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The moral of Babcock's story
The Spectators
The moral of Babcock's story
Babcock & Brown CEO Michael Larkin tells Business Spectator's Tony Boyd:
One of Babcock & Brown's mistakes was assuming the company would find buyers for assets when credit had dried up
Hopefully in two or three years' time the company will be substantially reduced and be in runoff
He defends retention payments yet to be paid to executives
He says companies should avoid over-diversification and compensation must be tied to performance
Tony Boyd: Michael, you’ve announced a restructuring which basically means the equity holders and subordinated note holders get virtually nothing and the banks are going to get their interest paid when you sell assets. Could you tell us what went wrong to get to where we are now? What actually did Babcock & Brown get wrong?
Michael Larkin: We announced during the course of 2008 where we expected to be in terms of our earnings and what we were planning in terms of asset sales, most notably sales in European Wind – assets that we thought were very attractive – but also sales of US wind assets. What we found, first and foremost, was that there was an absence of purchasers for these assets. One of the first things that occurred was the absence of the availability of credit for purchasers to look to acquire those assets. At the same time there’d been a substantial softening of the real estate market flowing from the US housing downturn.
There was also a culmination of issues associated with the financial crisis which led to almost an absence of availability of credit in the markets. That absence of availability of credit meant that for a company like Babcock & Brown, which was dependent on transactions to meet our guidance, there were significant restrictions on us. The real asset deflation that started to occur was reflected in the real estate assets and that exacerbated our position. That deflationary impact on pricing flowed through to infrastructure assets as well.
TB: It would seem to me that two fundamental things went wrong: your risk management was not good enough and secondly, the former management who have left the company were too slow to react. I think Phil Green, the former chief executive, said in May last year that the worst was over and obviously that wasn’t the case. Do you agree with that?
ML: Look, I’m not going to comment on what other people may or may not have said and I can’t recall that Phil said that at the time. In any event, I don’t think many people could stand up and say they predicted or understood the nature and extent of the financial crisis that we still find ourselves in. In May last year many commentators from all walks of life were of the view that there were turning points which never materialised. Just to go back to your first point, in terms of risk management, I think to understand Babcock & Brown it is important to know that we really conducted two businesses. We conducted a business of originating and trading in assets and we conducted a business of asset and fund management. And in relation to the business of origination and trading in assets, including assets that we developed, that really did need to have the availability of credit for that business to continue. The absence of credit and the speed with which that credit left the market we certainly didn’t predict and I think it’s true to say that most didn’t predict it. Our model, which was highly leveraged, did require that credit to be available to continue.
TB: Turning to some more specific things, we’ve had a lot of reaction from note holders and you probably have too. Some of them seem to think that Babcock & Brown International Pty Ltd, which was the primary operating company and borrowed the money from the bankers, had guaranteed those notes. Is that correct?
ML: There is a subordinated guarantee from Babcock & Brown International Pty Ltd to Babcock & Brown Ltd and that subordinated guarantee still exists, but it is subordinated to the senior lenders.
TB: So what does that mean in practical terms?
ML: Subordinated note holders sit behind the senior lenders and I mean these were Babcock & Brown subordinated notes and it was very clear from the prospectus, all material and all of our disclosures about the priority between senior debt and the subordinated notes.
TB: So is it possible for them to take legal action to try and enforce the subordinated guarantee and get their money back?
ML: Well, they’d need to look at that, but the subordinated guarantee is just that, a subordinated guarantee. In plain simple English, nobody gets anything until the banks get their money back. The reason we’ve gone on to say we see negligible value for subordinated note holders is because we recognise that the senior lenders have to be repaid first.
TB: If we could look forward say two or three years, you have to repay about $1 billion dollars by 2011. What will Babcock & Brown look like in two or three years time?
ML: Well, what we are conducting is an orderly sale of all of the assets of Babcock & Brown and so that hopefully, and depending on which assets are sold and at which points in time, it will be substantially reduced and be in runoff.
TB: So really once that initial $1 billion in debt is repaid, what happens next? Do you think the company will continue as a going concern?
