Ha Noi Metro Rail System Project (RRP VIE 40080)

FINANCIAL ANALYSIS

1. Project viability and sustainability have been assessed by determining if anticipated financial revenues, net of the capital investment, operating cost and taxes, yield an adequate financial internal rate of return (FIRR) when compared to the weighted average cost of capital (WACC). With a metro rail project, sustainability and viability have to be viewed in the context of a financial contribution or subsidy from the state to the project revenues on account of the net social benefits. The FIRR is estimated in real terms, using 2009 constant prices and based on project capital cost excluding financial charges during implementation. To assess the sustainability of the metro investment of the Ha Noi People’s Committee (HPC), a financial statements analysis was carried out for Ha Noi Metropolitan Rail Project Board (HRB) in its role as the holder of HPC’s investment in the Ha Noi metro line 3 (Nhon to Ha Noi Railway Station) project. The financial projections are expressed in nominal terms, taking into account the effects of domestic and foreign inflation and currency fluctuations.

A. Financial Analysis

2. Assumptions. The FIRR was estimated for the period 2010–2039 (5 years implementation plus 25 years of operation). The estimate takes into account the project costs, comprised of the capital investment and the cost to operate the service and carry out routine preventive maintenance (operation and maintenance [O&M] cost). In the context of the FIRR analysis, the initial investment cost is made up of the base cost plus physical contingencies. In addition to the initial investment cost, the analysis takes into account investments in additional rolling stock and renewal or replacement of exhausted or expired assets during the 30-year period.

3. Revenues. An average per of D3,282 (2009 constant prices) is assumed for 2016, the first year of operation. It is set at 1.67 times the prevailing effective average fare, taking into account all volume and social welfare discounts. The fare is assumed to rise in real terms, at 75% of the expected per capita income growth in Ha Noi. Importantly, the underlying patronage forecast assumes that bus routes are reorganized to achieve a coordinated and efficient single (bus and metro) system, with an integrated fare tariff for journeys by metro or metro and bus.1 Based on the project preparatory technical assistance study for the Ho Chi Minh City mass line 2, without this assumption, the drop in expected patronage and fare revenue is expected to be substantial. Non-fare revenue from advertising and station-based retail commercial development is assumed to be equivalent to 5% of fare revenue, which is approximately the international average for metro systems in operation.

4. Subsidy. Operating cost, but not capital cost, is anticipated to be covered by fare revenue: the farebox recovery ratio is slightly below 1 during 2015–2016 but thereafter equals or exceeds 1.2 The project is anticipated to require a total subsidy over the project life of $935 million. With the subsidy included, the analysis shows an FIRR of 3.2%.

5. Weighted average cost of capital. The WACC of 1.5% has been calculated in real terms by removing the effect of domestic and foreign inflation. The project is being financed in US dollars or other major foreign currencies by the Asian Development Bank and other

1 With an integrated metro or metro and bus fare, passengers pay only one flag fall regardless of the number of transfers between metro lines or metro and bus services. A flag fall is the minimum fare for a journey. 2 Defined as fare revenue divided by O&M cost, this is a standard industry measure of an metr system’s ability to recover costs out of its main-source revenue. A farebox ratio below 100% indicates that a system is not recovering operating cost, and hence requires an operating subsidy, as well as a capital subsidy. Long- established operating rail metro systems in North America, the United Kingdom, and Japan still depend on a capital subsidy. 2

cofinancing institutions, with local currency counterpart funding. The FIRR of the project after tax is 3.2%, which exceeds the WACC of 1.5%. The net present value of the after-tax cash flows including subsidy, when discounted at WACC, is $281 million. The included total subsidy, discounted at WACC, is $783 million. The sensitivity analysis is summarized in Table 1, which also shows the required total subsidy in net present value discounted at WACC for each scenario. With the subsidy in place, the project FIRR is above the WACC for each scenario.

Table 1: Sensitivity Analysis Scenario FIRR NPV of Free cash flow NPV of Subsidy (%) ($ million) ($ million) Base case 3.29 281 783 10% increase in capital investment 2.82 237 817 10% increase in O&M cost 3.37 290 850 10% reduction in ridership 3.36 284 878 FIRR = financial internal rate of return, NPV = net present value, O&M = operation and maintenance. Source: Asian Development Bank.

B. Financial Projections

6. Assumptions. The projections are in nominal terms, with the domestic and foreign inflation rates based on the ADB forecast. A corporate income tax rate of 25%, based on the current tax law, is assumed to apply. Based on government revenue law and regulations, a value-added tax of 10% is applied to all items except resettlement cost and some general items of incremental administration. Imported items for the project are all duty-exempt.

