On May 11, just hours after Bombardier Inc. shareholders streamed out of a jet hangar near Montreal's Trudeau International Airport, the company's train executives received a phone call from the city's regional commuter-rail agency advising them they had lost a bid on a tender to Chinese rival CRRC Corp.
For Bombardier, the decision was wholly unexpected, and marked the Chinese rail-manufacturing giant's first significant contract win in Canada. Details of the agreement are fairly straightforward: Montreal's regional commuter-rail service – Réseau de transport métropolitain (RTM) – picked CRRC to supply 24 double-decker train cars. The agency had expected to spend $103-million; the Chinese manufacturer bid just $69-million.
Behind the numbers, however, is a more complicated backstory that includes RTM voiding the initial request for proposals and opening a second bidding process. Staff from RTM even travelled overseas to entice foreign bidders. In its new tender, the RTM changed some of the terms, deciding to nix a previous requirement that bidders have a service-proven vehicle that was already running. It also lowered the Canadian manufacturing-content requirement. The outcome has angered Bombardier, which says it is "baffled" by the decision and vowed to rethink its rail-manufacturing footprint in Canada if lower local-content rules become the new norm.
The Montreal-based train maker is facing other woes at the same time. The World Bank has launched a probe into possible wrongdoing by Bombardier in connection with a deal to supply signalling equipment for a rail project in Azerbaijan.
But the bigger story may involve the rise of the successful bidder.
Nine years since it stepped outside its own borders and made its first overseas acquisition, CRRC has embarked on a global pursuit for market share. The megamanufacturer, formed in 2015 through the merger of China's state-owned makers of locomotives and train cars, is the largest industrial company of its kind on Earth. And with its first contract win in Canada and plans to build its first Canadian plant under way, it is changing the game for global train making.
The Montreal order comes after other CRRC wins, in Philadelphia, Chicago and Los Angeles. It took less than five years for China to build the world's biggest high-speed rail network, a system running almost entirely on rolling stock supplied by CRRC's former entities – CNR and CSR. It might take even less time for CRRC to assume its spot as the yardstick against which the planet's rail-equipment manufacturers are measured. With 190,000 employees and annual revenue topping $32-billion, CRRC has become a new national export champion.
"The new player is the biggest in the world and has already changed the game," said Maria Leenen, chief executive officer at transportation consultancy SCI Verkehr in Hamburg, Germany.
China gets on track
Despite its vast network measuring tens of thousands of kilometres, China's railroads were hopelessly backward until recent decades: Steam engines still serviced many of the main lines as of the late 1990s. But the country had ambitions. In 1996, it unveiled a passenger train that could reach 120 kilometres an hour; its efforts to build a bullet-train system, however, failed to produce anything feasible.
In 2003, China named the hyper-ambitious Liu Zhijun its railways minister to oversee a great leap forward in domestic trains. He would turn to the outside world and build an industry on the backs of foreign technology. Between 2004 and 2006, China granted Alstom SA, Siemens AG, Bombardier, and Kawasaki Heavy Industries Ltd. access to the country's market. Mr. Liu's plan: build 12,000 kilometres of high-speed rail, and quickly.
Bombardier leapt in with both feet. It secured contracts by the hundreds of millions of dollars, including deals to build a people mover at the Beijing airport, as well as cars for a line linking the airport with downtown. Both were high-profile projects that put the Bombardier badge on the first transportation link seen by visitors to the city. Its rail cars were also tapped for China's marquee high-altitude train to Tibet and for passenger cars on major routes elsewhere.
In June, 2006, the company celebrated the delivery of its 1,000th subway car to China.
For Bombardier and other Western rail giants, the Chinese market was a huge opportunity. As part of the price of entry, foreign manufacturers had to reveal exactly how they made their products. That meant handing over train blueprints, delivering manufacturing instructions and training local engineers. China moved with breathtaking speed to acquire the foreign firms' know-how.
By 2006, ground had been broken on the first high-speed rail line, connecting Beijing to Shanghai, and in the next decade, the rail system would grow exponentially, supplied by hundreds of billions of dollars in stimulus spending by the Chinese government after the financial crisis. China is now home to the world's biggest high-speed rail network – a system of tracks spanning 19,000 kilometres as of the end of 2015 – and, in the process, Chinese companies, led by the newly formed CRRC, increased their production capacity. Just this December, China outlined plans to spend another 3.5 trillion yuan ($691-billion) to expand the network to 30,000 kilometres by 2020. The distance is roughly the same as crossing Canada five times by car between Vancouver and Halifax.
