babcocks debt trucks

Tony Boyd

When Babcock & Brown Power (BBP) had a market capitalisation of $2.4 billion its shareholders grudgingly accepted the generous base management fees paid to Babcock & Brown.

But at today's market capitalisation of $129 million, the management fees look a little out of proportion to the size of the business.

Babcock & Brown is this year set to make about $24 million in management fees from BBP. The payment of those fees is a priority that ranks ahead of the obligation to repay a $116 million corporate facility due by March 2009.

BBP has been slammed in equity markets, losing more than $2.2 billion in value because of excessive debt levels. Babcock & Brown had a financial incentive to load up BBP with more external debt rather than project debt because the more external debt involved the more it got paid as manager.

Under the base management fees agreement included in the 2006 prospectus for BBP, the level of external debt is an important input into the calculation of management fees, which are paid quarterly.

The aggregate fees paid to Babcock & Brown by BBP are equal to one per cent of the net investment value. Net investment value equals the average market capitalisation of BBP, plus the sum of any external debt of BBP and its investee entities at the last trading day of the relevant quarter, plus the sum of firm commitments to future investments less the sum of uncommitted cash balances.

BBP has a market cap today of $129 million. It has total debt of $3.687 billion including project debt of $790 million. If you subtract the project debt and uncommitted cash of about $300 million you come up with an external debt figure of $2.5 billion. That gives an NIV figure of about $2.6 billion.

In other words, Babcock & Brown this year stands to earn about $26 million in base fees from BBP.

External debt only became such a huge proportion of the management fee calculation because of the decision by BBP to buy the Alinta assets. That acquisition added about $2 billion to BBP's external debt or about $20 million to the annual management fee.

It was the Alinta transaction which tipped BBP into being too highly leveraged and was the source of yesterday's $452 million impairment charge.

Disgruntled investors don't need to be reminded that, if anything, the amount of work involved in managing BBP has not lessened and will become more intense as the company fights for its survival.

Senior management said yesterday that the workload had increased in the past three months because of refinancing negotiations, the selling of assets, dealing with investment bankers conducting strategic reviews and reviewing asset valuations with the help of external auditors.

But the prospect of BBP paying management fees to Babcock & Brown equal to a fifth of the value of the company is causing disquiet.

That comes at a bad time for a company that is already on the nose for its disclosure record. Management's credibility was further harmed this week when it said a $81 million provision made as part of the Alinta transaction was reversed this week to reduce the losses on the sale of Tamar Valley Power station.

It turns out the $81 million was not disclosed in a note to the accounts. Tamar Valley was sold for $100 million, which was about $70 million to $90 million below the values placed on the asset by analysts, several of whom have described it as a "fire sale".

The market sentiment toward BBP was summed up today by Credit Suisse analyst Sandra McCullagh who said: “In our view, BBP is too highly geared, has a business model that does not facilitate growth, and is laden with excessive management fees. A full sale needs to be seriously considered. With the current views on the performance of both management and the parent company, we don't expect there will be a mass of natural buyers for the stock and we expect the share price will continue to suffer.”