ML: Well, just to be clear, what we are continuing is a process of selling the assets of the business and how the company will continue once the majority of assets are sold we’ll determine at that time But it will continue to reduce in size and scale to a size that’s relevant for the company and the assets that exist.
TB: As part of this restructuring there are some retention payments for existing management. The figure I think is about $20 million that would flow to that group of people. Do you think shareholders would feel justified in being upset that so much money would be going to the executives when the company’s shares are worthless?
ML: Yes. Just to be clear, the retention amounts are flowing to a broad range of people within Babcock & Brown, right, and that is for those people who have carriage of the sale of assets, the ongoing day-to-day management of the company and the management teams. Now, we haven’t disclosed the amounts that are for the group as a whole or for the individuals, but it is a key part of our capacity to sell the assets and maintain the company in a form to be able to sell the assets that we retain certain people to do this. Everyone at Babcock & Brown understands that there is no long term job at Babcock & Brown and therefore we need a mechanism to be able to retain those people. It’s not many people compared with our current workforce and it’s not just the management team; it’s much broader and deeper than that, in order to sell these assets and manage the company.
So, the purpose of it was well understood. In the context of the payments to management, there is a whole series of criteria that the management have to meet. Firstly, they need to ensure that the business is conducted in a way which repays the banks in accordance with milestones that we’ve agreed. It is not available to any of the management team as a contractual right and certainly doesn’t exist if they resign or are made redundant. And there is a clear recognition, both with the banks and with the management team, that the management team will dramatically reduce as the business contracts. So, it is not available for everyone on an ongoing basis. It is not available in the circumstance where the banks step in and there are any number of triggers where the banks are able to step in. Finally, it’s not available to be paid until such time as the reserves that are required to meet employee entitlements and redundancy payments are met. So, I appreciate that there’ve been a lot of headlines in relation to retention for management, but I don’t think the full facts and circumstances have been laid out. And to the extent that we reach agreement with the management team on an individual basis and are required to lodge those details with the ASX as part of our disclosure obligations, we’ll do that at that time.
TB: The banks are entitled to a restructuring charge of 20 per cent of the $2 billion in debt that’s been deferred until 2018. Is that correct?
ML: That’s right.
TB: Is that potentially $400 million multiplied by nine to cover the period to June 2018?
ML: I think you’ve got to understand that there is no interest on the pay-if-you-can component of the $2.1 billion of the facility. The mechanism for that fee really recognises the fact that no interest would otherwise be due on that part of the facility.
TB: But is that calculation correct, that it’s potentially a restructuring fee of about $3 billion?
ML: Well, only if it was capable of being paid.
TB: Right.
ML: Remember that fee is also a pay-if-you-can. And so it’s pay if you can and only from the assets of Babcock & Brown, so that no amount of it is payable if it’s not able to be met by the assets.
TB: So it’s unlikely to be that amount of money?
ML: No, absolutely.
TB: And what about your own future? How long do you think you’ll be with Babcock & Brown?
ML: It’s unclear. What I recognise, as well as all of the management team, is that there is a certain job to be done. It doesn’t necessarily require all of the people in the management team for a protracted period of time and at the right point in time, and depending on progress we make, the management team including myself will look at what’s the right time to leave. As I said, the banks and the Board will also have a view and we’ll serve at the whim of the board.
TB: Well finally, what are the lessons that people should learn from the collapse of this company which once I think had a market value of $12 billion?
ML: Look, I think Babcock & Brown had a very diverse business and there was a lot of entrepreneurial spirit brought to bear in pursuing that diversity of those business activities. The breadth of activities, certainly in a market we find ourselves in now, is very difficult. It takes concentration away from key focus areas. I think that would be sort of first and foremost. I’ve said previously, and I hold to this, that our compensation structure was not properly aligned to the investment performance of either our funds or our shareholders and I think that was an inappropriately structured compensation. And I think we unfortunately operated in a market where there was limitless, seemingly, limitless availability of credit and whilst that credit was often times recourse only to the asset itself, it certainly created behaviours and buying opportunities for assets that we would reflect on now.
TB: Thanks very much, Michael.
BNB
babcock & brown limited
