Last Traded: $0.20Market Cap: $481mSector: Utilities Summary of...

Last Traded: $0.20
Market Cap: $481m
Sector: Utilities Summary of report dated 20/10/08
BUY / OUT PERFORM
Valuation: $1.34
What’s new? Babcock and Brown (BNB) and Babcock and Brown Infrastructure (BBI) announced some changes to the governance arrangements governing BBI. Similar changes were announced for BBP
All up, while the changes are positive, there are some significant omissions namely:
 The management agreement has not been published.
 It was not clarified when/if management agreement can be terminated by
security holder vote and what fees are payable.
The Chairman of BBI did however note in the separate audio briefing that:
 BBI security holders could resolve by way of majority vote to remove BNB as the manager as per the 2005 Explanatory Memorandum when Prime Infrastructure became BBI.
 'No compensation' would be payable to BNB.
While this is not new information, it is not widely appreciated and as such we were surprised it was not included in the ASX release. But it should also be noted that BNB would be able to participate in any vote via its c. 9% shareholding, diluting the possibility of success by equity holders. The Chairman did also note that the announced governance changes are only a start and more changes are expected to follow. The BBI Chairman did say that the banks did not want BNB removed as manager of BBI. It is difficult to see why the banks, particularly those that lend to the underlying assets, would feel compromised if BNB were to be removed as manager. So long as the process is well managed by BBI's independent directors, shouldn't the banks be indifferent? Such an outcome would clearly be in the best interests of equity holders. BBI's governance arrangements are not materially different to its peers (CommSec has reviewed the governance arrangements and summary of management agreements of BBI's peers) - what does differ massively is the perceived governance and conflicts of interest. BBI-BNB must therefore go further than its peers to restore confidence. Publishing the management agreement is therefore a must. Valuation CommSec's revised valuation is $1.34 per security (down 55 cps) based on an updated asset level DCF. Our sum of parts valuation is $1.05. Both valuations reflect up to date net debt calculations and revisions to EBITDA forecasts reflecting the most up to date information from BBI. While there remains profound value in BBI, it is difficult to see how this value will be reflected in the BBI security price in the short to medium term. If the current asset sales are postponed (which we are expecting) and the outcomes of the governance review fail to materially lift the BBI security price to something that resembles fair value, BNB will have little options left. In this vein, BNB may ultimately bow to pressure and agree to terminate the management agreement so that BBI can be sold in the medium term (either assets individually or BBI in total) rather than requiring a successful shareholder resolution.