would like to express my heartfelt thanks to my Dissertation Supervisor Dr. Ernest Lee for his patience and unfailing support throughout the preparation of this dissertation. He has offered me his guidance, advice, and encouragement without which I would not be able to complete this dissertation.

I must also thank the MTRCL Management for their kind permission to make use of the company data and certain merger integration details in compiling this dissertation.

Last but not least, my appreciations should go to all those supporting me in the preparation of this dissertation, in particular to my wife Peggy and my three children Jacky, Gigi and Fiona.

ii

CONTENTS
Page Declaration ......... Acknowledgements .......... Table of Contents... List of Illustrations (Figures, Charts and Tables)... Appendices......... i ii iii v vi

CHAPTER 1 1.1 1.2 1.3 1.4 1.5 1.6 1.7

INTRODUCTION 1 4 6 7 9 10 11

Overview of Public Transport Systems in Hong Kong Background to the Rail Merger. Governments Transport Strategy. Railway Development Strategy 2000... Objective and Scope of the Study.... Methodology. Structure of the Dissertation..

CHAPTER 2

LITERATURE REVIEW AND ANALYTICAL FRAMEWORK 13 17 19 21 24 26

2.1 2.2 2.3 2.4 2.5 2.6

Terminology of Mergers and Acquisitions... Merger Integration Processes... Major Factors Critical to Success of A Merger... Governments Core Objectives in A Merger Other Merger Experiences. Analytical Framework.

CHAPTER 3

ANALYSIS OF THE TWO RAILWAYS IN HONG KONG 28 35 42

3.1 3.2 3.3

Mass Transit Railway Corporation Limited (MTRCL).... Kowloon-Canton Railway Corporation (KCRC).. Similarity and Difference between the two railways..

CHAPTER 4 4.1 4.2 4.3

ANALYSIS OF THE RAIL MERGER 49 52 53

Payment Terms Merger Framework Agreement. Service Concession Agreement iii

4.4 4.5 4.6 4.7 4.8 4.9 4.10

Rail Operations after the Merger.. Merger Integration Implementation.. Stakeholders Analysis Fulfilment of 5 Parameters set by the Government... Fare Reduction and Fare Adjustment Mechanism.... Seamless Integration of railway network. Performance of railways after the merger...

53 54 72 83 85 85 87

CHAPTER 5 5.1 5.2 5.3 5.4

CONCLUSION AND RECOMMENDATIONS 89 92 93 94

Success of the Rail Merger Potential Pitfall and Drawback.. Limitation of This Research Possible Merger of Other Transport Operators and Future Research..

REFERENCE.........

95 - 98

APPENDICES....

99 - 101

iv

LIST OF ILLUSTRATIONS
FIGURES
Figure 1 2 3 4 5 Photo of Merger Celebration Ceremony........ Key Success Factors to Merger... Analytical Framework. Photo of Cultural Integration Activities Photo of MTRCL EGMs Voting Result on Merger Page 6 21 27 70 76

CHARTS
Chart 1 2 3 4 Merger Failure Causes.. Merger Integration Organization Structure........ Comparison of MTRCL Stock Price to Hang Sang Index........ Market Shares of Major Transport Operators Page 26 55 77 82

TABLES
Table 1 2 3 4 5 6 7 MTRCL Railway Lines (Pre-Merger)... KCRC Railway Lines and Light Rail (Pre-Merger) Average Daily Ridership for KCRC before Merger MTRCLs and KCRCs Vision, Mission & Values......... Fare Reduction Examples........ Patronage of other Transport Operators in June 2008.. MTRCL Operations Performance in First Half 2008. Page 29 36 37 46 76 82 88

APPENDICES
Appendix 1 2 MTRCL Operating Network with Future Extensions. MTRCL New Vision, Mission and Values... Page 99 101

vi

CHAPTER 1 INTRODUCTION
This chapter aims to introduce an overview of the dissertation to the readers. The dissertation will start with a brief overview of public transport systems in Hong Kong and followed by the background of the rail merger. The Governments Transport Strategy will then be recapitulated to reiterate its strategy to accord priority to railways with intention that railways will form the backbone of our future passenger transport network. Finally, the objective, scope of the study as well as the methodology of the research will be highlighted. 1.1 OVERVIEWS OF PUBLIC TRANSPORT IN HONG KONG Transport is of vital importance to a society to meet its social and economic needs. The economic success of Hong Kong depends largely on achieving a high level of mobility of both material and people. Hong Kong has a land area of only 1,104 square kilometres but it has a population of approximately 7 million with about 3.5 million under employment as at mid 2007.1 Hong Kong has a diverse multi-modal public transport system which includes the railways, trams, buses, minibuses, taxis and ferries. About 11 million passenger journeys are made everyday on the public transport system. Public Transport patronage increased in 2006 by about 1.7% over 2005 to 11.36 million passengers per day. The railways which carried 4.12 million passengers per day in 2006 overtook franchised buses to be the largest passenger carrying mode. 2

_______________________
1. 2

Hong Kong Year Book 2007 (http://www.yearbook.gov.hk/2007). HKSARG Annual Transport Digest 2007 (http://www.td.gov.hk//mini_site/atd/2007/s5).

There were two railway companies in Hong Kong before 2 December 2007. The railway operations of the Mass Transit Railway Corporation Limited (MTRCL) and the Kowloon Canton Railway Corporation (KCRC) were merged on 2 December 2007. The combined operating network with future extensions is shown in Appendix 1.

There are altogether 5 franchised bus companies in Hong Kong including The Citybus Limited, The New World First Bus Services Limited, The Kowloon Motor Bus Company (1933) Limited, Long Win Bus Company and The New Lantao Bus Company (1973) Limited. All together they carried 3.94 million passengers per day in 2006. 3

There are also non-franchised buses (NFBs) and their role is to supplement the mass carriers and to provide tailor-made service to specific groups of passengers. As at 31 March 2008, there were 7071 registered nonfranchised public buses.4

Public Light Buses (PLBs) are minibuses with not more than 16 seats. Their number is fixed by a Gazette notice at a maximum of 4350 vehicles. Some PLBs are used on scheduled services (distinguished by a green livery, hence called green minibuses) and others on non-scheduled services (red minibuses, as per their red livery). Red minibuses are free to operate anywhere, except where special prohibitions apply, without control over routes or fares. There are 1444 red minibuses in February 2008. In year 2007, RMBs carried about 415000 passengers daily. Green minibuses (GMBs) operate on fixed routes at fixed fares. In year 2007, GMBs carried about 1,400,000 passengers daily 5

_________________________
3 4. 5

HKSARG Annual Transport Digest 2007 (http://www.td.gov.hk/mini_site/atd/2007/s5) http://www.td.gov.hk//transport_in_hong_kong/public_transport/buses/non-franchised http://www.td.gov.hk/trasnport_in_hong-kong/public_transport/minibuses

Taxis provide a convenient personalized point to point transport service and play a key role in Hong Kongs public transport service. At present, there are 18,138 taxis in Hong Kong, of which 15,250 are urban taxis, 2838 are NT taxis and 50 are Lantau taxis. The average daily taxi patronage is about 1 million. 6

Starting from 1 April 1999, most of the ferry services are provided by licensed ferry operators. There are now 11 ferry operators providing 26 regular licensed passenger ferry services to outlying islands and across the Harbour as at 1 April 2008. Still there remain two franchised ferry services, operated by Star Ferry plying between Central and Tsim Sha Tsui as well as between Wan Chai and Tsim Sha Tsui. The licensed and franchised ferry services are supplemented by kaitos which are licensed to serve remote coastal settlements. In 2007, ferry passengers amounted to 54 million .7

Electric trams have been operating on Hong Kong Island since 1904. The Hongkong Tramways Limited operates six overlapping routes on 13 kilometres of double track along the northern shore of Hong Kong Island between Kennedy Town and Shau Kei Wan, and about three kilometres of single track around Happy Valley. The trams recorded an average of 230,000 passenger trips daily.8

Another tramway is a cable-hauled funicular railway, operated by Peak Tramways Company Limited since 1888. The 1.4 kilometres line runs between Central and the Peak and carries about 12,000 passengers a day, mainly tourists and local sightseers.9

_______________________
6 7 8 9

http://www.td.gov.hk/transport_in_hong_kong/public_transport/taxi http://www.td.gov.hk/transport_in_hong_kong/public_transport/ferries http://www.td.gov.hk/transport_in_hong_kong/public_transport/tram_and_peak_tram http:www.td.gov.hk/transport_in_hong_kong/public_transport/tram_and_peak_tram

1.2

BACKGROUND TO THE RAIL MERGER

The rail merger involves the merger of the rail operations of the Mass Transit Railway Corporation Limited (MTRCL) and the Kowloon Canton Railway Corporation (KCRC) but not the merging of the two companies. KCRC still exists as a legal entity after the merger and solely owned by the Government

The idea of merging the two railways in Hong Kong, namely merger of the railway operations of the Mass Transit Railway Corporation Limited (MTRCL) and the Kowloon Canton Railway Corporation (KCRC), was first put up on 25 June 2002 by the Government of the Hong Kong Special Administrative Region (HKSAR). After the Governments in-house study, it was concluded that a merger could bring benefits to railway Corporations, the general public and the Government.

In February 2004, the Government invited MTRCL and KCRC to commence discussions relating to a possible merger on the basis of the following five parameters: (a) adoption of a more objective and transparent fare adjustment mechanism;

(b)

abolition of the second boarding charge and review of the fare adjustment mechanism;

(c)

early resolution of interchange arrangements for new rail projects under planning, notably the Shatin to Central Link;

(d)

ensuring job security for frontline staff of both the Company and KCRC at the time of the rail merger; and

(e)

provision of seamless interchange arrangements in the long run.

In mid-September 2004, a Joint Merger Report prepared jointly by the two corporations was submitted to the Government for consideration.

On 11 April 2006, the Government and MTRCL entered into the Memorandum of Understanding which, amongst other things, addressed each of the five parameters above. The Memorandum of Understanding recorded the understanding reached between the MTR and the Government as to the structure and key terms of the Rail Merger as at 11 April 2006. These terms were not legally binding and created no legal obligations on either party as to the final structure or terms of the Rail Merger. 10

Under the Merger agreement, MTRCL will operate the KCRC system under a service concession for 50 years and will make regular payments to the Kowloon-Canton Railway Corporation for this right.

The followings are chronological highlights of Key Rail Merger Events:-

24 Feb 2004

Government invited MTRCL and KCRC to commence discussions on a possible merger of the two companies.

11 Apr 2006

Signing and announcement of the confidential Memorandum of Understanding between MTRCL and Government setting out the proposal structure and financial terms of the Rail Merger

7 Jul 2006

Government introduces the Rail Merger Bill to the LegCo which formed a Bills Committee to study the bill in detail.

8 Jun 2007
10

The Rail Merger ordinance was duly approved by LegCo.

_______________________
MTRCL Extraordinary General Meeting Circular 2007, p.17.

9 Aug 2007

Transaction Agreements to the Rail Merger were signed.

9 Oct 2007

The Rail Merger was approved by MTRCLs Independent shareholders.

2 Dec 2007

Appointed Day of the Rail Merger

Figure 1 The Merger Celebration Ceremony 2 December 2007

(Source: MTRCL Annual Report 2007)

1.3

GOVERNMENTS TRANSPORT STRATEGY

The Government has, in the past, published a number of papers with respect to its transport policy and strategy. These include a paper published in October 1999 entitled Hong Kong Moving Ahead - A Transport Strategy for the Future, a paper published in March 1998 entitled RDS-2, a paper resulting from RDS-2 headed RDS 2000 which was published in May 2000 and a paper in November 2006 which reaffirmed the position with respect to certain elements of RDS 2000.

The Governments current transport policy Hong Kong Moving Ahead A Transport Strategy for the Future was published in October 1999. It focuses on: Better integration of transport and land use planning Better use of railways as the back-bone of passenger transport system Better public transport services and facilities Better use of advanced technologies in transport management Better environmental protection

To summarise, one of the focal points of the Governments current transport strategy is to accord priority to railways with the intention that railways will form the backbone of the future passenger transport network.11

1.4

RAILWAY DEVELOPMENT STRATEGY 2000

In order to cater for Hong Kongs continued population growth (which is projected to reach 8.9 million by 2016), and the increasing cross-boundary social and economic activities, Government commissioned the Second Railway Development Strategy (RDS-2) in March 1998. 12

Based on the key findings of RDS-2, Government has formulated Railway Development Strategy 2000. The strategy maps out the preferred railway network expansion plan for the HKSAR up to the year 2016. On completion, the network would increase the rail share in the public transport system from 31% in 1998 to 43% by 2016. 13

________________________
11 12 13

MTRCL Extraordinary General Meeting Circular 2007, p.90. Railway Development Strategy 2000, p.3. Railway Development Strategy 2000, p.15.

The Network recommended in the Railway Development Strategy 2000 will feature six new rail corridors and a potential Port Rail Line (PRL). The six new rail corridors are:-

a)

an east-west corridor from Chai Wan to Tung Chung formed by the MTRCL Island Line (ISL), the North Hong Kong Island Line (NIL) and the Tung Chung Line (TCL);

b)

a second east-west corridor from Tseung Kwan O to Kennedy Town formed by the MTRCL Tseung Kwan O Extension, ISL and the West Hong Kong Island Line (WIL);

c)

a north-south corridor which, depending on the operator, could either run direct from Tai Wai or Ma On Shan to Hong Kong Island via South East Kowloon;

d)

a Kowloon Southern Link (KSL) that will provide convenient connection between the KCRC East Rail and West Rail via the Kowloon peninsula;

e)

a Northern Link (NOL) that will connect the KCRC East Rail and West Rail at the northern part of the New Territories; and

f)

a Regional Express Line (REL) that will provide rapid transport between the border and the Metro areas.

The potential PRL will be from Lo Wu to the Kwai Chung terminals, via either East Rail or West Rail.14

______________________
14

Railway Development Strategy 2000, p.4.

1.5

OBJECTIVE AND SCOPE OF THE STUDY

There is extensive published literature on mergers and acquisitions but mostly they focuse on the financial aspects of merger and acquisitions. There is little previous literature on the actual implementation of merger integration and virtually none on merger integration of railways of similar scale as the merger of railway operations of MTRCL and KCRC.

The objective of the proposed study is to review whether the Rail Merger between MTRCL and KCRC is successful or not. The study will focus on reviewing the merger result with its relevance to the Governments Transport Policy, impacts to its stakeholders, the community and the public passenger transport systems in Hong Kong. The study will review the key integration processes before and after the merger but will not touch on the merger deal as it is of commercial sensitivity.

The scope of the study will cover the pre-merger activities after the announcement of signing of Memorandum of Understanding by the MTRCL and the Government in April 2006 up to May 2008 i.e. the first six months after the merger which was taken place on 2 December 2007.

