Aug 28th 2008 | HONG KONG From The Economist print edition Racy infrastructure investments come under scrutiny
COMPARED with the shoddy standards of its American and European peers, Babcock & Brown, a debt-fuelled Australian investment bank, has not done too badly, really. Its shares may have tumbled and it is having problems rolling over short-term debt and selling assets. But its infrastructure investments such as power plants, transmission cables, and ports, have continued to do well. An affiliated fund, Babcock & Brown Infrastructure Group, posted a A$51m ($44m) loss in the last fiscal year, but figures released on August 26th showed that cash profits were up strongly. Babcock itself is making money.
Challenger, a rival also big in infrastructure, has graver underlying problems, but nothing on the scale of global banks. On August 25th it unveiled a $A44m loss after write-downs. However, operating results were good and it did not seem to have any yawning black holes. Nevertheless, shortly after both it and Babcock reported this month, their chief executives were ousted. Their entire business models now seem headed for the scrap heap.
That model was pioneered by Macquarie, Australia’s globe-trotting powerhouse, and involves putting an investment bank at the heart of a highly leveraged infrastructure-fund business, receiving big fees along the way. It too is now struggling, and has shuffled assets and shares from one fund to another. With the help of some institutional investors it has also taken one publicly listed fund private, which raises a troubling question: if the public markets value assets any differently from Macquarie, who is to say that Macquarie’s numbers are right?
Sceptics smell blood, arguing that there was always a flaw in the investment case for infrastructure funds—that they held assets which were dull but stable and thus could support high leverage. On August 27th Macquarie’s shares tumbled almost 10%, after a UBS analyst said that the global credit squeeze was hurting its business. Five days earlier Morgan Stanley issued a strikingly bearish report on Macquarie’s main listed fund, Macquarie Investment Group (MIG). It listed numerous pressure points. Traffic on the fund’s toll roads had, for example, been hit by high petrol prices, which meant people took fewer trips. MIG’s long-standing practice of paying out more in distributions to shareholders than it received from the underlying investments worked when it was cheap to borrow money. It no longer is.
The investment banks are suffering from a staggering change in sentiment. In 2004 Babcock went public at A$5 a share, only to see its value peak at A$35 in mid-2007 before collapsing to A$2.70. The common factor appears to be liquidity. It used to be easy to buy and sell assets, and refinance debt. Now no leveraged investment firm appears to be any stronger than the weakest link in its debt structure.
As a result, an assortment of toll roads, ports and buildings are on the block, says one private-equity manager, though the sellers are still holding out for high prices. In a rare deal this month, Babcock admitted it would receive A$100m for a power plant in which it had invested A$220m. The buyer was the Tasmanian government, which was keen to avoid power shortages. Financial investors, who are not burdened by social concerns, are prepared to sit it out in the hope that prices will fall further.
It would be premature to declare the infrastructure business dead, however. MIG, for example, still has operating margins above 70%, and unlike Babcock, Macquarie is flush with cash in both its funds and core holding company, having raised A$22 billion from investors during its past fiscal year. Some deals are still being done; on August 4th Macquarie announced the purchase of a Channel Islands ferry service. Small stuff, all in all, but a sign that there is life in the industry—and that now is a good time to have money.
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