When is a railway not a railway? Ask Japan's government.
The agency that owns Kyushu Railway, operator of bullet trains and intercity services on Japan's southernmost major island, hopes to raise 392 billion yen ($3.8 billion) from the world's biggest passenger rail IPO since 1997.
Compared to the three state rail operators spun off in the 1990s, that looks decent value. West Japan Railway, Central Japan Railway and East Japan Railway, whose high-speed services span the country's main island of Honshu, trade on a median of 11.1 times blended forward 12-month earnings estimates. On that measure, Kyushu Railway's forecast 38.2 billion yen of net income in the year through March would translate into about 424 billion yen of market value, about 8.2 percent above what the government plans to raise.
That's probably still underplaying things, because Kyushu Railway isn't really a rail company. While the country's big three shinkansen get more than two-thirds of their operating income from regulated transport fares, Kyushu Railway has traditionally received 60 percent of its sales and all of its operating profit from alternative activities such as property development, retail, tourism, financial services and running amusement parks and care homes.
That's actually a good thing, because for all their glamour, bullet trains are phenomenally expensive to run. Ancillary businesses have been a way of meeting the costs of operating transport networks ever since New York's Grand Central Station was built with the objective of paying for itself through rents on commercial property built atop the old rail yards. Hong Kong's subway company, MTR Corp., gets just 18 percent of its profit from transport in the territory. Major airports often look more like shopping malls than transit hubs.
It's a particularly common model in Japan, where a congeries of smaller regional rail operators sits below the big three listed shinkansen, running commuter bus and rail services while typically making most of their money from retail and property. Thanks to the mix of unregulated businesses alongside their transport units, they tend to trade on higher multiples, with a median forward price-earnings ratio of 16.3, compared to 11.1 for the big three.
Kyushu Railway is probably not quite in the league of the best regional rail operators. Most of them have solid bases in and around Japan's biggest cities of Tokyo, Yokohama, Osaka and Nagoya. Despite a population that's declining at the national level, those regions are still attracting migrants from elsewhere in the country, and also win the lion's share of a booming tourist trade.
Kyushu is more of a charming backwater. The island and even its main city of Fukuoka are forecast to experience a population decline between 2010 and 2020, unlike Honshu's major hubs. Nishi-Nippon, which operates commuter services around Fukuoka, is one of the less-valued regional operators in the above chart.
Still, if you generously awarded Nishi-Nippon's 14.5 forward price-earnings multiple to Kyushu Railway you'd have a company worth around 554 billion yen -- about 40 percent more than the government is asking. Price it like the lowest-rated regional operator, Keisei Electric, and it's still worth 485 billion yen.
A certain amount of low-balling would be understandable. Kyushu Railway's core transport network is finally on track to break even after decades of losses, the Nikkei Asian Review reported in July, thanks to an advance payment on usage fees for government infrastructure and reduced depreciation charges following a multi-billion dollar write-down of rail assets. But jittery investors may prefer to see hard evidence of a turnaround before they give too much credence to the company's forecast that group Ebitda will rise from 58 billion yen in 2015 to 78 billion yen in 2018.
The privatization last year of Japan Post Holdings and its banking and insurance subsidiaries has also been a dud for local shareholders, with only the insurance unit now trading marginally above its first-day price. Investors who've been burned once in helping plug the country's budget deficit will need some convincing to put their hands in their pockets again. Those with the appetite to take a punt on Kyushu Railway, though, could find themselves in possession of a decent cut-price ticket.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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