The research result would be then generalized to support further academic perusal in future as well as for experience sharing by other railway operators in preparing for merger integration. This study no doubt will be the pioneer in academic research on elaboration and reviewing of actual implementation of a merger of two sizeable railway operations. The research findings will be able to lay the platform for further academic perusal as well as providing a solid documentation for experience sharing by other railways and even other public transport operators like bus companies as well as public utilities.

1.6

METHODOLOGY

Literature review would be firstly conducted for understanding on the concept of merger and acquisition and an analytical framework would be developed to facilitate the study on the rail merger of MTRCL and KCRC.

The actual merger integration implementation processes would be summarized for evaluation of their relevance to the success of merger. Experience would then be generalized to support future academic studies and benchmarking by other railways and public transport operators and utilities.

The research will mainly adopt a qualitative approach in reviewing all publicly available documents including Government publications related to the rail merger of MTRCL and KCRC, Legislative Council papers, political parties publications, newspaper cuttings, media responses, press release of MTRCL and KCRC on merger related issues, MTRCL and KCRC Annual Reports, MTRCL Extraordinary General Meeting (EGM) Circular, as well as the two railways internal staff communication documents. Furthermore, search for available secondary data like Government Transport statistics on the travel pattern of public transportation after the rail merger of MTRCL and KCRC as well as its impacts to other transport operators will also be undertaken.

10

1.7

STRUCTURE OF THE DISSERTATION

The structure of the dissertation is arranged as listed below:

Chapter 1

Introduction

This chapter aims to introduce an overview of the dissertation to the readers. The dissertation will start with a brief overview of public transport systems in Hong Kong and followed by the background of the rail merger. The Governments Transport Strategy will then be recapitulated to reiterate its strategy to accord priority to railways with intention that railways will form the backbone of our future passenger transport network. Finally, the objective, scope of the study as well as the methodology of the research will be highlighted.

Chapter 2

Literature Review and Analytical Framework

The definitions of mergers and acquisitions and types of mergers will firstly be introduced. To follow, a brief introduction on merger integration key processes, key success factors and the Governments core objectives in a merger will be highlighted. An analytical framework will then be developed to facilitate the review in this research study.

Chapter 3

Analysis of the two railways in Hong Kong

A brief introduction on the MTRCL and KCRC would be delivered. Focus would be made on comparison of similarity and difference between the two railways for key considerations to be addressed in the Rail Merger.

11

Chapter 4

Analysis of the Rail Merger

The research would start with highlights on the payment terms, merger framework agreement and service concession agreement made between the MTRCL and the Government of the HKSAR to appreciate the scope of merger integration. Then, the details of merger integration

implementation would be discussed. Evaluation would then be made on the fulfilment of the Governments core objectives in a merger and stakeholder analysis including Government, shareholder, commuter, employee and other public transport operators. Finally, success of merger would be reviewed on adequacy of its fulfilment of the 5 parameters set by the Government, fare reduction and fare adjustment mechanism and seamless integration of railway network as well as a critical review on the performance of the MTRCL after the merger.

Chapter 5

Conclusion and Recommendations

In this chapter, the analysis findings would be evaluated to conclude whether the Rail Merger is a success or not up to the time this report is prepared. Potential pitfall and drawback, as well as limitation of this research and opportunity for future research would also be discussed.

12

CHAPTER 2

LITERATURE REVIEW AND ANALYTICAL FRAMEWORK

Literature review has been conducted on books, journals, Government publications, political parties publications, newspaper cuttings and media responses, and Legislative Council papers as well as publicly available documentations of the two railways like annual reports, press releases and internal staff communication documents which are made available to general staff.

Though there are lot of literature and previous academic researches on the financial aspects of merger and acquisitions, there is little previous academic research on merger of railways, in particular, that involving the extent and scale of merger like the case of merger between MTRCL and KCRC.

2.1

TERMINOLOGY OF MERERS AND ACQUISITIONS

A merger is a combination of two corporations in which only one corporation survives and the merged corporation goes out of existence. In a merger, the acquiring company assumes the assets and liabilities of the merged company. A statutory merger is a merger of two companies where the target company becomes a subsidiary of the parent company.

A merger differs from a consolidation, which is a business combination whereby two or companies join to form an entirely new company. In general, when the combining firms are approximately the same size, the term consolidation applies; when the two firms differ significantly by size, merger is the more appropriate term. In practice, however, this distinction is often blurred,

13

with the term merger being broadly applied to combinations that involve firms of both different and similar sizes. 15

Horizontal merger means purchasing business in the same field of endeavour in order to increase market shares, buy up surplus capacity or obtain a more profitable firm for its know-how, patents or processes; other reason are to counter competition by greater concentration or just to take advantage of the economies of scale.16

Horizontal mergers and acquisition combine two similar companies in a related line of business in the same industry. This can be the case of a merger between direct competitors.17

Vertical Merger is a somewhat more complicated process, since the buyer is not expanded into his own but an allied sphere. On the vertical scale, the entrepreneur can proceed upstream towards the source of his supply, such as raw materials or components or sub-contractors, or downstream through the channels of distribution towards the final customer, who may be another industrial user or the public, either direct or through the retailer or wholesaler.18

Vertical mergers and acquisition unite firms from successive processes within the same industry. They refer to organizations in a supplier-customer relationship.19

_____________________
15 16 17 18 19

Patrick A. Gaugham (2002) Mergers, Acquisitions, and Corporate Restructurings, p.7. Nicholas A.H. Stacey (1970) Mergers in Modern Business, p.33. Verena Kusstatscher, Gary L. Cooper (2005) Managing Emotions in Mergers and Acquisitions, p.12. Nicholas A.H. Stacey (1970) Mergers in Modern Business, p.33. Verena Kusstatscher, Gary L. Cooper (2005) Managing Emotions in Mergers and Acquisitions, p.12.

14

Conglomerate Merger is the technical term for diversification by acquisition and is a form of expansion. The acquiring company is not proposing to expand in its own field of endeavour but is an altogether different sphere. Diversification may imply entering an entirely new range of product activity. 20

Conglomerate mergers and acquisition occur between companies in completely unrelated business fields. They are often a consequence of diversification strategies. 21

Synergy is often associated with the physical sciences rather than with economics or finance. It refers to the type of reactions that occur when two substances or factors combine to produce a greater effect together than what the sum of the two operating independently could account for. It refers to the ability of a corporate combination to be more profitable than the individual profits of the firms that were combined.22

Synergy is widely used, albeit often misused, as justification for making acquisition. It is the rather simplistic notion that the combination of two businesses can create greater shareholder value than if they are operated separately. There are two basic types of synergy: operating ad financial. 23

Operating synergy consists of both economies of scale and economies of scope. Gain in efficiency can come from either factor as well as improved managerial practices. Both economics of scale and scope assume a level of management talent in place to realize the benefits of operating synergy

_____________________
20 21 22 23

Nicholas A.H. Stacey (1970) Mergers in Modern Business, p.33. Verena Kusstatscher, Gary L. Cooper (2005) Managing Emotions in Mergers and Acquisitions, p.12. Patrick, A. Gaugham (2002) Mergers, Acquisitions, and Corporate Restructurings, p.113. Donald M. DePamplis (2008) Mergers, Acquisitions, and Other Restructurings Activities, p.18.

15

Financial synergy refers to the impact of mergers and acquisition on the cost of capital of the acquiring firm or the newly formed firm resulting from the merger or acquisition. Theoretically, the cost of capital could be reduced if the merged firms have uncorrelated cash flow, realize financial economies of scale, or result in a better matching of investment opportunities with internally generated funds.

Economies of scale refer to the spreading of fixed costs over increasing production levels. Scale is defined by such fixed costs as depreciation of equipment and authorization of capitalized software; normal maintenance spending; obligation such as interest expense, less payments and unions, customer, and vendor contracts; and taxes. Such costs are fixed in the sense that they cannot be altered in the short-run. Consequently, for a given scale of level of fixed expense, the dollar value of fixed expense per dollar of revenue decrease as output and sales increase. 24

One of the most fundamental motives for merger and acquisition is growth. Companies seeking to expand are faced with a choice between internal growth and growth through mergers and acquisition. Internal growth may be a slow and uncertain process.

Growth through merger and acquisition may be a much more rapid process, although it brings with its own uncertainties. Companies may grow within their own industry or they may expand outside business category.25

______________________
24 25

Donald M. DePamplis (2008) Mergers, Acquisitions, and Other Restructurings Activities, p.19. Patrick, A. Gaugham (2002) Mergers, Acquisitions, and Corporate Restructurings, p.111.

16

2.2.

MERGER INTEGRATION PROCESSES

A poorly designed or inappropriate business strategy is among the most frequently cited reasons for the failure of mergers and acquisitions (M&A) to satisfy expectations. The acquisition process can be separated into a planning and an implementation stage. The planning stage consists of the development of the business and the acquisition plans. The implementation stage includes the search, screening, contacting the target, negotiation, integration planning, closing, integration, and evaluation activities. 26

The 10 phases of the acquisition process fall into two distinct sets of activities (i.e. pre- and post- purchase decision activities). The phases of the acquisition process are summarized as follows: 27

Phase 1: Phase 2:

Develop a strategic plan for the entire business (Business Plan). Develop the acquisition plan supporting the business plan (Acquisition Plan)

Phase 3: Phase 4: Phase 5: Phase 6:

Actively search for the acquisition candidates (Search) Screen and prioritize potential candidates (Screen) Initiate contact with the target (First Contact) Refine valuation, structure deal, perform due diligence, and develop financing plan (Negotiation)

Phase 7:

Develop a plan for integrating the acquired business (Integration Plan)

_____________________
26 27

Donald M. DePamplis (2008) Mergers, Acquisitions, and Other Restructurings Activities, p.140. Donald M. DePamplis (2008) Mergers, Acquisitions, and Other Restructurings Activities, p.142.

17

Phase 8:

Obtain all necessary approvals, resolve postclosing issues, and implement closing (Closing)

Phase 9: Phase 10:

Implement postclosing integration (Integration) Conduct postclosing evaluation of acquisition (Evaluation)

Mergers can also be described from a legal perspective and an economic Perspective. The distinction is relevant to deal structuring, regulatory issues and strategic planning. 28

A Legal Perspective

A merger is a combination of two or more firms in which all but one legally ceases to exist, and the combined organization continues under the original name of the surviving firm.

A statutory merger is one in which the acquiring company assumes the assets and liabilities of the target in accordance with the statutes of the state in which the combined companies will be incorporated.

A subsidiary merger of two companies occurs when he target becomes a subsidiary of the parent.

- Although the terms mergers and acquisitions often are used interchangeably, a statutory consolidation, which involves two or more companies joining to form a new company, is technically not a merger. A Merger of equals is a merger framework usually applied whenever the merger participants are comparable in size, competitive position, profitability, and market capitalization. Under such circumstances, it is unclear if either party is ceding control to the other and which party is providing the greatest synergy.

_____________________
28

Denold M. DePamplis (2008) Mergers, Acquisitions, and Other Restructuring Activities, p.5.

18

An Economic Perspective

Business combinations also may be classified as horizontal, vertical, and conglomerate mergers. How a merger is classified depends on whether the merging firms are in the same or different industries and on their positions in the corporate value chain.29

2.3

MAJOR FACTORS CRITICAL TO SUCCESS OF A MERGER

30

In the paper Implementing International Mergers and Acquisitions

, it

states three major factors are critical to success in any merger or acquisition:

First, a transaction must be undertaken for strategic reasons (as opposed to solely financial or tax reasons) such as to improve or develop competitive capabilities (e.g. lower costs through economies of scale or better technology, enhanced differentiation through better product design), to expand products, customers served, or geographic presence. More specifically, M&As must be viewed as means to achieve strategic outcomes rather than ends in themselves. In fact, they should be considered as just two such means, much like internal development, joint ventures, and strategic alliances. When M&As are driven solely by opportunism (i.e., a good deal) or the desire to do a deal, rather than sound strategic reasons, they are less likely to succeed.

_____________________
29 30

Porter, Michael (1985) Competitive Advantage, The Free Press, New York Schweiger, Csiszar and Napier (1993) Implementing International mergers and acquisitions, HR Human Resource Planning, p.53 70.

19

Second, the final purchase price of a merger or an acquisition typically reflects both the inherent value of a target business and its value to the buying or merging firm (i.e. combination value). The latter value is greater because of strategic benefits that a buying or merging firm anticipates it can obtain after a change in ownership. However, when the purchase price exceeds either the inherent or combination value (due to overestimation or poor negotiations), M&As are also less likely to succeed.

Finally, the value of M&As will ultimately be determined by the extent to which they can be effectively implemented. In spite of a reasonable purchase price and sound strategic reasons, M&As are less likely to succeed if the merging organizations are not effectively combined after the closing of a deal; i.e. strategic benefits are realized in practice. There are many examples of M&As that looked good prior to the closing of a deal, only to have failed after the deal because the challenges and difficulties of implementation were underestimated.

Based on the three factors, it is clear that top managers face many challenges in effectively transacting and implementing M&As. First and foremost, it is the challenge of knowing what is being bought and both its inherent and combination values. Second, is the challenge of implementing M&As to capture value.

As indicated in the Figure 2 below, for M&As to be effective, strategy must remain the central factor for driving implementation, since the ultimate value of the deal will be determined by the extent to which strategy is realized. 31

20

STRATEGY SOURCES OF M&A ADVANTAGES [?] ORGANIZATIONAL CHANGES IMPLEMENTATION PEFORMANCE Figure 2 - Key Success Factors to Merger

2.4

GOVERNMENTS CORE OBJECTIVES IN A MERGER

The possibility of merging Hong Kongs two rail corporations is not new. The issue has been raised before on the basis that a merger might result in resource savings and better management.32 The HKSAR Governments response to the speculation [on the merger] was that its internal assessment of the merger would take into account transport policy objectives, the interests of long-term railway development in Hong Kong, and the wider legislative and economic implications, and not just possible financial gains. 33

________________________
31 32

Hong Kong Economic Journal, Editorial, 30 October 2002. HKSARG, Operator award for the Shatin to Central Link & feasibility study of railway merger, press release, 25 June 2005.

33

Rothschild Report (2003) KCRC/MTRCL Merger Feasibility Study, abridged version, p.33.

21

In preparation for consideration of a possible merger, the HKSARG commissioned N M Rothschild & Sons (Hong Kong) Limited in 2003 for independent advice. Rothchilds report submitted in August 2003 concluded that a merger between the two corporations would be beneficial on sensible terms of exchange, fare reductions and regulation 34

It is important to note that only a portion of the information and advice N M Rothchild has given in its evaluation has been made public. It would be useful for the unabridged version to be made available to the public so as to enhance legislative and public scrutiny of the possible merger and its terms. 35

From the abridged version made available to public, the Governments core objectives in a merger can be summarized as in the followings: 36

a)

Financial

i.

