The Eurotunnel Back on Track

For most of its 16-year existence, Channel tunnel operator Eurotunnel has been a black hole of a business, undermined by crushing debt and massive underperformance. But scarcely three years after Eurotunnel stared down bankruptcy, the company’s weaknesses — underutilized capacity being one — now look like opportunities in the rapidly evolving European rail industry.

True, adversity weighed on 2009 results: damage from a September 2008 fire in a portion of the tunnel hurt revenue and limited 2009 profit to just $1.8 million, pending a $62.5 million payout from insurers. Once those damages are reimbursed, last year’s profit will outpace the company’s 2008 performance of $52.4 million and tower over its $1.3 million in 2007 — Eurotunnel’s first profitable year. Modest numbers, maybe, but a radical reversal. From 2003 to 2006, Eurotunnel lost $7.4 billion.

(See pictures of the world’s longest railroad tunnel.)

If Eurotunnel’s traffic is any indicator, then Europe is in recovery mode. Traffic on its shuttle service for vehicles and trucks is up for the first half of 2010 — 17% for autos and 41% for big rigs. Passengers on Eurostar trains, whose operator, France’s state-rail company, SNCF, pays Eurotunnel for Chunnel use, increased 6% over the same period. The company also operates an intermodal transport fleet of ships, trucks and trains. “Flows of merchandise and people are very much affected by larger economic cycles, and adaptation to slowing demand by both travelers and businesses has an impact on Eurotunnel revenues,” says Pierre Flabbée, a financial analyst who follows Eurotunnel for Kepler Capital Markets in Paris. “The fact that it has maintained profitability is very encouraging.” On July 23, meanwhile, Eurotunnel broke its single-day record by hauling 9,382 passenger vehicles between Folkestone, England, and Calais, France. Two days earlier, the company passed the threshold of 250 million passengers transported via Chunnel since its June 1994 opening.

Building the tunnel was a good business concept badly executed, as only an Anglo-French combine could manage. To get Eurotunnel back on track, CEO Jacques Gounon, who took over in 2005, had to address three big problems: huge debt, bad press and a staff that had begun to turn on itself in reaction to the surrounding negativity. “My aim was to take the gem into the light by getting debt down, returning focus to our customers and mobilizing employees to get behind a plan for the future.”

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The company’s troubles, you may recall, were epic. Construction problems delayed completion of the tunnel and its rail network by a full year — one factor that ballooned the original $7.7 billion budget to more than $13 billion. In the meantime, traffic and passenger estimates exceeded reality by more than 50%. The resulting income wasn’t sufficient to maintain the company’s crippling $11.8 billion debt: interest payments alone represented 50% of annual sales.

Gounon won a bitter battle to become CEO when, as a board member, he challenged management’s plans for yet another debt-for-equity swap. Trained as an engineer in one of France’s grandes écoles, he served as a technocrat in government and regional administration between stints in the private sector. But management posts at SNCF and Alstom gave him experience with rail. Easy with a smile yet reputed to have an iron will, Gounon, 57, says the key to turning Eurotunnel around was persuading debt holders to take a haircut. “For two years, I negotiated with our 150 creditors and 500,000 smaller shareholders to get $6.5 billion of debt off the books, warning that if that didn’t happen, we’d go bankrupt by 2007,” Gounon says of his coup in getting banks to eat $5.65 billion in Eurotunnel debt. “But in doing that, I also told them of areas of opportunity we’d identified for development.”

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One consequence of the debt-reduction deal, however, was a shrinking of Eurotunnel’s already withered share price. Gounon then laid off 900 employees — nearly a third of its staff — as he looked to cut costs. He also boosted shuttle prices by 10% to lift revenue — a move that risked sending customers to ferries and discount airlines. Eurotunnel had one big advantage, though, and Gounon began hammering away at it. “Time is money, and not only do customers save both thanks to our short, 35-minute travel time, but they also use a nonpolluting means of transport,” he says.

As part of his growth strategy, Gounon has taken Eurotunnel into a sector of rail travel that has burned other players: freight. SNCF continues piling up losses in the sector, while a relatively recent entrant, Veolia, reversed course, selling its freight business to Eurotunnel. In May, Eurotunnel reinforced its position by purchasing the third largest British operator, GB RailFreight.

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Unlike the go-anywhere, haul-anything approach of loss-making heavyweights like SNCF, Eurotunnel maintains profitability in freight by staying small and selective, Gounon says. The company targets specific clients and routes it has identified as viable — for instance, running small trains between silos for a grain producer in Burgundy and then hauling the collected load to a Marseilles-area processing center. Content with being profitable in such niches, Eurotunnel isn’t looking to increase its market stake too far beyond its 2% in France and 8% in the U.K.

Gounon is also planning to transform one of Eurotunnel’s first failings — inflated traffic estimates — into an opportunity as train service across Europe becomes more deregulated. Despite breaking its own traffic record, Eurotunnel operates at only 50% of capacity. That may prove golden when the expected boom in high-speed rail materializes once giants like SNCF and Deutsche Bahn, and possibly new rivals such as Air France and Veolia, are free to crisscross Europe. It’s expected to provoke a veritable scramble, which will significantly increase rail options (and lower prices) between the U.K. and continental Europe.

Wider selection of operators and prices will be a boon to Channel-hopping travelers, and so too to Eurotunnel, especially in the run-up to the 2012 Summer Olympics, when all rails will lead to London. Deutsche Bahn will start testing its high-speed trains on Eurotunnel and U.K. rails in October. In anticipation of these changes, Eurotunnel has joined four partners — including infrastructure units of Goldman Sachs and Prudential — in bidding for the concession to operate the High Speed One rail line, which is 67 miles (108 km) long and links the tunnel’s Folkestone mouth to St. Pancras station in London.

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The winning bidder will likely have to plunk down $2.3 billion or more for the 30-year concession. It would allow Eurotunnel to manage traffic on that link optimally for its own business. But whoever runs that section of track is going to be sending trains — and paying Eurotunnel for their passage — between London and the tunnel. Says Flabbée: “Everything that’s happened since the debt deal was struck shows Eurotunnel is a very viable company with clear ideas about how to grow and diversify but without getting overextended.” It’s a win-win for Eurotunnel, a company that’s finally on a very nice roll.

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