7. rates are assumed to include an applicable value-added tax of 10% and to be indexed to domestic inflation. Fares are assumed to increase in real terms based on forecast per capita income growth in Ha Noi. The annual O&M cost comes from engineering estimates and represents the annual metro running cost plus recurrent maintenance. O&M cost and capital spending to add rolling stock and refurbish or replace equipment during the project life are indexed to inflation. Assets are assumed to be replaced at the end of their economic life, with a capital spending allowance in the projections for replacement of E&M systems and equipment (other than rolling stock) after 15 years. Depreciation is taken in a straight line over the economic life of the assets as follows: 100 years for underground civil structure; 50 years for above ground civil structure; 30 years for track, power system, and rolling stock; 15 years for other equipment; and no depreciation for land.

8. Projected financial statements. Financial statements are estimated based on the condition that the annual subsidies, which commence in 2016, are sufficient to ensure a debt-service coverage ratio (annual operating profit before interest, tax, depreciation, and amortization plus subsidy if any, all divided by annual debt service) of 1.2 times throughout the debt-servicing period. Thus, subsidies have to meet any farebox recovery shortfall, equipment and systems refurbishment and replacement cost, required additions to the rolling stock fleet, and repayment of loan principal and interest. The resulting projected financial statements are summarized in Table 2.

3

Table 2: Summary forecast financial statements of the project ($ million) Item 2016 2018 2020 2022 2024 2025 Revenue 21.6 39.4 58.7 77.1 101.2 116.0 Depreciation 27.0 27.0 27.0 30.0 30.0 30.0 Interest 24.6 24.0 22.8 20.3 17.6 16.2 Net operating profit / (loss) (53.8) (51.2) (46.4) (35.5) (16.7) (5.0) Subsidy 31.8 49.2 121.2 60.1 44.0 33.7 Accumulated cash flow 6.9 28.2 6.9 31.8 56.8 69.3 Total assets 1,057.1 997.4 1,013.6 978.5 943.4 925.8 Loan 856.0 823.0 765.9 682.9 594.6 548.4 Equity 201.2 174.4 247.8 295.6 348.8 377.4 Debt service 24.6 40.8 62.4 62.4 62.4 62.4 Debt-service coverage ratio 1.20 1.20 1.99 1.20 1.20 1.20 Debt-to-equity ratio 4.3 4.7 3.1 2.3 1.7 1.5 Working ratio 1.0 0.9 0.8 0.7 0.6 0.5 Source: Asian Development Bank estimates.

C. Shared Project Financing and Subsidy Support

9. Viet Nam’s commitment to developing mass rail transit as a national (and not merely municipal) priority is confirmed in the framework Railway Law 2005, Article 56, 1. Under the Railway Law, the Ha Noi People’s Committee, as a centrally administered city, is assigned responsibility for investment, construction, management, and exploitation of a metro in the city (Article 55). On the principle that any task assignment to a local government must be accompanied by an appropriate resourcing solution (to ensure the local government can balance its budget),3 the Railway Law provides that the central government is responsible: (i) to provide partial funding support towards investment in an approved metro project financed from the state budget (Article 56, 3, b); and (ii) to include an amount in each year’s state budget to support the expenses of urban public transport including metro (Article 56, 4). This outlines the respective administrative responsibility of the government and HPC to secure resources to develop the city metro.

10. The Railway Law’s stipulation that the city should provide part of the ―funding support‖ towards the investment cost of metro creates an important incentive for the city to take ownership of the project and manage it effectively and efficiently, as the city shares the investment risk. Through its counterpart funding and subborrowing, HPC is assumed for the financial analysis to be responsible for financing principally rolling stock and E&M systems, land and resettlement, and incremental administration.4 In this scenario, against HPC counterpart funding of $78.6 million, the government makes available to the city $534.6 million as a grant and $464.0 million equivalent as a subloan in the local currency.

11. The project revenue is assumed to be composed of fare collection, charges for advertising on metro moveable and immoveable properties, and collection of rental on metro real estate, which are part of the exclusive local government revenue portion.5

12. Based on the suggested share of the financing between the government and Ha Noi city, projected financial statements for the executing agency (as project owner on behalf of HPC) can be calculated that indicate the expected subsidy requirement on the part of Ha Noi. The projections imply a split of the total required state subsidy whereby the central government is responsible for $338 million and HPC for $597 million equivalent. By paying

3 Law on the State Budget No. 01/2002/QH1, Article 4, clause 2d and Decree No 60/2003/ND-CP, Article 5, clause 2c. 4 A precedent is Prime Minister’s Decision 2148 of December 8, 2008 for the Ho Chi Minh City MRT line 2. 5 Article 22 paragraphs 1 (n) and (o) of the Decree No. 60/2003 ND-CP on Implementation of the Law on the State Budget (No 01/2002/QH1). 4

its $597 million share of the subsidy, HPC will be also be repaying the subloan ($464.0 million) for debt-free possession of a critical operating metro system.