CRRC declined numerous interview requests. But it recently unveiled some of its plans to China's state media, saying it wants to double sales outside China to as much as $15-billion (U.S.) over the next three years. It has had notable contract wins in Argentina and Malaysia. In Africa, a 750-kilometre electrified-rail line built by Chinese companies was launched in January: Connecting the Red Sea port of Djibouti with landlocked Addis Ababa in Ethiopia, the link is a key piece in China's strategy to build its influence on the continent, long dominated by Western powers.
According to analysts at Singapore-based investment bank UOB Kay Hian, one of CRRC's main competitive strengths is that its rail designs are typically part of a wider package that also includes financing and construction. In October, 2015, the government of Indonesia picked China for a $5-billion high-speed rail line in a shocking denouement to what had been a battle of Asian titans. Indonesian officials would later explain that China's bid was chosen largely because the country assumed financial risk of the project and not required, as the Japanese had done, a portion of Indonesian government participation.
Jurgen Sluijter, a transport economist with the Asian Development Bank, says there are signs China is linking its willingness to build other countries' rail systems to more strategic interests such as access to natural resources. He said while that makes it difficult to judge the competitiveness of the Chinese rail sector, the sheer pace at which China is developing its rail capability should make established rail-power countries such as Germany and Japan worry.
"The Chinese rail industry is developing at such an incredible speed that it will soon gain more experience than any other country, becoming the global leader in rail," Mr. Sluijter said. "That seems very likely to me."
CRRC has plans to establish 11 regional branches throughout the world to co-ordinate its bidding and local manufacturing, and already has plants in South Africa, Malaysia, Turkey and Iran as well as a joint venture facility in India. It set up a North American branch last year in Massachusetts to oversee work on the continent. Next up, Canada.
To the west of Moncton's city centre near Codiac Heights lies a mesh of train tracks known by locals as the "hump yard." Here, in a former Canadian National Railway Co. maintenance shop, ARS Canada Rolling Stock is setting up a 142,000-square-foot manufacturing facility with CRRC focused on making and selling cargo trains.
The effort has generated little fanfare outside Atlantic Canada. Arturo Contreras, chief executive officer of ARS Canada, told Radio Canada last September the venture would create 200 jobs in the first phase of production, including welders and mechanics, and employ 700 at peak production. It is aiming to produce 1,500 rail cars for the Canadian and U.S. markets in its first year (largely rail grain hoppers and boxcars), relying on CRRC for the technology.
"We are going to start as a small player aiming to grow and become one of the main players in the North American market," Mr. Contreras said.
Chinese competition across the United States in passenger-rail manufacturing also threatens North America's freight-rail system, Oxford Economics said in a May report. U.S.-based companies such as Trinity Rail, in Dallas, still produce the majority of cargo-rail cars seen on tracks across the United States, but the arrival of Chinese manufacturers such as CRRC into the U.S. market is threatening domestic competitiveness, the economic forecaster said.
"The future of these long-established producers and suppliers is now potentially at risk because of alleged anti-competitive practices – such as state-supported financing – carried out by foreign state-owned enterprises, predominantly from China," Oxford said. Australia's experience suggests the end result could be "the collapse" of rail car manufacturing in the United States, it concludes.
CRRC has said it expects to tally $8-billion worth of orders from international customers for fiscal 2016. By 2025, it wants to generate 35 per cent of its total revenue from international contracts, up from 7 per cent last year. "The goal is to grab more market share from established global rivals," according to China Daily.
It's working. And one big reason is price.
China's aggressive tactics have already shown up in numerous public-transit tenders, driving rival manufacturers mad and litigious. In 2014, CNR won a contract to supply 280 cars for Boston's subway system. South Korean manufacturer Hyundai Rotem Co., which also bid, subsequently sued the Massachusetts Bay Transportation Authority over the contract, saying the Chinese offer of $566-million was "unreasonably low" compared with the other bids.
CRRC is also testing the waters in Toronto's market. Deputy mayor Denzil Minnan-Wong said he had met with the firm or its agents on several occasions. At the request of the mayor's office, he said, he sat down at City Hall in early April with the company's global president and its North American president to discuss transit.
