positive speculator article, page-2

For those who haven't read this..

Malcolm Maiden, Fairfax

THE job in front of infrastructure investment vehicles that have been tapping loan money to pump up distributions to investors was laid out by Transurban's new chief executive, Chris Lynch, yesterday after Transurban announced that it was kicking the habit.

"Our understanding is that the model of borrowing money to pay distributions is just not sustainable in this market, on access to debt and cost of debt," Lynch said. Translation: in a world where debt is more difficult to locate and more expensive, ramping up yields with recycled debt money not only doesn't help, it hurts.

In Transurban's case, the debt device produced a retreat from the toll road company's share register by a large portion of the funds management industry, which sees such financial engineering as an obstacle to understanding the underlying value of the investment.

It also hurt investor confidence after the credit crisis erupted — because a company that is deliberately raising more debt than it needs in this environment is creating an unnecessarily high-maintenance financial structure, and an unnecessarily risky one.

All the geared infrastructure groups are open to such a criticism, and Babcock & Brown affiliate Babcock & Brown Power yesterday also bit the bullet, announcing it was cancelling an expected 13¢ June-half distribution that would have made 26¢ for the year, and announcing that it would also in future align distributions with operating cash flow. Future distributions will accordingly be lower than they would have been: BBP said yesterday that payments would total between 13¢ and 18¢ in 2008-2009.

Another member of the B&B stable, Babcock & Brown Infrastructure, also flagged a change yesterday. It maintained distribution guidance for 2007-08, but said it was reviewing its capital management, including distribution levels, asset sales and gearing.

B&B Power's shares dipped 20% on the news, and B&B Infrastructure rose 4.6%, which goes to show that the Babcock octopus is a complicated animal, particularly now as it attempts to stabilise its position and restore investor confidence. For other groups that subsidise distributions with debt money, such as Macquarie Infrastructure, Macquarie Communications Infrastructure and ConnectEast, it is Lynch's revamp that will prove the more useful template.

Transurban will distribute 29¢ for the June half-year as predicted, but has slashed its distribution target for the year to June 2009 from 58¢ to 22¢: in effect, next year Lynch is cutting out the debt-funded portion of the distribution, and paying out only what is covered by operating cash flow.

At the same time, Transurban is raising up to $1 billion, by placing 120 million shares, or almost 10% of expanded issued capital, to institutions at a fixed price of $5.49 per security to raise $659 million, having three-quarters of the 29¢ June-half distribution underwritten for another $239 million, and by offering smaller shareholders up to $100 million worth of stock at or below the placement price, in lots of up to $5000.

The Canada Pension Plan, which is part of Canada's national super scheme, owns just under 5% of Transurban already, and has put its hand up for the entire 120 million share placement. It will buy less if other institutions want in, but will take at least 75% of the shares, and push up towards a maximum stake of 15%, putting it alongside another Canadian super fund, the Ontario Teachers' Pension Plan, which already owns 15%.

Lynch reckons he can also swing $20 million a year to Transurban's bottom line with a once-off $10 million attack on administrative costs. For starters, he intends to move the group out of high-end dark glass offices in Melbourne's Rialto building on the Docklands fringe and Sydney's Gateway building near the Quay.

His key move, though, is his strengthening of Transurban's balance sheet and simultaneous cutting of payouts; more than halving the nominal yield on Transurban securities in the process, from about 10.7% at the last share price of $5.41 to a more sedate 4%.

Transurban will emerge from this process with balance sheet gearing of about 44%, and all its debt will support the existing toll road businesses, or future expansion, instead of having the dual role of funding the business, and part-funding distributions.

The group's distribution yield will be lower for the foreseeable future, but at 4% it will be in line with overseas infrastructure funds, which, unlike Australian funds, have not tended to boost yields by streaming borrowings into distributions.

The size of the distribution cheques will grow over time as economies expand and road traffic increases, and as new roads are either built or bought. Higher petrol prices are a caveat, but that is a consideration that is separate to the refinancing exercise.

The market's immediate reaction when Transurban resumes trading today after the restructuring announcement will be negative. There will be selling pressure as retail investors who liked the debt-boosted 10%-plus yield evacuate, and seek similar yields elsewhere: the battered bank shares loom as one obvious bolt-hole.

Institutions, however, have never totally believed the artificial yields most Australian infrastructure groups offer, and the broker analysts who serve them have relied mainly on valuing future cash flows. Discounted cash-flow sums have valued Transurban at between $6 and $7 a share in recent times, and the changes Lynch is making makes that calculation more solid.

In that respect, the move by the Canadian Pension Plan to soak up paper at $5.49 is crucial to the outcome. Lynch's hope is that after the retail selling washes through, more institutions agree with the Canadians, and buy into Transurban as a low-volatility income generator.