babcocks credibility has gone

Babcock's credibility has gone


* Michael West
* June 14, 2008


The plight of Babcock & Brown can be put down to a loss of confidence in management and a balance sheet that is recklessly leveraged and overwhelmed by related-party revenues.

This is a slow-motion train wreck where total destruction of shareholder wealth can be averted only by either a white knight riding in with a rescue package or a precisely managed work-out and overhaul of the defunct business model - including $20 million in salaries.

Although panic sellers and margin loan punters exacerbated the fall in the B&B share price, and though the finger will be pointed at hedge funds "short-selling", its is the fundamentals that have brought the financial engineer undone.

Of its $2 billion in revenue as of its December balance date, a mere $25 million came from external advisory sources. The rest comprised base and performance-fee income, and advisory income from Babcock's "captured vehicles".

A large chunk of this satellite income is not repeatable. It is "one-off" revenue and most of the satellites themselves are over-geared and heading for asset write-downs.

This is why the hedge funds are "short" - those who managed to borrow stock, that is. And this is also why no big institutions have gone "long" and come to the rescue yet.

If the value is there somebody will pounce and make a fortune. And at least one major corporate has run the numbers.

The ability of all the Babcock entities to raise either debt or equity is curtailed. The independent directors of the satellites will be leery about forking out fees to the parent, and yet this is how it makes a profit.

These factors render an equity raising difficult. As for access to credit, bankers will look at Babcock's ability to fund the $11 billion in debt already on the balance sheet and its ability to raise fresh equity at a reasonable price. Neither option looks palatable.

This brings us to the two levers which the chief executive, Phil Green, and his crew can pull to possibly avert a wreck.

A white knight is possible but due diligence would take some time and any corporate saviour would demand to rank above the current equity holders. It would demand security and the dilution would further damage minority shareholders.

The second lever is wind. Babcock has already said it is selling some wind farm assets, which are excellent. .

Are they enough to stave off the banks? In the December accounts, assets under development (in wind, real estate and electricity) are valued at $1.6 billion. Thanks to regulatory and political pressure in Europe on its power companies to expand into renewable energy, Babcock does have a market. It can sell these at a profit. Whether that is enough, though, would be debatable.

Besides its balance sheet, a vital factor in the encroaching demise of the financial engineering firm is confidence.

Over the past month Babcock management has taken a serious hit to its credibility with research analysts. In the past, the analysts appeared happy - at least in their written research - to take Babcock at its word.

That credibility has gone - and the Babcock model relies on market confidence to drive up stock prices, refinance, raise equity and produce demand for its spin-offs