The firm's pitch has been simple: We can do it reliably, and more cheaply. This is a persuasive argument in Toronto, where the city has suffered through extended problems getting Bombardier-built streetcars delivered on time. Some councillors have even mused about blacklisting the firm from future transit orders.
The Chinese merger has already prompted other business deals in the rail industry. Japan's Hitachi bought Italy's Finmeccanica SpA's rail-signalling business in 2015. U.S.-based Wabtec Corp. took control of France's Faiveley in 2016. And this year, U.S. cargo-rail manufacturer Greenbrier boosted its investment in its Amsted-Maxion Brazilian business to become the biggest freight rail car builder in South America.
Bombardier has a massive presence worldwide in rail, with more than 500 customers in 70 countries and some 100,000 train cars in service. Its rail systems serve 29 global megacities that are home to 10 billion people or more and it expects to count 41 such cities as clients within 15 years. But they're not taking those facts for granted.
"We have to understand that the Chinese are looking to compete outside of China and they will bring their specific dynamics to this market," Laurent Troger, who leads BT as CEO, told International Railway Journal in May. "We will keep positioning ourselves as the leading-edge provider that will optimise the total cost of ownership for our customers. We consider that we have the best technology, and the best products, and we want to maintain our leadership in delivering the highest value for our customers."
Bombardier declined to make Mr. Troger available to speak to The Globe and Mail.
In a conversation aimed at better understanding the company's position, a Bombardier rail official acknowledged CRRC's expansion has put pressure on Bombardier and other manufacturers by speeding up the need to be more competitive. She said the Chinese have been able to make gains particularly with clients seeking to limit up-front purchasing costs and arrange financing. But she said Bombardier has found it can get over this hurdle by showing that its more reliable and perfected equipment has a lower cost over several decades of operation.
China's advice to those spooked by its ambition is simple: Join us. "When facing a market where it's very hard to win through competition, co-operation is the best option. That means joint bidding, sharing technology and splitting markets," Capital Finance Institute's Prof Liu said.
Bombardier has done just that, reflecting that its relationship with CRRC is not entirely adversarial. In September, 2015, the company announced a deal with CRRC that will see the two competitors deepen their strategic relationship by combining their respective expertise for potential joint bids on select contracts. In the future, the two companies could also partner on broader market development and manufacturing, Bombardier said in a statement.
In China, three of Bombardier's six joint ventures in the country have been with subsidiaries of CRRC. Products the joint ventures have delivered include high-speed trains, metro trains and monorails. In North America, the two companies are partnering on a bid to revamp New York City's aging subway system, according to Beijing-based finance publication Caixin Global. It remains unclear how far this relationship will go. But one thing is certain: The rise of the Chinese has exposed Bombardier's own strengths and shortcomings. And management, led by chief executive Alain Bellemare and Mr. Troger, seem determined to fix the deficiencies.
"We spent a lot of time in 2016 to really understand how we can successfully compete on a standalone basis," Mr. Bellemare told analysts at the company's investor day in New York City late last year. "That is the reason why you're seeing all these actions in motion today."
Beset with challenges
Projected revenue for 2017 at the train business – known as Bombardier Transportation (BT) – is $8.5-billion with a current backlog of $31-billion in orders.
After years of inconsistent performance, profit is also picking up. Pretax margins before special items are projected to be 7.5 per cent of revenue in fiscal 2017 following an 8-per-cent performance in the first quarter. Recent contract wins include a nearly $300-million order to build 70 low-floor trams for the City of Zurich and an initial order worth $1.22-billion for 71 double-decker trains for France's SNCF, which it will supply together with Alstom.
Pension fund Caisse de dépôt et placement du Québec bought a 30-per-cent stake in BT for $1.5-billion in 2015 following an international auction. The deal saw BT reorganized into a separate holding company with its own board and brought the fresh eyes of a new investor into the mix. Publicly, the Caisse says it likes BT's market position, consistent cash flow and growth potential. Privately, however, although restructuring efforts have yielded a notable improvement in profit, the view is that there's still work to be done to get costs down and improve contract execution at a time when the Chinese threat looms ever larger.
As one source put it: "The world is pretty unforgiving in terms of whether you can be there with the right contract price or not. And if you can't, you lose."