Proceeds maximize proceeds from any merger and extract them as early as possible.

ii.

Value maximize the aggregate value of the HKSARGs investment in the railway businesses, including the impact of synergies.

________________________
34 35

Civil Exchange (2004) Merging Hong Kongs Railways: The Public Interest Perspective, p.2. A full report was submitted to the HKSARG on 12 August 2003 and it is not available to the public. Upon request from legislators of the Panel on Transport of the Legislator Council I Feb 2004, an abridged version was then made available to the public I April 2004.

36

Reproduced and adapted from Rothschild (2003) KCRC/MTRCL Merger Feasibility Study, abridged version, p.8.

22

iii.

MTRCL equity story given its majority shareholding in MTRCL, the HKSARG has an interest in improving the listed companys growth prospects and equity story to maximize the value of its shareholding (and proceeds from potential future sell-downs).

iv.

Privatization demonstrate the HKSARGs commitment to its Asset Disposal Programme.

v.

Minimize financial support a merger should not give rise to increased financial support for future infrastructure projects.

b)

Transactional

i.

Speed and simplicity any transaction (and the structure chosen to facilitate such an exercise) should provide for a swift and simple execution process with low execution risk.

ii.

Retention of MTRCL listing whilst the retention of MTRCLs listing is not a goal in itself, retaining a listing in any merger would secure the HKSARGs continued access to equity capital.

iii.

Post-merger operational efficiency any decision on merger should be predicated on enabling the seamless operational integration of the two corporations.

c)

Transport/Planning

i.

Fare setting mechanism a merger offers an opportunity to achieve a change, albeit within the confines of what MTRCL in particular will assent to.

ii.

Fare reductions a merger may be an opportune time for the HKSARG to achieve (at least partially) its transport

23

policy in relation to rail fares. iii. Passenger interchange enables the two corporations over time to create more convenient interchanges for the travelling public. iv. Rail as transport backbone enhances the competitiveness of railway corporations.

d)

Social/Environmental

i. ii.

Minimize the extent of job reductions caused by any merger Environmental effects of bus competition a stronger and more competitive railway should ease congestion and reduce pollution.

The above will form part of evaluation criteria on the success of the rail merger.

2.5

OTHER MERGER EXPERIENCES

A reference has also been made to the vast merger integration practitioners experience from a profound management consultant acquired through their tremendous handling of numerous merger integration projects across different industries and cultures. The followings are just some key highlights of their accumulated experience: 37

________________________
37

Reproduced and adapted from Post Merger Management Series (2001) Mckinsey & Company Inc.

24

From the Mckinsey & Company literature titled Merger Principles, it lists out ten basic merger principles:(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) Focus on value-creation, not integration for its own sake. Set high aspirations Identify synergies and build commitment Pursue practical solutions Protect current business momentum Put excellence over perceived fairness Identify cultural challenges early Appoint top performers and line managers to the integration team Recognise and deal with anxiety Overcommunicate

From the Mckinsey & Company literature titled Tailoring Merger Integration Management, it lists out ten major decisions or questions that will determine each integrations individual approach. They are: (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) What kind of merger architecture should be used and what is the role of the integration office? What is each teams charter? What kind of baselines should be developed? What targets should be set? How should synergies be confirmed? What kind of masterplan is appropriate? What sort of tracking and monitoring is required? Which management tools are needed? How should risk be managed during the integration? How should communication be managed?

From

the

Mckinsey

&

Company

literature

titled

Merger

Communication, it states that Corporate leaders charged with implementing the merger of two companies have an ambitious goal: capturing the full value inherent in the combination. A host of players have a stake in this work and are central to its success. Communication is a critical factor in garnering their support and harnessing their energy and talents. The same publication also highlights three important steps for merger communication and they are:-

25

(1) (2) (3)

Putting a communication infrastructure in place Developing the communication plan Organising its implementation.

Cultural Integration According to Mckinsey experience on merger, 48 percentages of merger failure causes were due to cultural related issues with breakdown of causes as shown in Chart 1 below.
Percent of merger failure causes Other

Business issues

5 10 22

Poor communication

Poor 16 integration strategies

19 Cultural differences 21 Poor management 7

Lack of employee support

Chart 1 Merger Failure Causes

38

2.6

ANALYTICAL FRAMEWORK As depicted in Figure 3 below, an analytical framework is developed to

facilitate the research. The evaluation will start reviewing the whether the merger will fulfil the Governments core objectives in a merger. Then, analysis on the stakeholders including Government, shareholders, commuter, employee and other public transport operators will be carried out. Finally, the merger process will be evaluated against actual result achieved and the

comprehensiveness to meet the 5 parameters set by the Government on the merger; the fare reduction; fare adjustment mechanism, seamless integration of railway network as well as the performance of the railways after the merger.

____________________
38

Reproduced and adapted from Mckinseys presentation Cultural Diversity Presentation, August 2006.

26

The Merger of Two Railways in Hong Kong

Evaluation Framework Governments Core Objectives Financial Transactional Transport/Planning Social/Environmental Stakeholder Analysis Government Shareholder Commuter Employee Other Public Transport Operators

Successful Merger of the two railways Fulfilment of 5 parameters set by Government Fare reduction and Fare Adjustment Mechanism Seamless integration of railway network Performance of the railways

Figure 3

Analytical Framework

27

CHAPTER 3
ANALYSIS OF THE TWO RAILWAYS IN HONG KONG
In this chapter, it starts with a brief introduction on MTRCL and KCRC and then followed by a comparison of similarity and difference between them.

3.1

MASS TRANSIT RAILWAY CORPORATION LIMITED (MTRCL)

a)

Overviews

The Mass Transit Railway Corporation (MTRC) was established in 1975 under the Mass Transit Railway Corporation Ordinance (Cap 270 of the Laws of Hong Kong) to construct and operate a mass transit railway system in Hong Kong as a statutory corporation and was wholly-owned by the Government. In 1979, the first section of the Mass Transit Railway Corporation was opened for passenger service followed by other lines in 1982 and 1986. In 1998, the Airport Express, a purpose-built railway serving Hong Kongs Chek Lap Kok Airport, was opened for passenger service. 39

In February 2000, the Mass Transit Railway Ordinance (Cap 556 of the Laws of Hong Kong) was passed into law by Legislative Council, providing the legal framework for the partial privatisation. Under the ordinance, the MTRCL was granted a 50-year franchise, effective from 30 June 2000, to operate the MTRCL and to construct and operate any extension to the railway, subject to the terms and conditions contained in the Operating Agreement. The MTRCL was listed on the Stock Exchange of Hong Kong Limited (the Stock Exchange) on 5 October 2000. The HKSARG now owns a 76.4% of the company. 40 _______________________
39 40

MTRCL Extraordinary General Meeting Circular (2007), p.99. Civic Exchange (2004), p.4.

28

The MTRCL Railway comprises seven inter-connecting lines: the Tsuen Wan Line, the Kwun Tong Line, the Island Line, the Tung Chung Line, the Tseung Kwan O Line, the Disneyland Resort Line and the Airport Express. The total patronage for the MTRCL Lines for the year ended 31 December 2006 was 867 million, representing an increase of approximately 1% as compared with 2005. For the first six months of 2007, total patronage on the MTRCL lines reached another record of 429.3 million, a 2.6% increase over the same period in 2006.41

Table 1 below depicts the existing railway lines of MTRCL before the merger:

Lines

Terminus to Terminus

Length (Km)

Station (Nos) 15 16 14 8 5 7 2

Year started 1979 1982 1985 1998 1988 2002 2005

Kwun Tong Line Tsuen Wan Line Island Line Tung Chung Line Airport Express Line Tseung Kwan O Line Disneyland Resort Line

Yau Ma Tei to Tiu Keng Leng Tsuen Wan to Central Sheung Wan to Chai Wan Tung Chung to Central Hong Kong to Asia World-Expo Po Lam to North Point Sunny Bay to Disneyland Theme Park

15.8 16.9 13.3 31.1 35.3 10.7 3.5

Table 1: MTRCL Railway Lines (Pre-Merger) 42

(Source: The website of the Highways Department of the HKSAR Government)

_______________________
41 42

MTRCL Extraordinary General Meeting Circular,(2007), p.99. http://www.hyd.gov.hk/eng/major/road//rail/index.htm.

29

b)

Patronage and Financial Review

In 2007, all the above MTRCL Lines carried average daily traffic of about 2,560,000 passengers.43 After the rail merger, the average weekday patronage rose to 3.5 million. For the year 2007 as a whole, average weekday patronage on domestic service was 2.7 million, an increase of 5.5% from 2006. 44 Total fare revenues increased by 9.1% from HK$6,523 million to HK$7,115 million with fare revenue from Domestic Service (including KCRC Lines after the Rail Merger) increased by 5.1% in 2007 to HK$6,213 million. Non-fare revenues increased by 18.5% in 2007 to HK$3,575 million comprising HK$1,741 million of station commercial and rail related business incomes and HK$1,834 million of property rental, management and other incomes. Total revenues for 2007, therefore increased by 12.0% to HK$10,690 million. Total operating costs, excluding merger related expenses, increased by 10.1% in 2007 to HK$4,778 million after accounting for the incremental operating costs following the Rail Merger in December. Operating profits from railway and related businesses before depreciation and amortisation therefore increased y 13.7% to HK$5,912 million before accounting for merger related expense. We estimate that the Rail Merger contributed approximately HK4284 million to such operating profit from 2 December 2007 to the year end before merger related costs. Operating margin also increased from 54.5% in 2006 to 55.3%. 45 From the above available facts, MTRCL has demonstrated a strong performance, with increasing patronage as well as sound financial performance even before the Rail Merger. More details on its latest performance up to middle of 2008 (i.e. first half year performance after the Rail Merger) will be covered in later Chapter 4 on the analysis of the Rail Merger. ___________________
43 44 45

http://www.hyd.gov.hk/eng/major/road//rail/index.htm. MTRCL Annual Report 2007, p.26. MTRCL Annual Report 2007, p.26.

30

c)

Rail Projects MTRCL has undertaken only the Tseung Kwan O South (Phase I) rail

project since the opening of the Airport Express Line in 1998, unlike KCRC which had been actively involved in the planning and construction of a number of railway lines in the immediate past ten years as shown in the later part of this chapter on the analysis of KCRC. However, it is beyond doubt that MTRCL has also demonstrated success and accumulated vast experience in the planning and construction of railway lines in Hong Kong.

Taking into account of the vast number as well as extreme complexity of railway lines under planning as stated in the Railway Development Strategy 2000 and those listed in the latest Government Policy Address, as listed below for MTRCL and those listed under KCRC in later paragraphs, the Rail Merger no doubt will generate great opportunity of cross fertilization of rail project planning and construction expertises as well as sharing of resources between the two railway companies. i. Under Construction (with gazettal documents)

Tseung Kwan O Extension (Phase II) Tseung Kwan O South Station at Area 86 46 Tseung Kwan O South Station is situated in Tseung Kwan O Area 86 adjacent to the existing Tseung Kwan O Depot. The station is needed to meet the traffic demand generated from the property development in Area 86. The construction works for the station commenced in 2006 for completion in 2009.

______________________
46

http://www.hyd.gov.hk/eng/major/road//rail/index.htm.

31

When the station is opened for passenger services, the Tseung Kwan O Line train service will bifurcate at Tseung Kwan O Station with trains running south to Tseung Kwan O South Station, as well as to the existing terminus at Po Lam

ii.

Rail Projects Pending Authorization (with gazettal documents) West Island Line 47

The West Island Line (WIL) is an extension of the existing Island Line from Sheung Wan to Kennedy Town for the provision of domestic passenger service. It provides an approximately 3 kilometers long electrified double-track railway system with three proposed railway stations at Sai Ying Pun, near the University of Hong Kong and at Kennedy Town.

iii.

Rail Projects Under Planning: Kwun Tong Line Extension 48

The Kwun Tong Line Extension (KTE) will involve an extension of the existing Kwun Tong Line from Yau Ma Tei Station to Whampoa with an intermediate station at Homantin, scheduled for completion by 2015. The extension will serve the140,000 people living in Whampoa and Homantin with an estimated daily patronage of 180,000 in 2016.

______________________
47 48

http://www.hyd.gov.hk/eng/major/road//rail/index.htm http://www.hyd.gov.hk/eng/major/road//rail/index.htm

32

With this extension, passengers from Whampoa will be able to reach MongKok in five minutes, compared with 25 minutes by road-based transport during the current rush hour. Furthermore, Homantin Station will be an integrated interchange station, which will allow passengers to change from there to other stations. North Hong Kong Island Line 49

The North Hong Kong Island Line (NIL) is an extension of the existing Tung Chung Line (TCL) along the north shore of Hong Kong Island to run through onto the eastern half of the existing Island Line (ISL) at Fortress Hill Station. Tseung Kwan O Line (TKOL) will join and run through onto the western half of ISL at Causeway Bay section of ISL and the Nathan road section of Tsuen Wan Line (TWL) by redistributing the crossharbour trips to TCL and TKOL. According to the Railway Development Strategy 2000, the likely completion window of the project would be between 2008 and 2012. The current estimated cost is 8 billion (2006 prices).

However, with a reduction in the forecast employment in the Central Reclamation due to changes in land use assumptions since the Second Railway Development Study, and the anticipated opening of Shatin to Central Link ahead of the NIL, which would share some of the crossharbour trips and relieve the Nathan Road section of TWL, it has been decided in early 2003 that the completion of NIL would be deferred to beyond 2016.

_______________________
49

http://www.hyd.gov.hk/eng/major/road//rail/index.htm

33

South Island Line 50

The

proposed

scheme

in

the

Technical

Report

for

Phased

Implementation of the South Island Line (SIL), submitted by the MTRCL in February 2005, consisted of:

SIL(E), South Island Line (East), from South horizons, via Lei Tung , Wong Chuk Hang, Ocean Park to Admiralty, with Happy Valley and Wanchai Stations as optional;

SIL(W), South Island Line (West), from Wong Chuk Hang, via Aberdeen, Wah Fu, Cyberport to University; and

A depot for SIL at Wong Chuk Hang.

The proposed route length is 15 km. Most of the SIL will be located in tunnel except for short sections at Cyberport and Wong Chuk Hang / Ocean Park areas, which will be on viaducts. A bridge will be constructed between Ap Lei Chau and Wong Chuk hang alongside the existing Ap Lei Chau Bridge. A medium capacity railway system, which can better match the demand and is more cost effective than the conventional heavy metro rail system, is recommended for the SIL.

On 30 June 2005, Government announced that the SIL(E) and SIL(W) would be considered in the light of the results Planning Departments review on the planning of tourism and commercial development in the Southern District and the Governments consideration of Ocean Parks redevelopment proposal.