D. Ha Noi Metropolitan Project Board Financial Sustainability Analysis

13. Assumptions. To examine the financial sustainability of HRB, projected financial statements were prepared of HRB as sole investor in the metro line, based on (i) assumed central budget spending (or ―grant‖) for construction of infrastructure, consultancy and contingencies; (ii) a subloan from Ministry of Finance for E&M systems, rolling stock, station operation, and depot; (iii) a projection period of 2010–2014 (construction) plus 25 years (2015–2039) of operations; (iv) subloan terms; and (v) provision by HPC of the input equity capital of $78.6 million.

14. Results. The pro forma financial statements appear in Table 3. Financial statements analysis was carried out, with the following key result: (i) central budget expenditure and grants have a $534.6 million maximum outstanding balance from the year 2015 onwards, and (ii) the subloan is fully repaid in 36 years from 2010.

15. Ha Noi Metropolitan Rail Transport Board Local Subsidy. In addition to providing the equity input of $78.6 million, HPC is required to provide annual cash support to HRB throughout the assessment period in the range of $19.7 million to $61.5 million, with peaks in 2020–2021. The total subsidy paid to HRB over the entire period is $597 million, and the subloan is repaid in 2045. On this basis HRB can be expected to be financially sustainable as an investor in the project on behalf of HPC.

E. Conclusion

16. The project is expected to require a total subsidy of $935 million equivalent. This has been derived on the assumption that a project debt-service coverage ratio of 1.2 (operating profit before interest, corporate income tax, depreciation, and amortization plus annual subsidy, all divided by debt service) would be maintained until the loans have been fully repaid. The project shows a consistent recovery of annual operating cost out of fare revenue, beginning with the second year of operation. The free cash flow in real terms— including capital expenditure on equipment renewal, and additional rolling stock to serve expected demand growth, and including the subsidy—yields an after-tax FIRR of 3.2%, which is above the 1.5% WACC. Development of a metro as a key transport mode in major cities is confirmed as a fundamental state policy in the framework Railway Law 2005.6 The law assigns responsibility for policy implementation to the provincial and centrally administered city level, and also stipulates the government’s responsibility to provide support to approved investment in the metro. Prime Minister’s Decision 2148 of 8 December 2008, which specifies the state budget funding support and relending of international financial institution financing for the mass rapid transit line 2 in Ho Chi Minh City, has been adopted for financing support for the project in February 2011.

17. Assuming state funding arrangements and subloan support similar to that under Decision 2148, the analysis of projected financial statements supports a reasonable expectation that HRB will be financially sustainable as an investor in the project on behalf of HPC.

6 Railway Law No 35/2005/QH11, Article 56. 5

Table 3: Ha Noi Metropolitan Rail Transport Project Board (as Line 3 Investor) Forecast Financial Statements (2010–2026)