Actions to revamp the business are cutting wide and deep. When Mr. Bellemare met investors this past December, the company had just announced it would chop 5,000 jobs in its train unit as part of a wider restructuring effort touching about 10 per cent of its 70,900 employees. That followed another cull affecting about 3,000 train jobs.
At the same time, the company is fending off other challenges. A consortium led by the Swedish unit of Bombardier Transportation that won a bid for a railway project in Azerbaijan in 2013 came under scrutiny by Sweden's National Anti-Corruption Bureau, which investigated allegations of bribery or collusion. Three Bombardier employees were arrested.
And the World Bank's own probe of the company could have far-reaching consequences. If the investigation finds that Bombardier engaged in any corrupt practices, it would be barred under World Bank rules, from participating in "any other project financed, in whole or in part, by the bank."
For CRRC's part, its execution has not been faultless as it absorbs new technology and tries to bring its supply base up to speed. Singapore shipped two dozen defective Chinese-made subway trains back to CRRC subsidiary CSR Sifang last year after hairline cracks were discovered in the structure connecting the car body to the undercarriage. More recently, a report by South Africa's News24 said a contract worth almost eight billion rand ($832,000,000 Canadian) to supply new CRRC-manufactured locomotives to rail company Transnet hit a rough patch as technical problems plagued the first of the trains to arrive in that country.
Whether these are merely growing pains or a more profound obstacle to growth remains to be seen. Though it has won contracts, CRRC hasn't yet delivered any products in North America and if it's unable to do so on time and on budget, that could hurt its international reputation, according to Desjardins Securities analysts.
Analysts say that the growing Chinese presence will inevitably increase industry collaboration on all levels in the years ahead as a way to boost efficiency and economies of scale. In terms of formal mergers, both Siemens and Alstom have been mentioned at different times in recent years as potential partners for Bombardier but nothing has come of the talks. The urgency of consolidation has only increased over time.
There are significant anti-trust and political challenges to any tie-up between Bombardier Transportation, Siemens and Alstom. All three businesses are based in Europe and have geographical and product-line overlap, meaning they'd likely have to close plants and lay off workers to achieve the kind of cost savings necessary to make a deal worthwhile. But if the companies could convince lawmakers and regulatory authorities that the Chinese threat is a transformational, or even existential, one for their businesses, they might have a chance at winning approval for a deal, said Nicholas Heymann, an analyst with William Blair in New York. The thinking is that Europe would be better off with one or two major home-grown players able to supply the continental market, rather than three or four.
"Today the Chinese are the 800-pound gorilla in the business," Mr. Heymann said. "And the Europeans don't want to get their trains from China."
The other possibility, of course, is that Bombardier strikes a merger with the Chinese. And though analysts do not see Bombardier's founding family ceding control of the train business outright – that would leave the company's plane making business a pure-play orphan with a far riskier profile – a deeper partnership is possible. CRRC has already once weighed taking a stake in BT, according to the Wall Street Journal.
However it plays out, further industry tie-ups appear inevitable. "Stuff is going to happen in this sector. It can't sit the way it is today," said a senior source with knowledge of BT. "I think what matters here is making sure that you're not left at the altar."
With files from reporters Eric Reguly and Oliver Moore
CRRC's recent contract wins
- CRRC Corp. subsidiary Tangshan Co. Ltd. signed a 1.1 billion yuan ($218-million) deal in May with the Southeastern Pennsylvania Transportation Authority to supply 45 commuter coaches slated to run through Philadelphia, Delaware and New Jersey. It will be the first time double-decker coaches made in China will operate in North America.
- CRRC Qingdao Sinfang won a deal worth 2.5 billion yuan ($495-million) to deliver 11 high-speed trains for use on the 142-kilometre Jarkata-to-Bandung high-speed rail corridor in Indonesia. It is part of a wider project worth €5.2-billion ($7.9-billion), to be mostly funded by the China Development Bank.
- CRRC won a contract to supply 71 engineering wagons by Transport for London. The wagons are to be used to move equipment needed for for maintenance work. It is the first order for rolling stock in Britain won by CRRC.
- CRRC Zhuzhou Electric Locomotive signed a contract with Macedonian state railway MZ to supply four electric locomotives. The €8-million deal ($12-million) is being financed by the European Bank for Reconstruction and Development.
Source: Consultancy SCI Verkehr GmbH