_______________________
50

http://www.hyd.gov.hk/eng/major/road//rail/index.htm

34

3.2

KOWLOON-CANTON RAILWAY CORPORATION (KCRC)

a)

Overviews

The British Section of the Kowloon-Canton Railway, or KCR, came into service in 1910 as a single track system, running from Tsim Sha Tsui in Kowloon through the New Territories and up to the Border at Lo Wu. The section of the railway later became known as the East Rail.

Trains were initially steam hauled, but diesel traction was gradually introduced in the 1950s and by 1962 had replaced all steam trains. The year 1978 marked the commencement of the railways modernisation and electrification programme. The first stage of electrification was completed with the start of an inner suburban service between Kowloon and Sha Tin on 6 May 1982. Just over a year later, on 15 July 1983, electrification was extended to Lo Wu.

Prior to 1982, the KCRC had operated as a Government department, but in December of that year the Kowloon-Canton Railway Corporation was created through the enactment of the Kowloon-Canton Railway Corporation Ordinance. The Corporation was wholly government owned, and a Management Board appointed by the Chief Executive of the Hong Kong Special Administrative Region monitored its operations.

Its network of 120 kilometres, managed under service concession agreement after the rail merger by the MTRCL, provides three domestic passenger rail services: East Rail, which operates between East Tsim Sha Tsui and the boundary at Lo Wu and Lo Ma Chau and branches off to Ma On Shan at Tai Wai; the West Rail, which runs between the North West New Territories and urban Kowloon; and the Light Rail, which acts as a feeder service for the West Rail while serving as a major mode of inter- and intra-town transport within

35

the North West New Territories. All of these railways are supported by feeder buses.

The Table 2 below depicts the existing railway lines and Light Rail of the KCRC before the merger:

Lines

Terminus to Terminus

Length (Km)

Station (Nos) 14 9 9 68 stops

51

Year started 1910 2003 2004 1988

East Rail West Rail Ma On Shan Rail Light Rail

East Tsim Sha Tsui to Lo Wu Nam Cheong to Tuen Mun Tai Wai to Wu Kai Sha Tuen Mun to Yuen Long

34.3 30.5 11.4 36.2

Table 2: KCRC Railway Lines and Light Rail (Pre-Merger)

In addition to its core territorial rail services, KCRC was also in the business of operating intercity passenger and freight services as well as property development and related commercial activities 52

____________________
51 52

http://www.hyd.gov.hk/eng/major/road//rail/index.htm. KCRC Annual Report 2007, p.5.

36

b)

Patronage and Financial Review

The patronage of various KCRC railway line before the merger was shown in Table 3 below: Passenger Trips 2007
(From 1 January to 1 December 2007)

2006

% Increase/ Decrease)

East Rail domestic (including Ma On Shan Rail) East Rail cross-boundary (to Lo Wu and Lok Ma Chau) Intercity Through Train West Rail Light Rail Bus (excluding East Rail Buses) Total average daily passenger trips

689,000

677,000

1.8

250,300

241,000

3.9

8,950 213,000 371,700 88,600 1,621,850

8,970 200,100 373,800 82,400 1,583,270

53

(0.2) 6.6 (0.6) 7.5 2.4

Table 3: Average Daily Ridership for KCRC before Merger

Transport revenue for 2007 amounted to HK$4,524 million, representing the income from the Corporation transport operations up to the day before the merger on 2 December 2007, compared with HK$4,746 million for the year in 2006. Compared with the same period in 2006, transport revenue for the period up to 1 December 2007 increased by 4.3%, mainly because of better performance of the cross-boundary and East Rail domestic services resulting from the growth of the cross-boundary market and the local economy as well as increased patronage fro the newly opened Lok Ma Chau Spur Lin and the continuous build up of patronage from West Rail 54

_____________________
53
54

KCRC Annual Report 2007, p.21. KCRC Annual Report 2007, p.71.

37

As shown in above Table 3, KCRC recorded increase in patronage of 2.4% when compared the same period in year 2006 up to the Rail Merger. It also had achieved good financial performance in term of railway operations revenue. The Rail Merger would no doubt build on the solid foundation to achieve even better patronage and performance.

On 2 December 2007 the Rail Merger Ordinance came into effect. The Rail Merger Ordinance expressly empowers the KCRC to grant a service concession to MTRCL and expands the scope of the MTR Corporation and expands the scope of the MTRCLs franchise for taking up the operations of KCRCs transport services. Following the merger, the MTR Corporation took up the operations of the merged KCRC and MTRCL railway networks. KCRC

today is an asset holding company with responsibility to invest its current significant cash revenues, service its outstanding debts and ensure its ongoing new capital projects will be funded to completion. 55

c).

Rail Projects

i.

Under Construction (with gazettal documents)

KCRC had been actively building new railway lines in the past few years. It had completed construction and opened new railway lines like the West Rail in 2003, Ma On Shan Rail in 2004, Lok Ma Chau Spur Line in 2007. Similar to earlier comments stated under analysis for MTRCL, the Rail Merger no doubt will generate great opportunity of sharing of rail project planning and construction expertises as well as resources between the two railway companies.

_____________
55

KCRC Annual Report 2007, p.3.

38

Kowloon Southern Link 56

Kowloon Southern Link (KSL) is an extension of West Rail Line from its Nam Cheong Station to connect with East Rail Line at East Tsim Sha Tsui. The link is approximately 4.5 km long between Nam Cheong Station and East Tsim Sha Tsui Station. When KSL is completed, West Rail Line will then have cross-platform interchange with East Rail Line at Hung Hom. KSL will provide one new station at West Kowloon. The design and build contracts have commenced in August 2005 for completion in 2009. The project cost is estimated to be around 8.3 billion (MOD prices).

ii.

Rail Project Pending Authorization (with gazettal documents):

Nil

iii.

Rail Projects Under Planning Northern Link 57

The Northern Link (NOL) will run between the existing West Rail Line at Kam Sheung Road and the Lok Ma Chau Terminus of the existing East Rail Line. It will intersect with the East Rail Line at a new station at Chau Tau of San Tin, where passengers can interchange with the East Rail Line.

_____________
56
57

http://www.hyd.gov.hk/eng/major/road//rail/index.htm. http://www.hyd.gov.hk/eng/major/road//rail/index.htm.

39

When completed, it will provide domestic passenger service at the northern part of the new Territories and cross-boundary passenger services for the western part of the HKSAR. Provisions will also be made to allow the addition of three immediate stations at San Tin, Ngau Tam Mei and Au Tau to tie in with future development in those areas. Port Rail Line 58

The Port Rail Line (PRL) is a new freight rail connection from Lo Wu to a new port rail terminal at Kwai Chung. The line has two route options, one as part of West Rail Line via Kam Sheung Road to Kwai Chung and other via East Rail Line and then a new tunnel from Tai Wai to Kwai Chung.

Allowing direct cross-boundary freight service through Lo Wu to the Kwai Chung ports, the PRL would support the growth of the port cargo by tapping freight from the deep hinterland of the Mainland and could benefit the Hong Kong Special Administrative Regions economy.

The implementation of the projects depends on cross-boundary freight build-up and the estimated cost would be between 5 and 10 billion (2006 prices).

_______________________
58

http://www.hyd.gov.hk/eng/major/road//rail/index.htm.

40

Shatin to Central Link 59

The Shatin to Central Link (SCL) is one of the priority rail projects recommended in the Railway Development Strategy 2000 (RDS-2000). It forms a new rail link between Tai Wai and the Central Business District in Hong Kong Island through the proposed new development area in South East Kowloon. The line significantly increases the cross-harbour and Shatin-Kowloon rail capacities and also helps to redistribute the flows and relieve the other railway lines in Hong Kong and Metro Kowloon.

The components and functions of the SCL are: -

Tai Wai to Hung Hom (11 km long): Extension of Ma On Shan Line from Tai Wai to Hung Hom, via South East Kowloon and then connect to Kowloon Southern Link and West Rail Line. This railway line will significantly increase the Shatin-Kowloon capacity and provide railway service to the new developments in South East Kowloon.

Fourth Rail Harbour Crossing (6 km long): Extension of the East Rail Line across the harbour to Hong Kong Island. This railway line will increase the cross-harbour rail capacity and enhance the connectivity between the new territories and Hong Kong Island.

____________________
59

http://www.hyd.gov.hk/eng/major/road//rail/index.htm.

41

There are nine stations including Tai Wai, Diamond Hill, Kai Tak, To Kwa Wan, Ma Tau Wai, Homantin, Hung Hom, Exhibition and Admiralty as well as one depot at Diamond Hill. Travel times are 69 minutes between Tuen Mun and Wu Kai Sha and 50 minutes between Lo Wu and Admiralty.

SCL passengers can interchange between station platforms at Tai Wai and Hung Hom stations with East Rail Line, at Diamond Hill Station with the Kwun Tong Line, at Homantin Station with future Kwan Tong Line Extension, at Exhibition Station with future North Hong Kong Island Line and at Admiralty Station with the Island Line, Tsuen Wan Line and future South Island Line.

3.3

SIMILARITY AND DIFFERENCE BETWEEN THE TWO RAILWAYS

a)

Similarities

The core business of both MTRCL and KCRC is to provide a safe and reliable railway service to the public by the operating their existing network and by developing new lines. Both Corporations also undertake property developments at sites above or near to railway stations as an integral part of the railway development programme. These property developments generate income to contribute towards the capital cost for new railway projects, to fund improvements in existing railway networks and to secure a permanent and increasing ridership for the railway network. Both MTRCL and KCRC engaged in property investment and management and are active in non-fare businesses.

42

The overall organization setups for both MTRCL and KCRC are very similar too. For MTRCL, it was organized into the following nine functional areas:

i) ii) iii) iv) v) vi) vii) viii) ix)

Operations; Project; Property; Finance; Human Resources and Administration; Legal & Procurement; Corporate Relations; Internal Audit; and Marketing & Station Business.

Whereas in KCRC, it was organized into the following eight functional areas:

i) ii) iii) iv) v) vi) vii) viii)

Transport (including Marketing); Capital Projects; Property; Finance (including Procurement); Human Resource; Legal & Company Secretariat; Corporate Affairs; and Internal Audit.

43

Both railways are able to generate profits to sustain railway operations without need for Government subsidy. In fact, there is little duplication in railway services provided by the two railway companies before the merger. MTRCL was providing urban transportation in most urban area while KCRC was providing public transportation mainly in sub-urban area up to including northern west territories like Tuen Mun and Tin Shiu Wai as well as Northern East New Territories like Ma On Shan and Tai Po, Fan Ling, Sheung Shui. KCRC also provided cross border services to Lo Wu as well intercity Passenger and freight services to Mainland China. The overall railway services after the merger will be complimentary to each other network and enable the integrated railway network to cover nearly all of the most urban area in the Hong Kong Territories except the southern side of Hong Kong Island.

From the analysis on the railway characteristics and financial performance stated under previous paragraphs, beyond doubt both the MTRCL and KCRC have been managed successfully with revenue from the operating railway able to support its cost of operations.

From the railway projects under construction and under planning, KCRC would have railway lines to be built compared to MTRCL as at the time up to the merger. The approval to proceed for detailed planning for West Island Line and South Island Line for MTRCL was only granted after the Rail Merger. As stated above, there is plenty scope of sharing of expertises and resources in the rail projects and related construction ahead.

44

b)

Key Difference

There are a few major key differences between MTRCL and KCRC:-

Firstly, MTRCL was listed in the Hong Kong Stock Exchange while KCRC was solely owned by the HKSAR Government. This leads to an avoidable difference in corporate strategies in particular on the corporate governance, business strategies and enterprising spirit.

Secondly, KCRC mainly focuses on local businesses though it also has intercity passenger and freight business in Mainland China. However, MTRCL has a very clear and determined growth business outside Hong Kong in Mainland China and Europe. The MTRCL growth business is best explained as in the following paragraphs extracted from their Annual Report 2007.

Works on the Beijing Metro Line 4 (BJL4) project made steady progress and the process to gain approval of the Shenzhen Metro Line 4 (SZL4) project continued. In Shenzhen, we continued to support the Shenzhen Municipal Government in obtaining approval on the SZL4 project from the National Development and Reform Commission.We continue to pursue other projects in the Mainland of China, development of new lines in Hangzhou, Suzhou, Tianjin and WuhanIn Europe, our joint venture with Laing Rail, LOPOL, was awarded the London Overground concession on 19 June 2007. On 11 November, LOROL successfully took over the concession, which allows it to operate services on five existing lines in Greater London for seven years. 60

Undoubtedly, the vision and business aspiration to go beyond Hong Kong is explicitly exemplified in MTRCL.

____________________
60

MTRCL Annual Report 2007, p.17.

45

Thirdly, key difference existed explicitly in the corporate culture and management strategic vision & direction as highlighted in the below Table 4 comparison of Vision, Mission and Values (VMV).
MTRCL Vision
To be a world class enterprise, growing in Hong Kong and beyond, focusing on rail, property and related business , , , , .

KCRC
To be a world leader in providing quality transport services on the basis of prudent commercial principles , .

Mission

Providing excellent value to our customers, enhancing their quality of life, and contributing to development of the communities in which we operate , .

To provide a safe, reliable, profitable and integrated railway network that meets the increasing demand for territorial, cross-boundary and intercity railway services. , , , . The Corporation is dedicated to finding better ways to: , , : Serve customers and meet performance pledges Fulfil both Government and corporate objectives Maintain financial strength Develop sound business partnerships Build teamwork and commitment in staff Encourage initiative and reward success ,

Provide opportunities for employees to grow and prosper with Company and reward our investors , , , .

Develop the rail network as the backbone of public transport in Hong Kong

Grow in Mainland China and capture opportunities in Europe by building on our core competencies , , , .

Values

Excellent Services Mutual Respect Value Creation Enterprising Spirit

Keep Customer first Continue improving Respect & trust Communicate effectively

Table 4 MTRCLs and KCRCs Vision, Mission and Values (VMV)

46

MTRCLs Vision includes railway, property and other related business as well as growth beyond Hong Kong but KCRCs vision focuses on transport and focus on local transport services. This is a vast difference in strategic direction between the two companies.

The missions of both companies are very similar in term of serving customers but inevitably for the MTRCLs missions they incorporate attributes of overall strategic transport network of Hong Kong as well as growth in Mainland China and Europe but not so in KCRC. The MTRCLs mission provides a clear direction for building its overseas business i.e. mainly in Mainland China and Europe, with good business rationale behind. The MTRCLs focus is to develop new business in Mainland China possibly with sizeable investment while they would develop asset light investment in Europe only.

