The Queensland Government and its advisers have created a sufficiently large indicative range for the float of QR National that it will be up to the market to determine how much of the multilayered growth story it is prepared to capitalise into the final price.

The Queensland Government is set to receive something between about $3.6 billion and $5 billion in proceeds from the float, and QR National will have a market capitalisation between $6.1 billion and $7.32 billion, with the final outcome dependant on how much faith investors have in forecasts of a step-change in the rail freight group’s financial performance.

The pitch to investors is multifaceted.

QR is, of course, a privatisation story and generally privatisations of strong businesses with dominant market positions ought to release considerable value. Against that, 85% of its employees are protected from forced redundancy for at least three years, the Queensland Government will retain a shareholding of between 25% and 40% for at least two years — and therefore QR National will remain politically sensitive for some time to come. With a ceiling on individual shareholding of 15% there is also no prospect of it being taken over.

The broader appeal of the float, however, relates to the China and India growth stories and the group’s ability to share in that growth through strongly increasing volumes in its key coal haulage division. While it has faced some recent above-rail competition from Asciano, QR National dominates Queensland coal haulage and has an emerging position in NSW.

The group, having invested about $3.4 billion in three past three years, largely in rolling stock and network expansions for its Queensland operations, is planning to spend another $3.76 billion over the next two years, again with a heavy focus on its Queensland coal operations.

That’s the local outworking of the Asian growth story and helps explain why, having generated earnings before interest and tax of $204 million in 2009-10, it is forecasting EBIT of $427 million this financial year and $578 million in 2011-12.

There is more to QR National than coal — it handles other commodities in Queensland and Western Australia and has a national intermodal transport and logistics division — but a 5% increase in coal volumes is worth more than $50 million of after-tax profit to it. Mind you, a 5% decrease in volumes — which could occur if China stumbled or there was global adoption of carbon pricing — could knock as much as $40 million off profits.

While the offer has been loaded up with retail incentives — a 10 cent discount to the institutional price, a ceiling of $2.80 a share and a loyalty bonus share for every 20 held and retained for a year for non-Queenslanders (1-for-15 for Queenslanders), the outcome of the float will probably be determined by the level of offshore interest.

In Europe, the combination of rail and privatisation will pique interest, while the North Americans are very familiar with investing in railways. Foreign institutions generally will get the Asian growth exposure story.

All the institutions will be intrigued by the data benchmarking the group against both international peers and Asciano’s Pacific National.

As QR National says, it generally under-performs on revenue yields and cost efficiency, which translates to a material difference in profitability. There is significant upside in QR National if chief executive Lance Hockridge and his team, who have already overseen significant improvement, can simply run the business better.

Since Hockridge was appointed CEO in 2007 earnings before interest, tax depreciation and amortisation (EBITDA) have improved from $417 million to $628 million and are forecast to top $1.1 billion in 2011-12. EBITDA margins have risen from 17.4% in 2007 to 21.6% in 2009-10 and are forecast to rise further and more sharply, to 26.6% this financial year and 29.5% in 2011-12.

The float, the second-largest (behind Telstra) ever launched in this market, will be an important test of investor appetite and confidence. The lacklustre post-float performance of Myer’s share price, despite it out-performing its prospectus forecasts, has had a chilling effect on IPOs.

Previous experience — notably with the Queensland toll road floats — may explain why apart from the loyalty shares the float structure is relatively straightforward and doesn’t use the instalment structure discredited by the BrisConnections float in particular.

The uncertainty relating to the investor response to such a large offering probably explains why there is a reasonably wide range for its pricing, why the Queensland Government is prepared to contemplate a broad range of outcomes for its own shareholding and why there is a 6% over-allocation and market stabilisation mechanism in the structure. The Government and the float’s lead managers have given themselves plenty of flexibility in shaping the float’s outcome.

*This article originally appeared on Business Spectator.

Peter Fray

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