waiting for a short covering rally

could be a long wait if West is right.

Babcock on trigger point

B&B in freefall as woes mount
Michael West
June 12, 2008 - 12:47PM

Babcock & Brown shares are getting smashed on speculation of hedge funds shorting the stock into oblivion - into the hands of its bankers, that is.

The story doing the rounds is that if Babcock shares fall to $7.50, that would trigger a $2.5 billion market capitalisation review clause with its syndicate of banks. The upshot would be a total collapse in market confidence as Babcock would be in a similar basket to Allco and Centro - in the hands of its bankers.

The stock fell as low as $7.90 this morning and recovered to trade at $8.07 just before noon.

There are two problems with this story. One, there is no "borrow'' in Babcock stock right now, no shares on loan for shorts. It's all tied up. Most of the selling is coming from giant quant fund Barclays Global Investors, which sells on volatility. BGI sold down below 5% earlier this week and is likely to be in the market again today.

The problem is buyers are vanishing in the panic and Babcock is yet to emerge to clarify the debate over the "market review" clauses.

The second story is that Babcock & Brown's founders in the US hold about 17% of the company in a convertible note, which means that could convert to equity in the event of the group hitting its $7.50 trigger point.

Most of the selling, then, is coming from existing shareholders. There is a likelihood that hedge funds will "cover'' today - or buy back their short positions if they are already short - or simply buy the stock for a bounce.

Longer term of course, the picture is more cloudy. It is clear the business model is broken and the market has little faith that management can replicate its track record of earnings growth by knocking out deal after deal and snipping big fees. Rather, management is preoccupied with surviving, plugging holes everywhere in the group's constellation of satellites.

No plugging is more vigorous that in Babcock & Brown Power today. The stock has been caned 41c to 89.5c since it came out of a trading halt mid-morning.

While BBP's banking syndicate has agreed to the $2.7 billion refinancing, there remains another $300 million to $400 million to be found, from somewhere, for working capital requirements. And that somewhere looks like it could well be the parent.

The fact that BBP has been hit with worries about gas supply thanks to the explosion at Apache's Veranus plant in WA does not help things. But it is ratings agency Fitch which has also whipped up concern among banks and institutions. While Fitch has assigned a BBB rating on the $2.7 billion secured facility - a notch above junk status - the devil is in the rater's detail.



"The Fitch ratings news is not delivering an investment-grade rating of BBB minus,'' says a release for institutional clients.

"BBPF is what the Babcock system calls an asset level entity. It has a contractual close of a secured facility of A$2.7bn. Fitch gave the facility an investment grade rating of BBB minus. However, equity investors should also pay attention to the Fitch 'Issuer Default Rating' for BBPF, it is a non investment grade rating of BB+. This rating is not in the news headline.''

This downgrade in the Issuer Default Rating from Fitch does not provide a lot of comfort to institutions who are tossing up whether to back BBP for a recovery. A lot of the stock in a recent issue went to hedge funds and they are selling today.

"In the BBPF case, the security of the loan will give it higher recovery given default, hence the secured facility rating is notched above the IDR,'' says Fitch. "Since equity holders rank behind debt in the recovery process given default, from an equity perspective, we feel the BB+ rating is more meaningful.''

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