The mission of KCRC include attribute to fulfil Government objectives but MTRCLs does not include Government at all though Government is still the major shareholders of MTRCL after its stock listing, This is obviously due to the fact that KCRC was a Government Department before and they are solely owned by the Government too. MTRCL is a stock exchange listed company and hence they have to put more emphasis on the commercial enterprise focus to meet the unavoidable commercial business efficiency drives expected by shareholders and less social services mentality than KCRC.

For customer services, MTRCLs Value Excellent Services, it can be considered more or less equivalent to KCRCs Value Keep Customer First.

For staff, MTRCLs Value Mutual Respect is more or less similar to the KCRCs Respect & trust.

For communication, KCRCs Value Communicate Effectively though is with the original intent to primarily focus on communication with staff to motivate

47

staff and boost morale; it also covers communication to customers. For MTRCL, there is no explicit Value on Communication; it is interpreted that the Values of MTRCL Excellent Service and Mutual Respect should have covered the inherent needs on effective communication with staff and customers in order to exemplify the two Values.

For KCRCs Value Continue Improvement, it can be considered more or less equivalent to the MTRCLs Value Value Creation and Enterprising Spirit on the other hands in board sense. However, the MTRCLs Values on Value Creation and Enterprising Spirit provides explicitly a clear drive and focus for business excellence and enterprising spirit whereas the KCRCs attribute Continue Improvement does not.

Culture of a company is built and fostered through its Vision, Mission and Values (VMV). No doubt, the difference in MTRCLs and KCRCs VMV would explain adequately the difference in corporate culture between them.

How to integrate the two companies with the vast difference in corporate culture and how to cultivate a new set of Vision, Mission and Values for the merged company will be a challenge and more elaboration will be included under later chapter of this dissertation.

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CHATPER 4
ANALYSIS OF THE RAIL MERGER

The research would start with highlights on the payment terms, merger framework agreement and service concession agreement made between the MTRCL and the Government of the HKSAR to appreciate the scope of merger integration. Then, the details of merger integration implementation would be discussed. Evaluation would then be made on the fulfilment of the Governments core objectives in a merger and stakeholder analysis including Government, shareholder, commuter, employee and other public transport operators. Finally, success of merger would be reviewed on adequacy of its fulfilment of the 5 parameters set by the Government, fare reduction and fare adjustment mechanism and seamless integration of railway network as well as a critical review on the performance of the MTRCL after the merger. PAYMENT TERMS 61

4.1

The MTRCL will be required to pay to KCRC the following payments

a)

Initial payments:

Upfront Payment of HK$4.25 billion for the right of the Service Concession Agreement and for the acquisition of certain short-lived railway assets of KCRC such as stores and spares.

____________________
61

MTRCL EGM Circular, 2007, p.21.

49

b)

Fixed annual payments: HK$750 million for the right to use and operate the Concession Property for the operation of the service concession.

c)

Variable annual payments Starting from the fourth year of the service concession, an annual share of the actual revenue generated from the KCRC System. The applicable percentage will vary according to the amount of revenue from the KCRC System for the relevant financial year as follows: i the first HK$2.5 billion of revenue from the KCRC System, the applicable percentage will be 0.0%; ii. iii for the next HK$2.5 billion, the applicable percentage will be 10.0% for the next HK$2.5 billion, the applicable percentage will be 15.0%; and, iv for the revenue from the KCRC System above the first HK$7.5 billion, the applicable percentage will be 35.0%.

d)

A payment of HK$7.79 billion for the acquisition of property and the sale of the shares in the KCRC Subsidiaries under the Sale and Purchase Agreement.

50

One can note that the MTRCL has to pay upfront HK$4.25 billion for the right to operate the concession service and another upfront payment of HK$7.79 billion for the right of property package. The total upfront payment of HK$ 12.04 billion is a heavy upfront investment. On top, the MTRCL has to pay fixed annual payment of HK$750 million for the service concession agreement plus a variable annual payment depending on revenue generated from the KCRC network. Furthermore, the fare reduction on the merger date would lead to a fare revenue reduction of HK$600 million per year. It is expected that estimated synergies of HK$450 million per annum will be fully realised over the first three years after the Merger Date, based on a joint study [before the merger] by the MTRCL and KCRC 62

All the above mentioned expenses have to be recovered from synergies (both cost synergies and revenue synergies) arising from the merger integration, together with further business growth opportunity to be generated due to expanded network and internal productivity improvement from the merger. This would create a challenge to the MTRCL Management in operating the combined rail operations to achieve the required synergies.

____________________
62

MTRCL EGM Circular 2007, p.22.

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4.2

MERGER FRAMEWORK AGREEMENT 63

The Merger Framework Agreement is a formal transaction document to include all agreed terms and conditions on the rail merger between the MTRCL and the Government. It contains provisions for the overall structure and certain specific aspects of the Rail Merger, including the details of the seamless interchange requirements and programme; the Corporate governance of the Company post-Rail Merger; the payments relating to property enabling works; arrangements relating to the details related to railway property development; staff arrangement in particular preventing the company from terminating the employment of Relevant Frontline Staff for any reason that relates to the process of integrating the operations of the Company and KCRC; the implementation of certain fare reductions; arrangements in relation to the proposed Shatin to Central Link and other legal procedures on claims and liabilities and etc. It also stipulated the Companys retention of its English name and (pursuant to the Rail Merger Ordinance) the change of its Chinese name to .

Under the Merger Framework Agreement, there is a clause for liquidated damage payable by the MTR to the HKSAR Government should the barrier interchange and seamless services (i.e. removal of interchange ticket gates at three interchange stations at Nam Cheong, Mei Foo and Kowloon Tong) not achieved within one year from the Merger Date, on top of many other stipulated requirement. This also creates challenge to the MTRCL Management in fulfilling the different requirements under the Agreement.

____________________
63

MTRCL Extraordinary General Meeting Circular (2007), p.28.

52

4.3

SERVICE CONCESSION AGREEMENT 64

The Service Concession Agreement contains provisions in relation to the grant and operation of the Service Concession, including the grant of the Service Concession to the Company to access, use and operate the Concession Property; the term (being an initial period of 50 years from the Merger Date) of the Service Concession and redelivery of the KCRC System upon expiry or termination of the Concession Period; governing of the provision of the KCRC Services by the Company to the Required Standards applicable to the KCR Services, the details of payment of the Upfront Payment of HK$4.25 billion, the Fixed Annual Payments and the Variable Annual Payments; the arrangement of intellectual property rightetc. RAIL OPERATIONS AFTER THE MERGER 65

4.4

With effect from the Merger Date, the MTRCL Services and the KCRC System will be operated as a single combined system. A number of the

anticipated synergies may take time to create but it is expected that all significant aspects of the integration will be implemented within three years after the Merger Date.

One of the key parameters for the Government, when considering the Rail Merger, was to ensure that the Rail Merger creates a seamless integration of travel between the MTRCL Railway and KCRC Railway. This will require, amongst other things, the removal of ticketing barriers at MTRCL and KCRC interchange stations allowing passengers to travel from the KCRC Railway to the MTRCL Railway (and vice versa) without the need to pass through intermediate ticket barriers or the need to pay a second boarding charge. The

_____________________
64 65

MTRCL Annual Report 2007, p.29. MTRCL Extraordinary General Meeting Circular (2007), p.35.

53

stations which will be affected by this process are Kowloon Tong, Nam Cheong and Mei Foo. The removal of such barriers is planned to be completed within 12 months after the Merger Date.

In addition to seamless interchanges between the two systems, the MTRC Services and KCRC Services will be aligned and integrated as far as practicable. The integration will include unified branding logos, signage and passenger information across the network and a new set of single uniform for staff and the combined operating teams at interchange stations.

With effect from the Merger Date, as an integrated Railway, both the MTRCL Railway and the KCRC Railway will be subject to a single regulatory regime. The operations of the integrated Railway will be regulated by the

MTRCL Ordinance, the MTRCL Regulations and the Operating Agreement.

4.5

MERGER INTEGRATION IMPLEMENTATION

a)

The Merger Integration Organization

In the early implementation phase of the merger integration, we need a formal merger integration organization to approve work and funding. The set up in the initial phase of merger integration organization is depicted in Chart 2 below:

54

JIG

MIMC MIO PMSCC SIPMO TFs/STs

HRIMC

MCommC

ITMC ITPMO HRPMO

Chart 2 - Merger Integration Organization Structure

Legend: JIG - Joint Integration Group (JIG) MIMC - Merger Integration Management Committee (MIMC) MIO - Merger Integration Office (MIO) ITIMC - Information Technology Integration Management Committee ITPMO - Information Technology Project Management Office (ITPMO) HRIMC - Human Resources Integration Management Committee (HRIMC) HRPMO -Human Resources Project Management Office (HRPMO) MCommC - Merger Communications Committee (MCommC) PMSCC - Pre-Merger Safety Management Committee (PMSC) TF - Task Forces (11 nos) ST Sub-Teams (37 nos)

55

At the highest level is the Joint Integration Group (JIG) which is the highest level of the merger organization. It is co-chaired by both CEOs of MTR and KCRC and attended by Directors of both companies. It formulated strategic plans and set direction for all merger integration activities and settles all unresolved issues.

Reporting to the JIG, there are three different set ups.

i)

Merger Integration Management Committee (MIMC)

It is the body actually strategically leading the functional merger integration across both companies. It approve all merger related work, budget and expenses too.

Reporting to the MIMC is also the Merger Integration Office (MIO) which is responsible to MIMC for all actual merger integration implementation. This is the unit with full time staff seconded from Line Function to work independently solely on the merger integration works. It is in fact, the execution wing of the MIMC and leads and drives all the Task Forces, Sub-Teams, Project Management Offices for multi-disciplines merger integration works. At the peak demand of merger integration works, there are 30 full time staff seconded from both MTR and KCRC to work in this unit.

Pre-Merger Safety Coordination Committee (PMSCC) is the organization responsible to MIMC ensuring safety of operations would not be affected both before and after the merger during all merger integration activities. A safety consultant had been engaged to lead this PMSCC to ensure safety for operations not affected by any merger integration process as well as the future planning for safety after the merger would be robust to meet the

56

future operations and demand.

Seamless Integration Project Management Office (SIPMO) is responsible for all the Day 1 Integration Projects including the Day 1 Integration Ticketing, non-ERP related

Task Forces (TF) and Sub-Teams (ST) are those teams actually working on the details of functional merger integration. There were all together 11 Task Forces and 37 Sub-Teams ranging from integration for Finance, Human Resources, Property, Projects, Legal, Procurement, Operations.etc. The 37 Sub-Teams are in fact further breakdown of each TF say for example for Finance Task Force, it had been further broken down into five sub-teams namely Financial Control, Treasury, Internal Audit, Store and IT.

The 11 Task Forces are:

Passenger and Freight Task Force Total Station and Station Maintenance Task Force Operations Engineering Task Force Operations Revenue Generation Task Force Project Integration Task Force Property Task Force Finance Task Force Human Resources & Administration Task Force Communication Task Force Legal & Procurement Task Force Safety, Quality & Environment Task Force

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ii.

Information Technology Management Committee (ITIMC)

It is responsible for all integration work related to Information Technology. This includes the transformation of ex-KCRC main framework computer related software to the MTR Oracle framework software Reporting to the ITIMC is the Information

Technology Project Management Office (ITPMO) which take up all actual project management of implementation details for all information technology related merger integration activities.

iii.

Human (HRIMC)

Resources

Integration

Management

Committee

It is the body working in all human resources related merger integration works. These include the set up of grading and structure for the new organization, the term and conditions for new employees of the merged company. Under the HRIMC is the Human Resources Project Management Office (HRPMO). This HRPMO in fact is responsible for execution of decision and plans made by the HRIMC.

iv.

Merger Communication Committee (MCommC)

It is the organization which handles all external and internal communications. It develop communication plan to fit different stages of the merger integration and handles media as well as develop communication plan for internal staff consultation and briefing as well as communication for lobbying Government and political parties on the approval of the Merger Bill by the LegCo and approval of the Merger Resolution by minority shareholders in the Extraordinary General Meeting.

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b)

Merger Integration Process

The merger integration process can be broadly divided into pre-merger activities and post-merger activities with a few distinct phases throughout.

Pre- Merger Activities

i.

Merger Design and Planning Phase (April to December 2006)

From the announcement of merger by the Government on 11 April 2006 up to end December 2006, it can be regarded as the Merger Design and Planning Phase. The focus of the activities is to understand each others business in details, to formulate the MergeCo approach, to design organizational structure and processes and plan for the required manpower for the future combined railway operations.

ii.

Merger Preparation and Delivery Phase (January November 2007)

For the 11 months in 2007 before the Merger Date on 2 December 2007, the focus of activities is to execute Day-1 readiness activities, plan and conduct training and communications, prepare for key synergy items integration.

During this phase, the merger integration organization also adopted necessary adjustment. The Task Force and Sub-Teams were scaled down and new Implementation Working Groups (IWG) and Topic Coordination Teams (TCT) were formed.

59

The Implementation Working Groups (IWGs) were formed to focus on preparation and implementation of selected subjects related to area including a) critical Day-1 operations, b) key synergy delivery, and c) complex organization changes. There were all together 12 IWGs formed. They are:

Interchange station operation Communication Coordination Control Centre operation Incident Handling Crisis Management System Safety Report Safety Management System and Safety Rules Energy Management Total Station Operations Contract Bundling Centralized Operations Project Management Centralized Technical and Engineering Services Organizational rationalization of Train Staff

The Topic Coordination Teams (TCTs) were formed to focus on the preparation of selected subjects with complicate interfacing issues across divisions and functions like training and qualification, licensingetc.

There were already 7 TCTs formed and they are:

Staff Training and Qualification Progressive Integration Corporate Licensing Programme Management Communications

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Works Instructions and Procedures Alignment Merger KPIs

Post-Merger Activities

It is the merger transition, stabilization and synergy delivery phase from December 2007 to December 2008: First 1st to 6 th months after the Merger Date

i.

The main focus of activities is to manage organization transition and interface issues, support the newly appointed Directors and Department Heads in the launching of new processes, monitor overall progress and highlight progress and issues with executives, provide focus on synergy capture and implementation while line functions focus on staff appointment

Immediately priorities for the Corporation after the merger included activities to ensure smooth transition. The new formed Line Management and personnel would be busy carrying out implementation of merging of the two railway function and not fully abreast of merger master plan and interdependencies across departments. unavoidable Personnel staff changes and in department would due to

transfer

appointment

create

discontinuity in merger knowledge transfer as well as there are complex changes requiring coordination across different

departments and functions. Needless to say, there is imminent need to drive further cultural integration.

On synergy delivery side, beyond doubt Line Management may easily pay less focus on synergy initiatives as they were just

61

settled down and would often busy with functional integration activities, as well as efforts required to keep business as usual. Slippage of synergy delivery would easily happen without awareness and so monitoring of synergy delivery programme is essential to ensure synergy delivery as planned. 7th month to 12th month after the Merger Day

ii.