Item 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 A. Income Statement Revenue 0.0 0.0 0.0 0.0 0.0 21.6 26.4 32.2 39.4 48.1 58.7 67.3 77.1 88.3 101.2 116.0 VAT to revenue 0.0 0.0 0.0 0.0 0.0 2.2 2.6 3.2 3.9 4.8 5.9 6.7 7.7 8.8 10.1 11.6 O&M costs 0.0 0.0 0.0 0.0 0.0 21.7 25.6 30.2 35.6 42.0 49.5 52.0 54.6 57.3 60.2 63.2 Operating profit 0.0 0.0 0.0 0.0 0.0 (2.3) (1.9) (1.2) (0.2) 1.3 3.3 8.6 14.8 22.2 30.9 41.2 MAUR overhead costs 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Depreciation a 0.0 0.0 0.0 0.0 0.0 29.4 29.4 29.4 29.4 29.4 29.4 32.4 32.4 32.4 32.4 32.4 Interest (subloan) 1 0.0 0.0 0.0 0.0 0.0 31.1 31.1 31.1 31.1 31.1 31.1 30.7 30.2 29.7 29.2 28.6 Profit before tax 0.0 0.0 0.0 0.0 0.0 (62.7) (62.3) (61.6) (60.6) (59.2) (57.1) (54.5) (47.8) (39.9) (30.6) (19.8) Corporate tax 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net operating profit / (loss) 0.0 0.0 0.0 0.0 0.0 (62.7) (62.3) (61.6) (60.6) (59.2) (57.1) (54.5) (47.8) (39.9) (30.6) (19.8) Local subsidy 596.7 39.6 39.2 38.5 57.2 55.7 61.5 56.3 50.0 42.7 33.9 23.6 B. Cash Flow Statement 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Operating income 0.0 0.0 0.0 0.0 0.0 (62.7) (62.3) (61.6) (60.6) (59.2) (57.1) (54.5) (47.8) (39.9) (30.6) (19.8) Depreciation 0.0 0.0 0.0 0.0 0.0 29.4 29.4 29.4 29.4 29.4 29.4 32.4 32.4 32.4 32.4 32.4 Net cash flow from operation 0.0 0.0 0.0 0.0 0.0 (33.4) (33.0) (32.3) (31.3) (29.8) (27.8) (22.1) (15.4) (7.5) 1.8 12.6 Equity 31.5 0.0 8.9 33.7 70.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Central government grant 50.0 175.4 176.6 129.7 2.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Central government subloan 4.0 60.8 140.2 167.9 91.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Investment cost 85.4 226.6 316.7 311.9 136.7 0.0 0.0 0.0 0.0 0.0 91.5 0.0 0.0 0.0 0.0 0.0 Subloan IDC 0.1 2.3 9.0 19.4 28.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Subloan repayment 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 6.5 7.0 7.4 7.9 8.5 9.0 Local subsidy 0.0 0.0 0.0 0.0 0.0 39.6 39.2 38.5 57.2 55.7 61.5 56.3 50.0 42.7 33.9 23.6 Net Cash Flow 0.0 7.3 0.0 (0.0) 0.0 6.2 6.2 6.2 25.9 25.9 (64.3) 27.2 27.2 27.2 27.2 27.2 Accumulated Cash Flow 0.0 7.3 7.3 7.3 7.3 13.6 19.8 26.0 51.9 77.8 13.5 40.7 68.0 95.2 122.4 149.6 C. Balance Sheet 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Current assets 0.0 7.3 7.3 7.3 7.3 13.6 19.8 26.0 51.9 77.8 13.5 40.7 68.0 95.2 122.4 149.6 Fixed assets 85.5 314.4 640.1 971.4 1,136.1 1,136.1 1,136.1 1,136.1 1,136.1 1,136.1 1,227.6 1,227.6 1,227.6 1,227.6 1,227.6 1,227.6 Accumulated depreciation 0.0 0.0 0.0 0.0 0.0 29.4 58.7 88.1 117.4 146.8 176.1 208.5 240.9 273.3 305.7 338.1 Net fixed assets 85.5 314.4 640.1 971.4 1,136.1 1,106.7 1,077.4 1,048.0 1,018.7 989.3 1,051.5 1,019.1 986.7 954.3 921.9 889.5 Total Assets 85.5 321.7 647.4 978.7 1,143.4 1,120.3 1,097.2 1,074.0 1,070.6 1,067.2 1,065.0 1,059.8 1,054.7 1,049.5 1,044.3 1,039.1 Central government subloan 4.0 64.9 205.0 372.9 464.0 464.0 464.0 464.0 464.0 464.0 457.5 450.5 443.1 435.1 426.7 417.6 Central government grant 50.0 225.4 402.0 531.7 534.6 534.6 534.6 534.6 534.6 534.6 534.6 534.6 534.6 534.6 534.6 534.6 Equity 31.5 31.5 40.4 74.2 144.9 121.7 98.6 75.5 72.0 68.6 73.0 74.8 77.0 79.8 83.1 86.9 Total Liabilities and Equity 85.5 321.8 647.5 978.7 1,143.5 1,120.3 1,097.2 1,074.1 1,070.6 1,067.2 1,065.1 1,059.9 1,054.7 1,049.5 1,044.3 1,039.1 (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) Debt-service coverage ratio 1.20 1.20 1.20 1.83 1.83 1.72 1.72 1.72 1.72 1.72 1.72 Debt-to-equity ratio 0.1 2.1 5.1 5.0 3.2 3.8 4.7 6.1 6.4 6.8 6.3 6.0 5.8 5.5 5.1 4.8 Working ratio 1.0 1.0 0.9 0.9 0.9 0.8 0.8 0.7 0.6 0.6 0.5 Required local subsidy 596.7 0.0 0.0 0.0 0.0 0.0 39.6 39.2 38.5 57.2 55.7 61.5 56.3 50.0 42.7 33.9 23.6 Debt-service amount 0.0 0.0 0.0 0.0 0.0 31.1 31.1 31.1 31.1 31.1 37.6 37.6 37.6 37.6 37.6 37.6 Farebox ratio - - - - - 0.95 0.98 1.02 1.05 1.09 1.13 1.23 1.34 1.47 1.60 1.75 {Please list and define, in alphabetical order, all abbreviations here.} a Differences between this table and Table C.9 "Forecast Financial Statements of the Project" are due to the sub-loan interest and IDC (interest during construction). IDC has a flow-through effect on depreciation and assets. {Source(s): Please provide source(s) here.}