Ahead of Carrie Lam Cheng Yuet-ngor taking over as HK’s Chief Executive in a couple of months, this is the second of several policy proposals focused on HK’s infrastructure and how to finance it.
It comes as Secretary for Commerce & Economic Development Greg So Kam-leung battles with the Legislative Council Finance Committee for approval to inject a further HK$5.4 billion of public money into HK Disneyland’s next upgrade of its theme park on Lantau.
Back in 1999, I led my German bank’s pitch to lead the inaugural debt facility for the theme park. We didn’t win the bid because we considered Disneyland to be a standalone project whereas the U.S. bank which won the bid realised that it was, in fact, essentially a HK Government risk. The Americans were right. The HK Government had already spent HK$13.6 billion on land reclamation plus road and rail access; it invested 53% of the equity; and injected a thirty – year subordinated debt piece. In contrast, Disney injected its 47% of the equity but is less concerned with the complete lack of dividends since the park opened in 2005 as it takes out management fees of up to 8% of EBITDA and royalties which together, LegCo learned for the first time in February, come to between 5 and 10 per cent of gross revenues. Both payments are made above the line, i.e. pre-interest, pre-tax and pre-dividend (if there is to ever be one). In its desperation to attract a big tourism brand, the HK government had been utterly out- negotiated by the Americans. That sense of feebleness is again being demonstrated in the latest request for further funding of the park.
Theme parks are very particular pieces of infrastructure. First, they attract return customers by continuously building new rides so they are locked into an invidious cycle of regular calls for funding, without which the attractiveness of the parks could wither away.
Second, theme parks are by their very nature, hugely operationally leveraged. Short term capital expenditure and running costs are pretty much fixed so movements in visitor numbers and spend / visitor have a disproportionate impact on earnings. Theme parks are vulnerable to sentiment (hence the focus on the Disney brand), discretionary decision making by visitors (they don’t need to visit) and competition from other parks. This last has increased in the ten years since HK Disneyland opened and now includes not just Disney’s much bigger park in Shanghai which opened last June but also parks in Singapore, Tokyo, Zhuhai and HK’s own Ocean Park. In such assessments, profit in the conventional sense is relevant only when deciding how much dividend to pay (if ever) and what the Profits Tax bill might be (the HK park has made an accounting profit in only three of the past 11 years). What matters is cash flow.
So the Government has three choices: 1) contribute to the latest call for funding on the basis that this is needed to keep the park competitive 2) not contribute and risk the park losing its appeal 3) recognise that, in fact, it does have other options.
The Government is pursuing the first of these choices. Likely benefits generated by the new investment may be as captured by the project itself or by overseas visitors’ spending elsewhere in HK whilst here. Mr. So has estimated that a very precise HK$31.6 billion of these external benefits would be lost if visitor numbers fell by 15% over the next forty years. Prima facie, avoiding such losses gives a not unreasonable IRR of 14% on the incremental investment but, over the next 40 years, the park will have gone through several investment cycles (not to mention HK maybe being returned to China proper) so the assumptions underlying this forecast have to be very subjective. The Government also needs to assess the cost of the proposal: does it take independent advice on this or does it rely on Disney?
The second of these choices is unlikely to be attractive because the Government does,in fact, have other choices.
First, can it renegotiate the terms of its deal with Disney? There is always scope to do this, perhaps by threatening to not contribute to the latest call for funding, perhaps by more subtle means (we are not privy to the terms of the Joint Venture Agreement between the Government and Disney). The Government is, in fact, doing this but the improvements have to date been trivial.
Second, should it exit the project altogether and deploy the proceeds / assets elsewhere? Why does the Government need to still retain ownership? It already has Ocean Park (which has pandas). Were it to sell, Disney would be the obvious buyer. I can’t think of a likely third party buyer unless it could oust Disney but Disney will have pre-emption rights in its Joint Venture Agreement with the Government. Disney’s arrangements with the six hosts of its theme parks worldwide vary widely; it is currently looking to take full ownership of its Paris park which has also underperformed over time. Selling out would have no impact on the numbers of visitors to the park or to HK generally which had been the original justification for the Government’s investment.
In order to materially improve the JV terms if maintaining the current ownership or to secure anything but a knock – down price if selling to Disney, the Government needs a realistic fall back position. This would be to close the park altogether, take back the huge, flat site and build a whole lot of much needed housing there. There would be some fall in numbers visiting HK, the contributions from whom would need to be factored in, but the site has to be very attractive: it has all of the attendant infrastructure already in place and there would be water views to boot (which sounds similar to my proposal for the port facilities at Kwai Tsing!) Rather than a fall back position, this may even turn out to be the preferred option. Either way, there is scope to significantly improve HK’s hand. All it needs is a renegotiation considerably more robust than that on the original deal or efforts so far on the current deal. There is no fixed timetable for such decisions so it could slip – or be pushed – beyond 1 July but, either way, it is time to man – or woman – up!
