Damage To B&b May Well Turn Out To Be Terminal

The Age

Friday June 13, 2008

Michael West

The asset manager has gone the way of its imitators MFS, Allco and Rubicon. The banks can step in.

THE fate of Babcock & Brown is in the balance. Although the immediate focus will rest on a credit "review" triggered by the collapse of the stock price beneath $7.50 yesterday, the damage to the Babcock brand may be irreparable.

A financial engineer, Babcock relies on market confidence to gear up, buy assets, revalue and repackage them, and spin them off.

The model is busted. Whether CEO Phil Green and his troops can dance their way out of strife with a restructure is as sure as the toss of a coin. Babcock has gone the way of its own imitators MFS, Allco and Rubicon. The banks now have a right to step in.

Their first concern is the structure and the debt in the mother ship. Can the cash flows from underlying operations fund the repayment of the loans? It would appear to be line ball. There is more than $50 billion in debt across the Babcock empire of listed and unlisted satellites.

The visible stuff rounds off at about $46 billion: comprising $2.8 billion full recourse debt to the parent, $7.7 billion non-recourse, $31 billion within the listed funds and their assets, and $4.8 billion in the GPT joint venture. The unlisted stuff remains the subject of conjecture.

The maze of guarantees and cross-guarantees, the loans between various vehicles, the management agreements and the legal minutiae of the entire structure will have to be evaluated.

Babcock & Brown has become a political issue. It will survive for some time at least - and there will be trading opportunities for the savvy and the foolhardy. It could recover. You can bet its financiers will pull out every stop to restructure and recapitalise, for this one is almost too big to fail.

Not only does Babcock control a host of essential services in energy and transport, but the mother ship and its satellite stocks are owned by hundreds of thousands of small investors.

Many are elderly investors who acquired the stocks for the handsome yield. Pity it was a manufactured yield in most cases, paid that is from capital rather than cash flow.

The small investors, and indeed the super funds, were sucked in by the lure of a fancy yield of 7% or so - it appeared to be great value for investing in a solid infrastructure play.

The reality was quite different. These were always high-risk propositions because of their sheer leverage. Some of the satellite yields are now up to 25%. When the mayhem in the financial engineers is past - and they are dead or recapitalised and restructured - the Macquarie-inspired infrastructure fund model, which allows distributions to be paid out of capital from a trust, will probably be deemed a policy disaster. This fund model has already claimed the scalps of Centro, Allco, Rubicon and MFS, and now Babcock is perilously close to the edge.

What the whole party has done, however, is enrich a handful of top executives and their hangers-on at the expense of thousands of small investors who have collectively dusted billions. Much of the executive pay was ripped out of capital, up front, when the deals were struck.

The selling in Babcock yesterday was heavy and appeared to be retail-led as CommSec has dominated selling volumes for the past two days. In fact, selling from a major shareholder in Barclays started the rout a couple of days ago. Ironically, Barclays was the last big fund to head for the door of MFS before it collapsed, though it only slimmed down its Babcock holding by a modest amount.

As buyers deserted the trading screen and the parent company spiralled helplessly, almost self-fulfillingly, towards its "review" threshold, the contagion engulfed every Babcock satellite.

Most of the selling came from existing shareholders. Some selling will have come from investors who took up stock in the Babcock placement in April pitched at $13.65 a share. Other selling will have been margin-call related as the B&B securities lending is pitched on an LVR of 75%. The further it falls, the more forced sellers get flushed out.

A spokeswoman said that besides the 333.3 million shares on issue in the parent, another 50 million were held in Babcock & Brown International Pty Ltd (BBIPL), which represents 13% of issued capital.

She confirmed that these shares could be converted into ordinary equity and be included in the trigger-point calculation for the banks - as could some 33 million zero-priced options and other pre-IPO options issued at $5 at the float.

With the BBIPL stock, the price of the review event would come down to about $6.58 a share. Babcock shares would have to trade above $6.58 at the four-month point before the banks could demand their money back.

Elsewhere, the plugging of holes proceeded apace yesterday in Babcock & Brown Power. The stock came out of a trading halt mid-morning and was driven down to 77? before a late pick-up to close at 90?, still down 40.5?.

While BBP's banking syndicate has agreed to the $2.7 billion refinancing, another $300 million to $400 million must be found, from somewhere, for working capital. It could be from the parent.

The explosion at Apache's Varanus plant does not help. But ratings agency Fitch has also caused concern. Fitch has assigned a BBB rating on the $2.7 billion secured facility - a notch above junk status.

However, equity investors should also pay attention to the Fitch "issuer default rating" for BBPF, which is a non-investment-grade rating of BB+ - junk status in other words. mwest@fairfax.com.au

© 2008 The Age

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