A NOVEMBER equity raising of $1.8 billion has not reversed negative market sentiment towards Prime Infrastructure, the recently rebadged Babcock & Brown Infrastructure.
While most of the debt-laden basket cases of 2009 bounced hard after completing recapitalisations, Prime closed on Friday at $3.72, down 27 per cent on the recapitalisation share price of $5.08.
Two pieces of bad news have contributed to the security price falls. A disputed stamp duty assessment could set the group back $46 million, while the December announcement of a regulatory review of Prime's highest value investment, Natural Gas Pipelines of America (NGPL), has shaken analyst valuations.
The review by the Federal Energy Regulatory Commission (FERC) will assess whether the returns generated by NGPL are ''unjust and unreasonable''.
The FERC alleges that NGPL generates returns of around 24 per cent, double the 12 per cent allowable following a 1996 rate case.
While the FERC review is in its early stages, its impact could be substantial. After reviewing FERC's initial filings, UBS downgraded its valuation of NGPL by 38 per cent, or 69 cents per Prime security, leading to a price target for Prime of $3.90.
However, one free thinking fund manager believes that the outcomes of the review may not significantly affect NGPL. In an analysis titled ''When regulators can't do math: gas pipeline edition'', Bronte Capital fund manager and blogger John Hempton argues that ''the FERC stuffed up.
It simply got the math wrong because it does not understand rates of return and depreciation - a staggering oversight for a body charged with regulating pipelines.
''Worse - on the math presented - the rates on the NGPL should be increased in order to allow for the FERC mandated 12 per cent return.''
At the heart of Hempton's complex mathematical analysis lies a simple principle, that pipeline returns can only be assessed over the life of the asset and not at a snapshot in time. It is inevitable that if annual profits are constant over the life of the project, but are compared with the written-down book value of a pipeline late in its life, the returns will appear high despite meeting benchmarks only over the longer term.
Prime has not commented on the legitimacy of Hempton's thesis, but with NGPL's own cost and revenue analysis set to be made public later this week, investors would do well to keep a close eye on company filings as a worst-case result looks to be priced in to Prime securities.
Rate rise no sure thing
MONEY market fluctuations on Friday saw the implied probability of an interest rate rise start the day at around 80 per cent, before dropping below 70 per cent by lunch time.
The Australian dollar also dipped below US89ยข to a four-week low.
These were curious movements at a time when most Reserve Bank-watchers believe that a February interest rate rise is a sure bet.
The movement also came on a day when figures showed that last month's private sector credit growth was stronger than expected, news that would normally have pushed markets in the other direction.
It seems that the unusual market movements are explained by murmurs from a secretive group called Medley Global Advisors.
The New York-based Medley, which calls itself ''the leading provider of macro-political intelligence'' to hedge funds and investment banks, has built its reputation on being close to central bankers.
Medley is known both for charging several hundred thousand dollars for a subscription to its reports, and for fiercely protecting access to the group's output. Sources say that standard terms and conditions promise legal action if Medley reports are forwarded to third parties.
According to market scuttlebutt, Medley speculated on Friday that it was a real possibility that the RBA would leave rates at 3.75 per cent tomorrow, and pointed to slower rises ahead.
Many trading desks explained the day's market movements by hinting at the Medley report.
Sceptics, however, pointed out that rumours can develop a life of their own, and Medley's secrecy only inflames the situation.
By tomorrow afternoon it will be clearer if Medley's massive subscription fees are a good investment.
Cheese plan goes stale
A CHANGE of strategy is needed if Warrnambool Cheese and Butter is to maintain its credibility and see off the takeover overtures of the Murray Goulburn co-operative.
The board of WCB has refused to engage with its potential suitor to date, commenting that an indicative offer of about $4 per share "does not reflect WCB's medium and long-term prospects", while also pointing to WCB's record of delivering high milk prices to suppliers.
This second argument has no place in defending a public company.
Indeed, the board's apparent preoccupation with prices paid to suppliers may explain the minimal institutional ownership of WCB as well as being a major cause of the company racking up a $20 million loss in the year to June 2009.
With Murray Goulburn set to increase the pressure on WCB, the board needs to engage with the valuation question.
Vague outlook statements are not enough. What is required is a clearly articulated plan for growing maintainable profits to a level that would justify a share price above $4 in the medium term. Earnings of around $15 million will be needed.
Without such a plan, WCB has little defence to claims that milk processing is a scale game requiring geographic spread and access to capital for long-term success.