The focus of activities is to clean up remaining integration and interfacing issues, monitor synergy capture against plan, plan for Year 2 synergy items and develop new productivity initiatives and plan.

c)

Integration Plans

The Integration Plan is the output deliverable to be produced by each sub-team and it is the proposal for required integration for the functional area they are responsible. The Integration plans will cover the following content:

i) ii) iii) iv) v) vi) vii) viii)

Executive Summary Organization Process and System Integration Other MergeCo Initiatives Risk Assessment and Mitigation Plan Appointed Day Requirements Summary Synergy Summary Cost of Integration Summary

There were in total 51 Integration Plans prepared and they set the blue print for the future Merged Company (MergeCo).

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d)

Seamless Service and Interchange

The integration of the two railway systems is expected to provide passengers with a single seamless service that meets their needs. There are four planned areas for changes to provide this seamless service:

i. ii.

Improving interchange arrangements at the three common stations Integrating the ticketing system, and extending system-wide products such as the tourist ticket

iii. iv.

Providing consistent passenger information, with a single brand Providing applicable) comparable customer service standards (where

For Seamless Interchange, there are three stations that are common to MTR and KCRC networks Nam Cheong, which connects the Tung Chung Line and West Rail, Mei Foo, which connects the Tsuen Wan Line and West Rail, and Kowloon Tong, which connects the Kwun Tong Line and East Rail. The planned changes involve removing the barriers between the two systems, restructuring the stations to improve passenger flow.

Improved interchange at other stations has been considered, but is found not viable. At Mong Kok stations and Tsuen Wan stations, the stations are too far apart. At Tsim Sha Tsui stations, there are too many points of public access along the subways and given the difficulties in getting sufficient space for unpaid mini-concourses at street level, no further physical integration is planned. Nevertheless, an integrated fare scheme has been provided for passenger interchanging at Tsim Sha Tsui Stations.

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e)

Integrated Ticketing system

Though the TRCL and KCRC systems have already adopted common use of Octopus card, the functionality of software behind, the fare deduction logic and combinations of different ticketing machines raised the compatibility issues when combining the two railway systems into one integrated fare systems. Furthermore, MTRCL and KCRC have their own ticket machines to handle their respective single journey tickets and there tremendous MTRCL and KCRC standalone ticket products (e.g. West Rail Monthly Pass only applicable to West Rail Line of KCRC and Tourist Day Pass of MTRCL only applicable to MTRCL urban lines before merger. All these make the work to develop a single fully integrated ticketing system very complicate matter. Due to the complicated software changes and new hardware requirements, including modified ticketing gates and ticket machines, the integrated single journey ticketing system will only be available in the second year of the merger. Prior to this, only Octopus Card users will enjoy the benefits of the new integrated fare structure. Given that the Octopus card users represent 90% of total trips, most passengers will be able to enjoy immediately the benefits of the new integrated fare structure.

f)

Provision of consistent passenger information and corporate branding

The objective for the changes is for the MergeCo to present a single and consistent face to its customers and the general public. The changes would include development and launch of a single brand, design of new corporate website, replacement of sings and logos at stations, rolling stock and vehicles, offices, depots, new route maps, notices, leaflets, tickets, design and replacement of new uniforms.

64

g)

Comparable customer standards

To ensure comparable and consistent customer service standards across the combined system, three changes would be made. Firstly, a new Communication Coordination Centre (CCC) serving a single contact point for all internal and external parties involved in incidents will be established to facilitate speedy consistent passenger information. Secondly, there would be combined Operations Control Centre but it would have to take be in line with development of new lines like Kowloon Southern Link and the Shatin Central Link. Hence, it would not be immediately available at the merger date but would take quite some years to achieve to avoid abortive investment. Thirdly, the two corporations hotlines will be integrated. This combined hotline will provide a single local point for customer information and service enquiry. The integrated system will facilitate a consistent and efficient monitoring of all enquires.

h)

Operations and Systems Integration

The merger would require a wide range of policies, practices and systems to be integrated. In each case, normally one of the two practices existing in the MTRCL or KCRC would be adopted on basis that the MergeCo would choose the best practice or even a third approach. The key areas to be integrated including Safety, Quality and Environmental policies and management systems including all statutory licences and permits, accounting policies and systems, Information Technology as well as ticketing and back office accounting systems.

Of course, the Corporate Governance and Board structure as well as the management and organization structure would need to be integrated.

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i)

Human Resources

MTRCL and KCRC together employed a total of some 12,000 staff covering all sectors of business. The majority of staff are employed to provide the railway services for over 3 million passengers a day. To ensure continuity of safe and reliable railway services and no interruption, a scheme to protect all frontline staff (namely non-managerial staff working directly on the provisions of railway services say train drivers, station staff, maintenance staff.etc.) job security had been established to minimize staff uncertainty and secure their commitment to the merger.

There are many areas under the Human Resources which required top management attention and extreme care in handling in order to address staff concerns and fairness. The followings are not meant to be exhaustive but just selected for elaboration to demonstrate the due diligence taken up by the Management of MTRCL and KCRC on caring to their staff (i.e. many HR related activities have to be undertaken well before the actual Merger Date.

Alignment of employment terms and conditions

Both MTRCL and KCRC have their own employment terms and conditions and alignment of terms and conditions is fundamental requirements for the Merger. However, terms and conditions have direct impact to individual staff salary package as well as welfare and benefits. Beyond doubt, all staff unions would be active to peruse the best benefits from staff perspectives. On the other hands, a balance must be struck by the Management between staff acceptance and short and long term cost to the merged company.

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Extensive staff consultation and communication sessions were held at different stage of the merger integration process to ensure common understanding and to minimize staff uncertainty.

Identification of staffing synergies, staff selection and appointment, staff re-deployment and career transition services

Needless to say, there would be staffing synergies expected from the Rail Merger. Since all frontline staff is under job protection against merger integration related job loss, the focus would then be on nonfrontline supporting functions and managerial staff. New organizations with built in staff synergies were developed jointly by MTRCL and KCRC and planned phase of implementation was adopted to minimize immediate impact to staff as far as practical and to take full consideration of natural wastage rate due to retirement and new demand from new lines in coming future.

It was covered in the MTRLC and KCRC Press Release that there would be more than 1,300 job vacancies coming up in next three years after the Rail Merger while there would be only about 650 job cut due to the Rail Merger. It is not difficult for general staff to realize that there would be mismatch in timing of requirements and skill set. The supporting function staff was most subject to job loss while the new posts to be coming up are mostly related to railway projects. Management has to exercise proactive measures to minimize staff impact.

One of the management initiatives was to introduce a Voluntary Separation Scheme with incentive to attract staff to submit resignation on their own accord. The vacancies left would relieve the severe job competition among staff. This scheme offered one month salary to every accumulated year of service with a ceiling capped at 20 months of

67

equivalent salary and it was well received by staff.

To ensure fairness on staff selection and appointment, every selection panel is composed by appropriate Management Representatives and HR Representative of MTRCL and KCRC. Also, an Employment Consultant was employed and representative from the Employment Consultant would participate in every Selection Panel.

The Management also rendered care to staff failed in selection interviews. Another consultant firm was engaged to provide career transition services to staff on career coaching.

Communications and Consultations

To minimize unavoidable staff uncertainty on job appointment, terms and conditions, and other HR related issues, special hotline and email for merger related queries were set up. Regular staff news letter on merger was released on regular basis and to assure consistency in message to staff, a joint merger news letter was prepared by a joint editorial board composed by MTRCL and KCRC Representatives.

Communication to staff was carefully planned and content was devised appropriately to avoid unnecessary staff sensitivity or tension raised unintentionally.

Besides communication to staff, extensive efforts were exercised on careful planning and implementation of communication to external stakeholders including the Government, shareholders, and politicians for approval of the Merger Bill in LegCo and Merger resolution in the Extraordinary General Meeting (EGM).

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Cultural Alignment and Integration

As highlighted under the chapter 2 on literature review, success of cultural integration is one of the critical success factors to smooth merger integration. The MTR Management has taken up the subject with top management commitment and invested a lot of resources and time to assure smooth cultural integration be achieved.

At the very early stage of the merger integration preparation, the Management of the MTRCL and KCRC jointly committed on resources and time to ensure adequate cultural integration activities to be implemented. A slogan One Company One Team together with One Team One Goal was launched in early May 2006 as the main theme of merger for alignment and focus of all staff in the MTRCL and KCRC. In fact, the slogan was developed and launch well before the Olympic Game and it slogan One World One Dream was launched afterward.

A Merger Integration song with very encouraging lactic was composed and the song was performed by a very popular and famous local singer. There was favourable response to the song and it was well accepted by staff. The melody of the song was composed as ring tong and put up in corporate intranet for free download by staff to mobile. All these activities did boost morale and team spirit among staff.

There were 99 cultural integration workshops organized for all 12,000 staff of MTRCL and KCRC before the merger
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, on top of numerous

cross company visits and other cultural integration activities like cookery competition, as shown in Figure 4 below, to foster team spirit among staff across the two companies. _________________
66

MTRCL Annual Report 2007, p.70

69

Figure 4

Photo of Merger Integration Cookery Competition to foster team spirit among staff of MTRCL and KCRC (Source: MTRCL Annual Report 2007)

Furthermore, there are numerous social gathering activities as well as experience sharing sessions across similar work function of MTRCL and KCRC to enable staff to get familiarization in advance to the Merger Date.

Also, there were job rotation and job attachment undertaken to allow certain amount of staff to work in the other company under supervision for sharing of work experience e.g. KCRC station operators to work in MTRCL station and vice versa.

Vision, Mission and Values

As highlighted under the previous literature review chapter, according to the Mckinsey Consultant Inc experience on merger integration, nearly 49% of merger failure causes were contributed by poor culture-related issues. Cultural alignment is important for the success of the merged company. The combined business would initiate a new strategic dimension well beyond the horizon and challenges faced by the two companies before the merger. The company Vision, Mission and Values

70

(VMV) must be further aligned though they are similar in certain aspects and hence a new set of VMV would be developed.

New Corporate VMV has been developed and in the process of roll out to every staff. Details of the new MTRCLs VMV is affixed in the Appendix 2 for reference. In summary, the new VMV is listed below:

Vision

The new Vision for the MTRCL after the Rail Merger is as listed below:

We aim to be a globally recognized leader that connects and grows communities with caring service.

It is interesting to note there is not a single word like railway in the statement and rationale taken up by the MTRCL Management is that the MTRCL now does not only focus on local railway services, though it is still regarded as the MTRCLs core business, the business vision for the MTRCL is go beyond Hong Kong with international business mainly in Europe and Mainland China.

In fact, the Vision statement connect and grows communities is embedded with transportation services as well as building new community through property development and new railway extensions and lines. Furthermore, caring service exemplify the customer services standard envisaged to be delivered.

Mission

The New MTRCLs Mission has six elements namely:

71

Enhance customers quality of life and anticipate their needs. Actively engage in communities we serve. Foster a company culture that staff can learn, grow and take pride in.

Provide sustainable returns to investors. Set ourselves new standard through innovation and continuous improvement.

Grow in Hong Kong, Mainland of China and capture opportunities in Europe by extending our core competencies.

The mission is updated in the context of the new Vision Statement and put emphasis on customers needs, engaging in communities that the MTRCL serves, care to staff and investors, drive for improvement as well as growth in Mainland China and Europe businesses.

The new Mission statements do raise the business vision and horizon and explicitly convey the MTRCL expectation to staff and public for the direction the MTRCL after the Rail Merger will be heading to.

Values

The new MTRCLs Values still have four elements. In fact, the four elements are exactly the same as those four Values of the MTRCL before the Rail Merger. They are:

Excellent Service Mutual Respect Value Creation Enterprising Spirit

The four core values are the same as those of pre-merger MTRCL but

72

they are to be elaborated and interpreted in the context of the new Vision and Mission.

The challenge is how to roll out the new VMV to all staff in the merged company. It is observed that the MTRCL Management demonstrated very determined drives and exemplified commitment from all top ands senior management to render support to the roll out. Each division is provided with budget for divisional VMV roll out programme to meet localized and functional needs, within a predetermined timeless and well defined timeless.

A staff attitude survey is planned to be conducted some time in November 2008 approximately around one year after the Rail Merger, to collect staff feedback for continuous improvement.

4.6

STAKEHOLDERS ANALYSIS

a)

Government

In short, almost all Governments core objectives in a merger as stated under the literature review section have been fulfilled. Key highlights are as listed below:

i.

Financial

Under the merger deal, the MTRCL has to pay to KCRC an upfront payment of HK$4.25 billion payable under the Service Concession Agreement being the upfront fee for the right to operate the Service Concession and the consideration for the Purchase rail assets plus upfront Property Payment of HK$7.79 billion payable under the Merger

73

Framework Agreements in consideration for the execution of the Property Package Agreements and the sale of the shares in the KCRC Subsidiaries under the Sale and Purchase Agreement in each case payable on the Merger Date. The KCRC is solely owned by the Government and payment to the KCRC is more or less equivalent to the payment direct to the Government. Also, as stated in the MTRCL Extraordinary General Meeting (EGM) Circular to shareholders, it is expected the by year 3 a $450 million of synergies per annum would be expected. All these would have meet the critical set for the financial objective.

ii.

Transactional

MTRCL listing status has not been affected by the merger. In fact, MTRCL did achieve good operational and financial performance after the Rail Merger. Details of MTRCL performance after the Rail Merge will be covered in later chapter.

iii.

Transport/Planning

An objective fare adjustment mechanism has been established and included in the merger agreement with MTRCL with fare reduction introduced starting immediately on the Merger Date. The seamless interchange has been progressively implemented since the merger date and further barrier free at the three interchange station at Nam Cheong, Mei Foo and Kowloon Tong would be ready within one year from the Merger date i.e. the interchange fare ticketing gates at the three stations would be removed and passengers for interchange would experience barrier free interchange afterwards. Again, the objective was met.

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iv.

Social/Environmental

Term and Condition for all staff were aligned and implemented by 1 March 2008 i.e. only three months after the merger date on 2 Dec 2007. Besides all frontline non-managerial staff where their job security was protected, all other staff selection and appointment were completed by early April 08 again completed only within 4 months from the merger date. This no doubt would help to reduce uncertainty period and enable staff to concentrate their commitment on the merger integration and work until the new merged company. In the MTRCL Announcement of Unaudited Results for the six months ended 30 June 2008, it states the number of patronage for the combined network of the merged rail operations increased by 4.0% when compared with the combined rail and bus patronage numbers of MTRCL and KCRC (as adjusted for interchange passengers) in the first half of 2007 (Pre-merger Comparable Patronage). Surely, it is a self-explanatory statement and demonstration of the competitiveness of the combined rail network due to fare reduction, increased interchange convenience and enhanced services after the merger.

b)

Shareholder

The vote on the merger by minority shareholders in the Extraordinary General Meeting held on 9 October resulted with 82.17% of shareholders voted for the merger. This by itself is a good reflection of the positive views by shareholders on the merger. See Figure 5 below for voting result.

