Babcock & Brown's savage share price descent is superficially about debt levels, but it also flags uncertainty about asset values, in Babcock and many other companies.
Babcock's banks can rely on yesterday's 27.5 per cent dive in the group's sharemarket value below $2.5 billion to initiate a review of its finances and operational strength.
As Babcock stressed in a statement released yesterday afternoon, about the time its share price was falling through the $2.5 billion barrier, the event gives its banks an option that they are not obliged to exercise - and if they do, a strictly prescribed and fairly lengthy process will kick in.
It told its banks late yesterday the $2.5 billion barrier appeared to have been breached by the share price plunge, and was told the banks would probably take until next week to reach a decision about initiating a review.
If the banks decide on a review, it will run for four months, and will not result in any action if, by then, Babcock's share price has recovered above the trigger point.
If the share price is still below the trigger at the end of the review period, Babcock will have two options: it can do what the banks require to stabilise the parent company and the $2.8 billion debt load it is shouldering (asset fire sales would almost certainly be part of that solution) or it can decline to take the medicine the banks prescribe. In that case a two-thirds majority of the two dozen or so banks that have provided the $2.8 billion, including Australia's Big Four trading banks, can serve notice on Babcock to repay the money within 90 days.
Babcock has some share capital in reserve that it may be able to mobilise to influence the outcome.
Based on its 333.3 million shares on issue, a share price of $7.51 was needed to keep Babcock above the $2.5 billion trigger. Yesterday's extraordinary plunge ran straight over that hurdle: Babcock closed 27.5 per cent lower at $6.90.
But there are 50 million convertible shares held by Babcock's US executives, and Babcock staff also hold 33 million options capable of being converted in the next few months. Theoretically, those blocks could be converted to ordinary shares, boosting Babcock's issued capital to 416.6 million shares and pushing the trigger point down to $6.01.
But $7.51 was the trigger yesterday, and it was breached: either formally or informally, the group's banks will be reviewing their exposure - and when they do, it is the quality of Babcock's assets that will be the real focus, not the weight of its debt.
Remember the same banks agreed just two months ago not only to renew Babcock's parent company debt facility, but extend it from $2.5 billion to $2.8 billion. They did so not because they had a view about Babcock's market value but because they had a view about the quality of Babcock's business model, the assets, and the amount of debt the assets can support.
The Babcock asset portfolio extends far beyond the listed parent company itself, because Babcock's chief executive, Phil Green, and his colleagues have created an empire of listed and unlisted investment vehicles. One of these vehicles, Babcock & Brown Power, acted as catalyst for this week's sell-off, as the disruptions to gas supplies in Western Australia sideswiped it, and complicated closure of its $2.7 billion debt refinancing.
Only the $2.8 billion head loan has recourse to the listed parent, but the total amount of debt in the empire is awesome: Credit Suisse estimates that it exceeds $46 billion, including another $7.7 billion that is on Babcock & Brown's balance sheet but on a non-recourse basis.
The larger debt total supports a global asset portfolio: some of it is considered to be high quality - wind farms in Europe, commercial property in Japan, ports in Britain and the former Alinta gas assets inside B&B Power are examples. And some is less highly regarded: Babcock Capital's Irish telecommunication company, eircom, is in that category.
The key, though, is that the entire global asset portfolio generates cash flow, for the various Babcock satellites, and ultimately for the head company, Babcock, in the form of fees from the management, purchase and sale of assets. Asset values are therefore central to the maintenance of revenue and to debt service capacity - in the satellites, and finally, in the parent company itself.
But as the subprime debt crisis continues to play out, asset sales have slowed to a crawl. There are plenty of companies looking to sell assets, including Babcock. But buyers are hard to find in an environment where cash is being hoarded and funding lines are still constipated, because the debt markets have not fully reopened and banks are rationing loans.
In that environment, it is very difficult for companies like Babcock and their lenders to work out what the asset base is: companies cannot confidently mark assets to market value if there is no market for the assets. This is an issue not just for asset structurers and traders like Babcock and Macquarie, but all companies that have borrowed against chunky, unlisted assets: Australian property trusts are a high-profile example.
One result of the uncertainty is that the banks are being patient. They have given companies including Centro and Allco time to restructure, and may well do the same with Babcock.
