QR tries to get derailed PR back on track Brett Clegg and Tracy Lee From: The Australian October 23, 2010 12:00AM
THE expensive public relations campaign around the $7 billion float of QR National went a little off track over the past week.
The derailment came against a backdrop of unflattering comments from small investors and talking-head market commentators.
For James Wright, the head of equities and chief investment officer at ING Investment Management, who controls $8bn in equities, the debate is all part of the noise of any major float, especially a privatisation. "There are so many agendas played out, including through the media, but for us it's all just noise which is best left unheeded," Wright says.
The fund manager is well placed to opine on the float of QR National on a number of fronts. As a former Treasury official in the 1990s he witnessed privatisations such as Qantas Airways and Commonwealth Bank of Australia. Later in Victoria he was involved in the massive Kennett sell-off of gas and electricity assets.
"These privatisations are political minefields and naturally generate debate," he says, adding that it's important, therefore, to be clear-minded about the underlying investment thesis.
QR National, formerly called Queensland Rail, is being sold off by the Bligh government as part of a sweeping asset sale program to pay down state debts.
So, does Wright actually like QR for his portfolio? The answer is he certainly does.
"We're bullish on China and the implications that has for coal volumes and the broader resources sector. QR gives you fast exposure to that longer-term thematic," Wright says.
He says the company will have a low gearing range, reflecting a high level of capital expenditure necessary to grow the asset base to meet rising freight and coal haulage volumes. "There are certainly risks in that capex, so it has to be carefully monitored and controlled. Importantly, the money is being spent to drive earnings and deliver a strong return on the investment," Wright says.
He believes the financial forecasts in the prospectus are conservative and very achievable.
Denis Donohue is even more exuberant. Does he like QR National? "We love it," he replies.
Donohue, the Brisbane-based managing director of Solaris Investment Managers, which looks after $4.5bn in client funds, also has a unique perspective. Back in 1973 to 1979, before going to university and making a career change into the world of finance, Donohue was an electrician at Queensland Rail's Northgate workshop in Brisbane's north.
During recent visits to the operations, he's been surprised at how little the work practices have changed or modernised in three decades. It's an opportunity for QR National chief Lance Hockridge to drive efficiences in coming years, thereby reducing costs, lifting productivity and expanding profit margins.
Hockridge is seen as a leader with a sensible hand who will deal respectfully and considerately with unions and employees as he seeks cultural change and improved outcomes. Both Wright and Donohue are nonplussed about the possibility of QR losing volumes to rival Asciano's Pacific National as contracts roll off in coming years. This is despite noted unhappiness among some major miners such as Rio Tinto and Xstrata.
"These are natural monopolies that always have a smaller rival to keep them honest. The dominant rail provider is the one with the most train sets, frequency and flexibility of service. In Queensland that is clearly QR National," Donohue says.
But Donohue makes a cogent point that, for a typical retail investor, the float numbers "package up horribly", with a high price-earnings ratio and low dividend yield. It doesn't look cheap on a PE basis, reflecting QR National's high capex spend and growth ambitions. The PE range is a heartbreaking 21.1 to 25.3 times and dividend yield is only 2.1 to 2.5 per cent.
It comes at a time, Donohue says, when "retail investors are still feeling averse to floats, following the poor performance of Myer and Telstra 3". The simplistic sticker shock may have put some investors off.
Yet, despite early negative reports in the financial press, on Thursday Queensland Treasurer Andrew Fraser announced that $1.05bn in shares were allocated to the "broker firm" component, where retail clients bid for shares via their stockbrokers. This had been scaled back some 20 per cent, reflecting solid demand.
But Donohue's point is emphasised by the average broking firm bid being a steep $35,000. That indicates that sophisticated and wealthy investors are likely to make up the bulk of retail demand, rather than the so-called "mum and dads" who dominated the Myer and Telstra floats.
Assuming the float goes off at the mid-point of the pricing range (reflecting a market capitalisation of $6.1bn-$7.3bn), and the Queensland state decides upon keeping the middle point of its intended 25 to 40 per cent, the total size of the raising will be about $4.5bn.
Based on the broker firm allocation, and indications of a healthy level of general prospectus applications (which close on November 12), it is reckoned that 35 to 40 per cent of this will be made up by retail investors.
Individuals are entitled to a loyalty bonus of additional shares if they hold the stock for a set period after listing, as well as a discount of 10 per cent on the institutional offer price, the latter capped at an allocation of $250,000. The indicative price per share is $2.50 to $3 and, including the maximum number of incentives, the price would have to fall to $2.29 in the after-market before any value loss.
When the QR National roadshow heads to Asia, flying out to Hong Kong on Sunday night, it will face heavy competition from a highly competitive regional IPO market. Asian-based fund managers are witnessing a booming IPO market, with many expecting about $40bn in new issuances in the next six months. Just this week Asian fund managers flocked to get a slice of the Hong Kong listing of American International Group's Asian insurance arm AIA, a float said to raise $US15bn ($15.3bn).
With the Asian market providing stiff competition for fresh funds, QR will also need to overcome the challenge of selling its offer at a time when the Australian dollar is sitting near record highs.
Yet one major player in the region, Hong Kong-based Perry Capital, is very engaged with the float, having had a team of five analysts scouring the opportunity, including several visits to QR operations and meetings, including meetings with Hockridge.
"Based on our meetings with management, we believe that they will be successful in executing the transformation program and achieve meaningful operational improvements," says managing partner Alp Ercil.
"Investors should be attracted to the combination of growth and stability. QR will give investors an opportunity to benefit from Asia's growing need of coal with less exposure to annual volume and price volatility."
Amid all the noise -- often from quarters with little real influence or money behind their criticisms -- it is the decisions made by the big fishes of the investment pool that will make or break the success of the QR National float -- the likes of Wright, Donohue and Ercil
They are clearly engaged, so it is a question of how many others will jump on the carriage, as the QR National express rolls out. A price at the top end of the range is unlikely, but demand appears robust below it.