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Figure 5

Photo of MTRCL EGMs Voting Result on the Merger Resolution

(Source: MTRCL Annual Report 2007)

The MTRCL stock price was $16.3 in Jan 2006, $18.75 in June 06, 19.54 in Dec 06, $18.58 in June 07, $26.15 in Nov 07, $29.8 in Jan 08, $26.7 in Mar 08 and $26.3 in May 08. In summary, the MTRCL Stock price was running in similar trend to the Hang Seng Index (HIS) but it was normally speaking running below the Hang Seng Index (HSI) for the period before the Rail Merger. However, the MTRCL stock price was higher than the Hang Seng Index after the Rail Merger. This may reflect the general favourable acceptance of the Rail Merger by investors and shareholders. The comparison of MTRCL stock price and Hang Seng Index (HIS) for the period from Jan 2006 (i.e. 3 months before the announcement of the merger on 11 April 2006) to end May 2008 (i.e. 6 months after the merger on 2 December 2007) is depicted in Chart 3 below.

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35000

35

HSI
30000 30

MTR
25000 25

20000

20

15000

15

10000

10

5000

0
Jan- Feb- Mar- Apr- May- Jun06 06 06 06 06 06 Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun06 06 06 06 06 06 07 07 07 07 07 07 Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun07 07 07 07 07 07 08 08 08 08 08 08

Chart 3 Comparison of MTRCL Stock Price to Hang Seng Index (HSI)

(Source: http://hk.finance .yahoo.com/q/hp?s=%5HSI, and http:// hk.finance.yahoo.com/q/hp?s=0066.hk)

c)

Commuter

i.

Fare Reduction

For commuter, the immediate benefits after the merger would be the significant fare reduction introduced on the first day of the rail merger. In the MTRCL Press Release of 11 April 2006, it stated the followings:-

Passengers will enjoy significant fare reductions All adult Octopus fares for long distance journeys at or above HK$12 will be reduced by a minimum of 10%.

All adult Octopus fares for medium distance journeys from HK$8.5 to - HK$11.9 will be reduced by a minimum of 5%

The Second Boarding Charge will be abolished, resulting in fare

77

reductions of HK$1 to HK$7 for passengers interchanging between the existing MTR and KCR networks All fares will be reduced by HK$0.2 Long distance journeys with fares at or above HK12 will be further reduced by HK$1 For those long distance journeys with fares at or above HK$12 where (a), (b), and (c) do not add up to 10% saving, a further reduction will be offered to achieve the 10% saving Medium distance journeys with fares from HK$8.5 to HK$11.9 will be reduced by a minimum of 5%. If (a) and (b) do not add up to a 5% saving, a further reduction will be offered to achieve the 5% reduction. Fare reductions will apply to MTR (excluding Airport Express), West Rail, East Rail (excluding Lo Wu/Lok Ma Chau trips) and Ma On Shan Rail. 2.8 million passenger trips will benefit each day The vast majority of the fare reductions will be funded by merger synergies The dollar amount of concessionary fare reductions will be half of the adult fare reductions.

78

Fare reduction examples

Example movements (for adult Octopus)

Existing fare

Removal of 2nd boarding charge

Octopus fare reduction

Long distance discount

Medium distance reduction to achieve 5%

New fare

Total Reduction

HK$

Top up

City One Shatin Kwun Tong Central Tai Po Market Central Tung Chung Tuen Mun Mei Foo (KCR) Mong Kok (MTR) Central

$11.8

$3.5

$0.2

$8.1

31.4% ($3.7)

$17.3

$1.5

$0.2

$1.0

$14.6

15.6% $2.7) 10.4% ($2.1) 10.4% (1.4)

$20.1

$0.2

$1.0

$0.9

$18.0

$13.5

$0.2

$1.0

$0.2

$12.1

$10.0

$0.2

$0.3

$9.5

5.0% ($0.5)

The dollar amount of concessionary fare reductions will be half of the adult fare reductions

Table 5

Fare Reduction Examples

(Source: MTRCL Press Release 11 April 2006)

ii.

Public Opinion Survey

According to the MTRCL Press Release dated 11 April 2007, a Public Opinion Programme (POP) at the University of Hong Kong was commissioned to conduct a public opinion survey to track Hong Kongs peoples views on the proposed merger. 509 respondents were randomly selected by the POP and successfully interviewed by POP interviewers via telephone. The survey findings show that 84% of respondents support the

79

rail merger in general, 76% find the proposed fare reductions to be offered immediately after the merger acceptable, and over half of the respondents expressed dissatisfaction towards the progress since the proposed merger was announced one year ago. Inevitably, the general public would have positive views towards the rail merger.

iii.

Customer Satisfaction Index (CSI) Survey

It has been practices in MTRCL and KCRC to conduct regular customer quality index survey by independent marketing survey companies. However, the content of the survey questionnaire, the survey population coverage and survey interval are different between the two rail companies before the merger. In order to have comparable data base for performance before and after merger, a set of common attributes to be incorporated in customer satisfaction survey was agreed and survey on such attributes was conducted in September 2007 (about 3 months before the merger). Another survey was conducted at about 3 months after the merger in March 2008 with a further one targeted in September 2008. A comparison between the two customer satisfaction survey results on those common attributes confirmed there is not much difference between the two rounds of customer quality index surveys. In other words, the customers are in generally satisfied with the service quality after the rail merger at the same level to the service quality before merger.

iv.

Customer Complaints figures

The figures for the customer complaints would be a good indicator on the service after the rail merger too. Unfortunately, the definition of the customer complaints adopted by MTRCL and KCRC before the rail merger is of significant difference and so it is not meaningful for direct comparison of the absolute figures. For consistency, a new common set of definition on

80

customer complaints had been developed and adopted since the merger date. It is naturally the number of complaints was higher in the initial two months immediately after the merger and the figures dropped to insignificant level. On basis of applicable and comparable attributes for both the MTRCL and KCRC rail operations before and after merger, the absolute number of customer complaints was significantly less after the merger.

d)

Employee

MTRCL and KCRC employed around 12,000 staff in total before the merger. No doubt, uncertainty and concern about job security would be the top staff concern and affected staff morale. The quick to settle alignment of terms and conditions as well as selection and appointment it would be in better position to address staff uncertainty.

The Terms and Conditions of the two railways were aligned in a speedy and effective way and implemented on 1 March 2008 at only 3 months after the merger. Furthermore, the selection and appointment of all staff were completed by early April 2008. Full communications with staff in both MTRCL and KCRC had been conducted throughout the whole merger process to ensure transparency and understanding by staff at all level. All these would enhance staff communication and to minimize uncertainty about the merger.

e)

Other public transport operators

According to the Transport Department Statistics, the patronage of other public transport operator dropped after the merger in June 2008 when compared to the November 2007 figures (figures for the month before the merger) as shown in Table 6 below:-

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Nov 07 (Million) KMB City Bus NWFB All Franchised Buses Public Light Buses 2.843 0.593 0.522 4.0844 1.855

Jun 08 (Million) 2.594 0.545 0.455 3.709 1.822

Increase/ Decrease 8,76% 8.09% 12.84% 9.18% 1.78%

Table 6

Patronage of other transport operators in June 2008 67

The average patronage of the combined MTRCL network gets average a 4 - 5% increase up to end of June 2008, according to the MTRCLs Press Release on 5 August 2008 for first six month performance of 2008 up to 30 June 2008.

The following Chart 4 illustrates the percentage of market share by MTR compared to other transport operators in the month of December 2007 immediately after the merger.

Chart 4

Market Shares of Major Transport Operators

(Source: MTRCL Annual Report 2007)

____________________
67

MTRCL Annual Report 2007, p.70.

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4.7

FULFILMENT OF 5 PARAMETERS SET BY THE GOVERNMENT

The 5 parameters set by the Government for the merger are:

a)

Adoption of a more objective and transparent fare adjustment mechanism

This was met with a transparent fare adjustment mechanism incorporated into the merger framework agreement made between MTRCL and the Government.

b)

Abolition of second boarding charge and review of the fare structure with the objective of reduction fares

This was implemented on the same date of the merger date on 2 December and reflected already in the new integrated fare table and fare reduction.

c)

Early resolution of interchange arrangements for new rail projects under planning notably the Shatin to Central Link

The resolution between interchange for Shatin to Central Link reached and new proposal finalized after the merger submitted to the Government for consideration.

d)

Ensuring job security for frontline staff at the time of rail merger

The definition of frontline staff was reached between the Government and staff representatives including the Unions. All selections and appointments of staff including frontline and nonfrontline staff were completed by early April 2008.

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e)

Provision of seamless interchange arrangements in the long run

The seamless interchange arrangements at the three interchange stations namely Nam Cheong, Mei Foo and Kowloon would be implemented as planned within one year from the merger date (i.e. latest by 2 December 2008). This is a mandatory requirement as stipulated in the Merger Framework Agreement. Any delay would be subject to liquidation and claims by the Government to MTRCL. That is why the MTRCL Management paid very high management attention on the seamless interchange project progress. In the long run, the interchange between the long lasting dispute between MTRCL and KCRC before the merger would be settled Should there be any delay and the seamless interchange at the three stations would Further seamless interchange would be addressed in future new lines and railway extensions including proposal for the Shatin to Central Link.

4.8

FARE REDUCTION AND FARE ADJUSTMENT MECHANISM (FAM)

Before the merger, both the MTRCL and KCRC have fare autonomy, and they set their fares in accordance with prudent commercial principles, taking into account of prevailing marketing conditions, competition and business objectives of the company.

As one of the five parameters set by the Government on the rail merger is a transparent and objective fare adjustment mechanism, the MTRCL has agreed with the Government a formulaic approach for determining future fare adjustment to replace the fare autonomy after the rail merger (MTRCL EGM Circular). The Fare Adjustment Mechanism will work as follows:

84

Overall weighted fare adjustment rate = 0.5 x yearly % change in CCPI + 0.5 x yearly % change in Nominal Wage Index - t

Where,

Overall weighted fare adjustment rate is calculated based on the basket of specified fares on the integrated railway as set out separately;

CCPI stands for Government Composite Consumer Price Index;

t is a productivity factor. The purpose of t is to incentivise the company to achieve productivity gains. t will be deemded to be zero in the first five years following the Merger Date. t will have a value of 0.1% starting from the sixth year following the Merger Date. The value of t will not be subject to review until after the ninth anniversary of the Merger Date under the agreed review mechanism for the FAM; and

Nominal Wage Index refers to transport services sector only.

85

4.9

SEAMLESS INTEGRATION OF RAILWAY NETWORK

As stated already in earlier paragraph, the seamless interchange arrangements at the three interchange stations namely Nam Cheong, Mei Foo and Kowloon would be implemented as planned within one year from the Merger Date (i.e. latest by 2 December 2008). Further seamless interchange would be addressed in future new lines and railway extensions including proposal finalized for the Shatin to Central Link.

Besides the rail projects under planning stated in previous Chapter 3 including the Kwun Tong Line Extension, North Hong Kong Island Line, Northern Link, Port Rail Line, Shatin to Central Link and South Island Line, there would be opportunity for better planning and integration of the new rail project namely the Hong Kong Section of Guangzhou - Shenzhen - Hong Kong Express Rail Link.

The Hong Kong Section for the Guangzhou-Shenzhen-Hong Kong Express Rail Link (XRL) which will link Hong Kong to the Shibi Station at Guangzhou through the Futian Station and the Longhua Sation at Shenzhen, will form part of the national high-speed rail network. By means of this new intercity rail corridor, the journey time between Guangzhou and Hong Kong would be reduced from 100 minutes to 50 minutes. The Hong Kong section of the XRL will run along a dedicated corridor from a new terminus at West Kowloon to the boundary near Lok Ma Chau for connection with the Mainland section of XRL. The Regional Express Line envisaged in Railway Development Strategy 2000 now becomes the Hong Kong section of the XRL.
68

With the

Merger, this new Guangzhou-Shenzhen-Hongkong Express Rail Link would be better integrated with the existing railway and unnecessary wastage of resources for bidding can be avoided. ___________________
68

http://www.hyd.gov.hk/eng/major/road//rail/index.htm.

86

4.10

PERFORMANCE OF THE RAILWAYS AFTER THE MERGER

The success of the rail merger was highlighted in the MTRCL Press Release dated 5 August 2008 for announcement of unaudited results for the six months ended 30 June 2008. In the Press Release, it states For the first half of 2008 total patronage for all of our rail and bus passenger services (integrated MTR System) increased by 66.1% to 721.2 million as compared to that of the same period last year mainly due to the Rail Merger. On a Like for Like basis, such passenger numbers would have increased by 4.0% when compared with the combined rail and bus patronage numbers of MTR Corporation and KCRC (as adjusted for interchange passengers) in the first half of 2007 (Pre-Merger Comparable Patronage)Our overall market share of the franchised public transport market rose to 41.6% in the first five months of 2008.Total fare revenue was HK$5,592 million in the first half of 2008.such fare revenue also represents a slight increase of 0.9% over the combined fare revenue of the rail and bus services of MTR Corporation ad KCRC in the same period in 2007. It is unquestionable on the outstanding patronage and financial performance achieved by the MTRCL after the Rail Merger.

There is an Operating Agreement to stipulate the required performance requirements between the Government and the MTR. In parallel, there is also Customer Service Pledge set by MTRCL with actual performance regularly published for public review. Most of the attributes are similar between the Operating Agreement and Customer Service Pledges while the latter cover more attributes directly faced by the customers related to customer services (e.g. temperature and cleanliness are in the customer service pledges but not in the performance requirements).

