Babcock & Brown's leveraged infrastructure model is bound to come under further pressure this week following Friday's dramatic events in satellite group Babcock & Brown Power (BBP).
BBP got shellacked late last week after it tipped the "shorts'' off, conceding it could need to raise another $300 million in equity to fund its capex requirements. It was already struggling to refinance its debt. Now the stock is 40% lower in two days of trading, Babcock would find it hard to raise equity without smashing the price again. The dilution would be prohibitive.
Compounding its woes, BBP management went into the bunker on Friday afternoon and is yet to emerge. In that time, Reuters emerged with a report saying BBP's refinancing had been "downsized'' from $3.1 billion to $2.7 billion. That would indicate the banks have jacked up and said no more from us, thanks.
BBP, like other struggling Babcock satellites, has been groaning under its weight of debt. In BBP's case, much of the pressure comes from indigestion after it swallowed some of the Alinta assets at the peak of the market last year.
The refinancing had already been a stretch. Now, BBP may have to increase its debt and therefore dilute its cashflows - if the banks come at that - or sell assets. Since the old Alinta assets are apparently not on this menu, it could look to auction one or more of its power assets under development.
Then there is the other option, mooted by Babcock & Brown management. Babcock itself could step up to the plate. This would seem rather a desperate measure, although it would not have been even mentioned had Babcock boss Phil Green not been prepared to do it.
This brings an entirely new hue to the financial engineering landscape. It has always been a matter of conjecture whether a Macquarie or a Babcock would dive in to salvage a foundering spin-off. Macquarie, for its part, has made much of the non-recourse nature of the relationships. Although its business is far broader than Babcock's and its income streams more diverse. Babcock takes a more communal view of its constellation of satellites but has not yet had to stage a full rescue.
Macquarie itself is facing issues with its Macquarie Communications Infrastructure group with regard to valuation effects from Challenger's decision to sell down the Arqiva asset. Yet it has a couple of unlisted funds to resort to when it comes to placing stock.
Interestingly, Macquarie Equities Research - which slashed its forward earnings estimates on BBP by 25% and 35% - reckons the "leap of faith'' to trust Babcock's management guidance over capital management has "widened significantly''.
"The Company's inability to communicate the capital constraints of its business to shareholders in our view destroys the credibility of those controlling the Company and ultimately the financial outlook for BBP,'' said its analysts in their report.
The plight of BBP will do little to settle investor nerves across the Babcock empire. The maze of related party transactions only complicates the picture and makes the entire empire more vulnerable.
While the latest incident shapes up as a potential bailout from the Babcock mothership for a satellite in trouble, it is worth bearing in mind that the largesse travels both ways. At least two of the satellites have lent money to the mothership. One loan, from Babcock & Brown Wind, had been repaid.
Another appears to be a loan of $200 million from Babcock & Brown Infrastructure (BBI) to Babcock & Brown. At least the notes to the last BBI annual accounts show the loan to a Babcock & Brown Note Issuer #1 Pty Ltd which ASIC searches indicate is owned by the head stock.
Although Phil Green managed to plug a few holes with his lightning recapitalisation a few weeks ago, after the annual profit result, this ship still has some rough waters to traverse. And that's putting it lightly.
Again, and the importance of this point cannot be understated. The management agreements for all these things should be made public. In the case of some of them, the termination fees for management are so punitive - in some instances full freight fees still have to be paid to the ousted manager - that they should never have been sanctioned.
One, institutions should have canned them on debut and, two, if they were not there the assorted stocks would trade at a higher price on the assumption that the manager could be chucked out for doing a bad job.
The other significant failure of the model is that fees are largely paid on size, which is a big incentive to overpay and just get bigger for the sake of fees - as opposed to the best interests of their investors.
mwest@fairfax.com.au
BusinessDay
