Take a deep breath and relax. Today’s issue of the Markets and Money is not about the Reserve Bank. Maybe it will raise the cash rate to 4.75% tomorrow and maybe it won’t. But frankly we are tired of pretending to take the RBA seriously as it pretends to know how to perfectly manage the price of money.
Instead, then, let’s talk about the upcoming float of Queensland Rail. It’s a great exercise in understanding how to value assets and why the private sector manages better than the public sector. The $7 billion float is the largest privatisation since the T3 float, where the Federal government sold its last chunk of shares in Telstra. And the whole deal raises a number of issues.
The biggest issue is whether it’s a good investment. The prospectus doesn’t come out until October 10th. That should give you a good look at just what the assets of the company will be. It will also give you an idea of the capital structure, including how much of an equity stake Queensland government will retain and how much debt the new listing will take on at birth.
But let’s deal with the assets first. You can’t get much more tangible than a railroad. It’s a very difficult asset to replace. That alone makes railroads appealing, provided you get them at a good price.
But there’s also a pretty good argument to be made that railroad shares are inflation hedges. My colleague Porter Stansberry made this argument late last year with respect to Burlington Northern (more below). Why?
Rail haulers can push up prices when commodity prices rise, passing on costs. If coal and iron prices continue to trend up, so too should the prices for moving them from the mines to the ports. It’s a pretty strong competitive position. And when you’re investor, that’s what you’re looking for with any business: does it have a durable competitive advantage?
And that’s not even mentioning how high the barriers to entry are to compete with an established railroad company. The quasi-monopolistic nature of the business – the massive capital costs for building a rail network rule out all but a few players – ensures pricing power and an incredibly strong competitive position. How many entrepreneurs do you know that decide to build start up railroads?
All that said, you won’t know if Queensland Rail is good value until you have a good look at the balance sheet. There is also the lingering matter of how much of the company will be owned by the state Government. It could be anywhere from 25% to 40%, according to Queensland’s Treasurer Andrew Fraser.
A prudent investor might worry about having the government as a partner/big brother regulator. Just ask Telstra how that’s going. You are constantly at the mercy of meddlesome politicians who want to run your company like a charity.
Of course there will be the usual motley crew of blabber mouths who decry the privatisation of State assets. But let’s not confuse two issues. One issue is why the State Government of Queensland is forced to sell off $15 billion of assets. The answer to that is obvious: the government spends too much and can’t live within its means so it has to raise cash somehow. This is low hanging fruit. Watch out for rising taxes later.
But a more interesting secondary issue is why the government can’t run the railroad business profitably. If it were such a good business, wouldn’t it be throwing off gobs of cash to subsidise other government spending? Is it a bad business, or is just run badly?
Our guess – and it’s only a guess – is that Queensland Rail is probably an example of other enterprises run poorly by the government. Turn it over to proper custodians of capital who are accountable to shareholders and you’ll probably get a better company. By “better” we mean a company that turns a profit because it delivers more efficient services to its customers. That’s also a company that can employ people and deliver returns to shareholders too.
For some reason, there is always a cadre of jackasses who view profit as evil or contrary to the public good. But running a large asset like a rail network for a profit is obviously a public good. Profits are reinvested in the network, improving services and keeping people employed and promoting trade and the flow of goods and services. Private owner/operators are generally better asset managers than bureaucrats. And better asset management is better for everyone.
Besides, when public ownership of assets results in a loss, that loss is borne by the tax payer. It is, in effect, a stupidity tax, or a tax you pay for allowing inept managers to run large enterprises. Who benefits from a loss-making enterprise protected by a government monopoly? We’ll give you two guesses.
So far, the advertising campaign for the float has been pretty slick. It’s turned a boring rail company into a symbol of Australia’s future prosperity. Fraser has said in public that, “This is a once-in-a-lifetime opportunity. There is no other opportunity out there to leverage into the Asian region . . . and the resources boom. It is a unique proposition.”
In that sense, the float of the company raises our contrarian hackles. Flogging new shares to the public as a way of participating in a “can’t miss” boom is usually a sign of the top in a market. It’s a basic case of supply and demand. The finance industry’s job is to supply the public with dreams of riches. And when the public demands a way to ride the Asia/Commodities boom, the public will get what it wants.
But Bill’s old “Law of Perverse Outcomes” comes to mind. The Law states that investors tend to get what they deserve, not what they expect. What you’d expect from Queensland Rail is a company leveraged to the Asia boom and a kind of proxy for Australia’s future. This is an echo of the thinking that led Warren Buffet to buy Burlington Northern earlier this year in America.
But you probably shouldn’t buy a company because you’re bullish on a country. You should buy a company because it has a strong competitive position, makes lots of cash, is well run, and has a capital structure that makes it immune to the vagaries of the debt markets. You’d also want to own a business that wasn’t going to be endlessly tinkered with for political considerations by a large minority shareholder like the government.
Tomorrow we’ll get back on the global beat. China is worried about a bubble. The Fed will soon become the largest holder of U.S. Treasury debt. The gold price is going lunar. India wants to buy the Port of Brisbane. And the contest over rare earths is hotting up! More on the whole enchilada tomorrow! Until then…
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