As shown in the Table 7 below, the performance of the combined rail network was excellent and met all the requirements of the Operating Agreement:

87

Operations Performance in First Half 2008

Customer Service Pledge Target

Service performance item Train service delivery - Kwun Tong Line, Tsuen Wan Line, Island Line, TKO Line, Tung Chung Line, Disneyland Resort Line & Airport Express - East Rail Line (including Ma On Shan Line) - West Rail Line - Light Rail Passenger journeys on time - Kwun Tong Line, Tsuen Wan Line, Island Line, TKO Line, Tung Chung Line & Disneyland Resort Line - Airport Express - East Rail Line (including Ma On Shan Line) - West Rail Line Train punctuality - Kwun Tong Line, Tsuen Wan Line, Island Line, TKO line, Tung Chung Line & Disneyland Resort Line - Airport Express - East Rail Line (including Ma On Shan Line) - West Rail Line - Light Rail Train reliability: train car-km per train failure causing delays >5 minutes - Kwun Tong Line, Tsuen Wan Line, Island Line, TKO Line, Tung Chung Line, Disneyland Resort Line & Airport Express - East Rail Line (including Ma On Shan Line) & West Rail Line Ticket reliability: magnetic ticket transactions per ticket failure - Kwun Tong Line, Tsuen Wan Line, Island Line, TKO Line, Tung Chung Line, Disneyland Resort Line & Airport Express Add value machine reliability - Kwun Tong Line, Tsuen Wan Line, Island line TKO Line, Tung Chung Line, Disneyland Resort Line & Airport Express - East Rail Line (including Ma On Shan Line) - West Rail Line - Light Rail Ticket machine reliability - Kwun Tong Line, Tsuen Wan Line, Island Line, TKO Line, Tung Chung Line, Disneyland Resort Line & Airport Express - East Rail Line (including Ma On Shan Line) - West Rail Line - Light Rail Ticket gate reliability - Kwun Tong Line, Tsuen Wan Line, Island Line, TKO Line, Tung Chung Line, Disneyland Resort Line & Airport Express - East Rail Line (including Ma On Shan Line) - West Rail Line Light Rail platform Octopus processor reliability Escalator reliability - Kwun Tong Line, Tsuen Wan Line, Island Line, TKO Line, Tung Chung Line, Disneyland Resort Line & Airport Express - East Rail Line (including Ma On Shan Line) - West Rail Line Passenger lift reliability - Kwun Tong Line, Tsuen Wan Line, TKO Line, Tung Chung Line, Disneyland Resort Line & Airport Express - East Rail Line (including Ma On Shan Line) - West Rail Line Temperature and ventilation Trains, except Light Rail: to maintain a cool, pleasant and comfortable train environment generally at or below 260C Light Rail on-train air-conditioning failures per month Stations: 0to maintain a cool, pleasant and comfortable environment generally at or below 27 C for platforms and 290C for station concourses, except on very hot days Cleanliness Train compartment cleaned daily Train exterior: washed every 2 days (on average) Northwest Transit Service Area Bus Service - Service Delivery - Cleanliness: washed daily Passenger enquiry response time within 6 working days

Performance Requirement

Actual Performance

98.5% 98.5% 98.5% 98.5% 98.5% 98.5% 98.5% 98.5% 98.0% 98.0% 98.0% 98.0% 98.0% N/A N/A N/A 98.0% 98.0% 98.0% N/A 97.0% 97.0% 97.0% N/A 97.0% 97.0% 97.0% N/A 98.0% 98.0% 98.0% 98.5% 98.5% 98.5% N/A N/A N/A N/A N/A N/A N/A N/A

99.5% 99.5% 99.5% 99.5% 99.5% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 500,000 500,000 8,000 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.0% 99.5% 99.5% 99.5% 97.0% <3 times 90.0% 98.5% 99.0% 99.0% 99.0% 99.0%

99.9% 99.9% 99.9% 99.9% 99.9% 99.9% 99.9% 99.9% 99.8% 99.9% 99.8% 99.9% 99.9% 2,191,472 2,368,372 10,971 99.6% 99.9% 99.9% 99.7% 99.5% 99.8% 99.9% 99.8% 99.7% 99.9% 99.3% 99.9% 99.9% 99.9% 99.9% 99.8% 99.8% 99.8% 99.9% 0 time 99.6% 99.8% 100.0% 100.0% 99.5% 100.0%

The actual performance figures are for the operating period from 2 December 07 to 30 June 08 as per the post-merger Operating Agreement.

Table 7 MTRCL Operations Performance in First Half 2008

(Source: MTRCL Press Release 5 August 2008)

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CHAPTER 5

CONCLUSION AND RECOMMENDATIONS

In this chapter, the analysis findings would be evaluated to conclude whether the Rail Merger is a success or not up to the time this report is prepared. Potential pitfall and drawback, as well as limitation of this research opportunity for future research, would also be discussed.

5.1

SUCCESS OF THE RAIL MERGER

Before concluding whether the Rail Merger between MTRCL and KCRC is a successful case or not, it is better to recapitulate quickly the fulfilment of the criteria established under the Analytical Framework and key research findings stated under previous chapters to support the argument.

No doubt, the Rail Merger between MTRCL and KCRC is a horizontal merger as the two companies are providing public transportation services as their core business and their existing services mainly are complementary to other services rather than direct competition, though there was a competitive bidding for the tender of new line Shatin Central Link before. There are substantial operating synergies identified in previous joint merger study well before the actual merger implementation and the merger integration is to develop plan and set blue print for the future merged company broadly following the previous study. Significant growth opportunity would be generated in railway and property projects both locally in Hong Kong and outside it.

89

The 10 phases of the merger acquisition have been broadly followed by MTRCL but no elaboration has been included in this dissertation as the scope of this research does not touch on the negotiation and deal making process to avoid commercial sensitivity. The merger integration processes have also generally followed the Key Success Factors (i.e. Strategy, Organizational Changes, Implementation and Performance) with excellent operational and financial performance achieved by MTRCL after the Rail Merger, as shown in analysis findings under previous chapters.

The MTRCL has demonstrated very satisfactory rail operations performance and financial performance in the first half of 2008 as shown in the MTRCL Press Release on Announcement of unaudited results for the six months ended 30 June 2008 released in early August 2008. All the service pledge requirements were met or exceeded. The Rail Merger has already

implemented fare reduction on the merger date and patronage to the railways increased after merger when compared to the equivalent combined rail patronage of the pre-merger MTRCL and KCRC.

The merger of the two rail companies in Hong Kong would facilitate the Hong Kong Government towards achieving the objective in using railway as the backbone to public transportation in Hong Kong, as the competitiveness of the railway would be increased due to enhanced interchange and connectivity as well as fare reduction to achieve price competitiveness. This is demonstrated by the fact that MTRCL is able achieve an overall market share of the franchised public transport market of 41.6% in the first six months after the Rail Merger.

As summarized in the above analysis chapter, the MTRCL and KCRC Management did pay extreme attention and commitment of resources on staff communication, consultation as well as cultural integration. This has successfully minimized the potential failure of the merger due to poor

90

communication, cultural difference and lack of employee support as highlighted in other merger experience.

Furthermore, the Governments core objectives and the five parameters set for the rail merger had been met. Fare reduction had been implemented on the Merger Date for all Octopus card users and further fare reduction to single journey ticket users latest within one year from the Merger Date (i.e. on or before 2 December 2008).

As announced by MTRCL in early August 2008 for the first six months result up to 30 June 2008, MTRCL achieved 41.6% of overall market share of the franchised public transport in the first five months of 2008 after the Rail Merger. This would also facilitate the Government further towards the aim of using railways as the backbone of future passenger transport network.

Therefore, the Rail Merger between MTRCL and KCRC is concluded successful and it is worth experience sharing by other local and overseas public transportation and public utilities for feasibility study of possible merger of their operations.

The next step for the Government is to further enhance inter-modal coordination between the railways and other public transportation systems in particular to reduce direct competition between new railway and other public transport systems.

91

5.2

POTENTIAL PITFALL AND DRAWBACK

Both MTRCL and KCRC had very good business performance before the merger. The merger would easily led to complacency by the new Management and extreme care must be taken up by the new company in ensuring the merged railway operations would continue to deliver excellent service performance and to meet the increasing demand on public transportation, and the Governments intent to promote railway as the back borne of the public transportation systems in Hong Kong. The Government gets a continuous role to govern the MTRCL to assure no monopolistic influence on the public transportation by MTRCL after the Rail Merger.

According the announcement by the MTRCL, there would be 1300 new posts coming up the next three years immediately after the merger and on the other hands there would a reduction of only 650 posts arising from the merger integration. On the absolute figures themselves, there seems no problem on staff redeployment. However, care must be taken to address the timing of the posts coming up in the next three years, which are mainly due to construction of new railway lines and extension, and the reduction of post in imminent short period after the merger to maximize the achievement of synergies. Furthermore, the trade mix and skill set required by the new posts which are mainly in construction of railway may be greatly different to skill set of surplus staff released from the merger integration. A comprehensive manpower planning in term of staff redeployment and re-training would be needed to minimize staff issues.

How the new merged railway operations further explore untapped synergies arising from the combined railway operations to enhance service efficiency and cost effectiveness for better value creation to services to the public, including further fare reduction, would be critical to the success of the merger in longer run.

92

The two railway operations are very similar in functional context but there was great difference in corporate culture which substantially affects staff mindset and work approach. Cultural integration is important management actions to continue develop at least for the first one to two years to assure alignment and commitment by staff at all levels to the new Vision, Mission and Values (VMV).

5.3

LIMITATION OF THIS RESERACH

To avoid leakage of commercial or staff sensitive details, this research did not touch on the merger deal process or details related to staff sensitive issues. No doubt, this would affect the comprehensiveness of the research.

Furthermore, merger usually takes at least two to three years for substantial completion. It is now only a few months after the Rail Merger implemented on 2 December 2007, a further assessment on the Rail Merger on whether it is a success or not would be needed. The challenge lies on whether the MTRCL Management would be able to sustain the momentum and determinations to implement effective cultural integration and explore further cost and revenue synergies to support corporate performance and release further benefits to the community in the medium to longer run.

93

5.4

POSSIBLE MERGER OF OTHER TRANSPORT OPERATORS AND FUTURE RESEARCH

The successful experience of the merger of the two railways can be taken up as model for possible merger among other public transport operators and public utilities e.g. between the public franchised buses or even between the two public power companies China Light & Power and Hong Kong Electric. Of course, a balance between potential monopoly on supplies and benefits of merger must be struck after taking all perspectives into consideration.

The rail merger of MTRCL and KCRC is a successful model for experience sharing not only for other public transport operator and utilities locally in Hong Kong but for cross fertilization by public transport operators and utilities overseas too.

Further research on possible merger between other public transport operators (e.g. franchised buses) would be recommended.

94

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Alexandra Reed Lajoux (2006) The Art of M&A Integration, Second Edition, McGraw-Hill, USA.

Annette Risberg (2006) Mergers and Acquisitions, A critical Reader, Routledge USA.

Clarence I.D. (1965) Mergers and Acquisition: Planning and Action, London.

Charles Gancel, Irene Rodgers, Marc Raynaud (2002) Successful mergers, Acquisitions and Strategic Alliances, How to bridge corporate cultures, McGraw-Hill, UK.

Civil Exchange (2004) Merging Hong Kongs Railways, The Public Interest Perspective, Hong Kong.

Clark H. Johnson (1985) Integrating Acquired Companies, Management Accounting and Reporting Issues, John Wiley &Sons, USA.

David M. Schweiger, Ernst N. Csiszar, Nancy K. Napier (1993) Implementing International Mergers and Acquisitions, HR, Human Resource Planning.

David Fubini, Colin Price and Maurizio Zollo (2007) Mergers Leadership, Performance and Corporate Health, Palgrave Macmillan, Great Britain.

Denold DePhamphilis (2008) Mergers, Acquisitions, and Other Restructuring Activities, Fourth Edition, Academic Press, London.

Environmental, Transport and Works Bureau 1999, Hong Kong Moving Ahead.

95

Mass Transit Railway Corporation (2007) Extraordinary General Meeting Circular, Hong Kong.

Hans J.C Bakker and Jeroen W.A. Helmaink (2000) Successfully Integrating Two Businesses, Gower, Great Britain.

Harvard Business Review (2001), Harvard Business Review on Mergers and Acquisitions. Harvard Publishing, USA.

Hong Kong Economic Journal, Editorial, 30 October 2002.

HKSARG, Operator award for the Shatin to Central Link & feasibility study of railway merger, press release, 25 June 2005.

John Coffey, Valerie Garrow and Linda Holbeche (2002) Raping the Benefits of Mergers and Acquisitions, In Search of the Golden Fleece, Butterworth Heinemann, Great Britain.

Kowloon Canton Railway Corporation, Annual Report 2006

Kowloon Canton Railway Corporation, Annual Report 2007

Legislative Council Panels Papers on Transport, KCRC Corporate Governance

Mak CK, 1998, Hong Kongs Railway Development Strategy, UITP

Mass Transit Railway Corporation Limited, Annual Report 2006

Mass Transit Railway Corporation Limited, Annual Report, 2007

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Mass Transit Railway Corporation Limited, Press Release dated 5 August (2008), Announcement of unaudited results for the six months ended 30June 2008.

Merger of the MTR and KCR Systems Proposed Way Forward, 2007. HKSAR Government, Hong Kong.

Nicholas A.H. Stacey (1970) Mergers in Modern Business, Second Edition, Hutchinson of London.

Noble, R. H. (1993) Management of Mass Transit Railway, in Wag and Yeh (eds) Keep a City Moving: Urban Transport Management in Hong Kong. Tokyo: Asian Productivity Organization, Chapter 13, p. 185.

Patrick A. Gaughan (2002) Mergers, Acquisitions and Corporate Restructurings, Third Edition, John Wiley & Sons Inc.

Philip R. Harris, Robert T. Moran, Sarah V Moran (2004) Managing Cultural Difference, Sixth Edition, Elsevier Butterworth-Heinemann

Patrick A. Gaugham (2005) Mergers, What Can Go Wrong and How to Prevent It, Wiley, USA.

Porter, Michael (1985) Competitive Advantage, The Free Press, New York,

Stan Lees (2003) Global Acquisitions Strategic Integration and the Human Factor, Palgrave Macmillan, Great Britain.

The Mass Transit Railway Ordinance (Cap 556), Section 4

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Transport Bureau (2000) Railway Development Strategy 2000, Printing Department, Government of the Hong Kong Special Administrative Region

Transport Department Annual Report (2006), HKSAR Government

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Verena Kusstatscher, Cary L. Cooper (2005) Managing Emotions in Mergers and Acquisitions, Edward Elgar, UK.

98

Appendix 1 P.1 of 2

Source: MTR Annual Report 2007

99

Source: MTRCL Annual Report 2007

100

Appendix 2
New MTR VMV
Vision We aim to be a globally recognized leader that connects and grows communities with caring service. , , .

Mission Enhance customers quality of life and anticipate their needs. , . Actively engage in communities we serve. . Foster a company culture that staff can learn, grow and take pride in. , . Provide sustainable returns to investors. . Set ourselves new standards through innovation and continuous improvement. , . Grow in Hong Kong, Mainland of China and capture opportunities in Europe by extending our core competencies. , ,

Values Excellent Service We are committed to proactively provide safe, efficient and caring service valued by customers. , . Mutual Respect We work in an open team environment based on trust, joint commitment and respect. , , . We listen and respect the views of the community and other stakeholders . Value Creation We create profits through efficient execution, continuous improvement and innovation in delivering products and services valued by customers. , , , . Enterprising Spirit We have the courage to question the status quo to seek improvement, proactively taking initiatives and having the resourcefulness to overcome obstacles and reach new horizons. , ,

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