It's big but will investors buy the QR sales pitch?

There's no doubt it is big. Queensland Rail's freight business, QR National, hauls more than 60 per cent of Australia's coal destined for overseas steelworks and power plants. Each train, at more than two kilometres long, carries a total of 500,000 tonnes every day, mostly from Queensland's huge coal pit, the Bowen Basin, to ports along the eastern seaboard.

But will investors pump their hard-earned savings into the $3 billion-plus initial public offering of QR National? Like everything, its success will depend on what its owner for the past 145 years, the Queensland government, is willing to sell it for.

On Sunday investors will finally get an indicative price range for shares in Australia's second-largest float when the QR National prospectus is published in Brisbane by the youthful Queensland Treasurer, Andrew Fraser, and the company's affable boss, Lance Hockridge.

But it will be just over another month before the outcome of the sales pitch to some of the world's most influential fund managers will be known.

"If they are going to rape and plunder on the first round, good on them - they say there is a sucker born every day, but I am not one of them," says Don Gimbel, a senior managing director for New York's Carret Asset Management. "We dont stretch for anything . . . there are plenty of stocks selling [cheaply]. TheQueensland governmenthas faced an uphill battle to get this far.

Not least an alternative $4.85 billion bid forQRNationals rail-track network froma consortium of large mining companies, strong opposition fromsections of the unionmovement and volatile equitymarkets.

NowtheHockridge-led sales team faces another battle over the next six weeks enticing investors who remain under water on the float of the department store chainMyer last year and bear a large hang-up about the after-effects of the federal governments sale of Telstra. InQR Nationals homestate, mum-anddad investors are still reeling from the Brisconnections and Rivercity Motorway debacles.

Then hes got to persuade retail investors fromAustralias other five states and two territories to take a punt on a company notwell known outside the Sunshine State.QR National does not have the brand awareness of previous governmentowned entities such asQantas, the Commonwealth Bank or Telstra.

The basic sales pitch  care of a $15 million advertising campaign  is the chance to buy into a lumbering government entity which can be turned around to benefit even more fromthe resources boom.

QRNational expects to boost pretax earnings from$204 million to $427 million this financial year, and by 35 per cent to $578 million in 2011-12.

If they are calling it a turnaround story, I would like to knowwhy, says Gimbel, who has been managing funds for Americans and Australians for more than four decades and visits Australia twice a year.

TheQueensland government is expected to offerQRNational at a sufficient discount to ensure the float succeeds. Retail investors will be offered a discount of 5 to 10 per cent to what institutional investors pay, including loyalty shares for holding them for a certain period.

It will need to be priced at a decent discount to win over the likes ofGimbel, who insists he would be in no hurry to buy intoQRNational if it is priced too high  even if he takes a liking to the companys fundamentals.

Gimbel says he would base any investment inQRNational on two factors: the quality of its management and their experience.Hockridge boasts a 30-year career in heavy industry and transport, including a stint helping split Bluescope Steel fromBHP. The board includes heavyweights such as the chairman, John Prescott, a former boss ofBHP, and an ex- Wesfarmers director,Gene Tilbrook.

The float will also be an important test for Australias IPO market, just months after the pin was pulled on the $1.3 billion float of Australias second-largest civil construction company, Valemus.

Fortunately for theQueensland government, market sentiment has improved since the Valemus float was ditched in July. As things currently stand, it will gowell unless they price it at a ridiculous level, HughGiddy, a senior portfolio manager with InvestorsMutual, says. It will be priced quite expensively without a good dividend yield, as far aswe can tell. Although it will not be a steal, Giddy believes the float will be structured in such a way as to gain sufficient interest frominvestors. It is beingwell-planned to be a successful float, he says. It is good timing, it has strong retail interest, it is a big company in the top 50 and most of the institutions wont want to be underweight in it. At the moment it is looking good because the market is up. As theQRNational roadshowrolls on, the research armsof the investmentbanks charged with spruiking the IPO have runthenumbersover what fat can becut fromthecompany.

Merrill Lynch has pointed out that cost-cutting fromreducing its 9400-strong workforce can begin to take place only when an enterprise bargaining agreement expires in December 2013. It calculates that employee expenses total $1.1 billion and believes about $110 million could be stripped out ofQRNational if it is operated along the same lines as similar railroad companies in North America.

Despite his efforts to win overQR Nationals heavily unionised workforce, Hockridge concedes that there is a core group of 5 to 10 per cent of staff whowill not change their opposition to the changes.

Hockridge also remains unfazed by the potential for miners to set up their own rail-haulage operations.

So far, the Swiss miner Xstrata has been the only one to plough ahead with plans to set up rail-haulage operations in the formof X-Rail in theHunter Valley.

There are barriers for entry even for the big guys,Hockridge says.

There is no change out of $45 million for a single train set in this system, and that is before you add in any of the maintenance-type costs.

I amnot suggesting those companies cant afford it . . . but to get in this business in any serious way would very clearly be taking away fromthe resource business. TheQRNational sales team might be talking up the chance for investors to buy into a company that offers the potential to be turned around, but it does come with its fair share of risks.

The biggest risk is execution, Paul Xiradis, the chief executive of fund manager AusbilDexia, says. If you look at the ability to execute, [Ascianos rail operator] Pacific National have a very high satisfaction rate whereasQueensland Rail has a very high dissatisfaction rate among its customers. Xiradis, whose firmis one of Ascianos largest shareholders, says former government-owned assets are often seen as offering a bit of upside to investors because often they are not managed aswell as private companies. But Telstra  which he describes as an absolute disaster  has shownthat buying into a former government entity is not a recipe for success.He adds that it will be difficult forQR National to improve its efficiency because it has a three-year standstill agreement on redundancies.

There is a fair bit of windowdressing in some of the forward estimates, he says. As far as the space is concerned, it is a good area [and] it is nicely exposed to the increasing volumes in coal . . . but there is a risk of execution with Queensland Rail which needs to be assessed to determine the value. QRs chief of coal operations, MarcusMcAuliffe, is keen to talk about the potential to reap the benefits of growth in coal demand fromAsia. If your first stop in strategy discussion is to work out whether or not youre playing in a good sandpit, this is a good sandpit to be playing in based on the advice of all the commentators. There are just multiple predictions of strong growth, he says.

Undoubtedly there will be some fluctuations over the coming years but everyone is predicting that this is a very healthy market to be operating in. Probably the best evidence of that was whenwewent through theGFC . . . it was literally a matter of dont blink aswewent though the GFC. Gimbel might be sceptical of the brokers laudingQRNational, but he agrees the resourcesboomthat has keptAustralia upright throughout the global economicdownturnmakes Australia an attractive investment.

Even though China is making hugemoves innon-coal power, coal is still 85 per cent of Chinese power and it will continue to be about that for the next 20 years, he says from hishomein theUSstate ofMontana.

The guys I talk to still seeAustralia as flavour of the month. Youare betting on China ... andmybet is that it will continue to grow.Australian coal is going to continue to be substantially indemandupnorth. It is a point theQRNational sales team is sure to be ramming home over the next sixweeks.