Babcock’s future in the balance: Kohler

Phil Green and the team at Babcock & Brown would have been going through the first phase of grief over the weekend; shock, numbness, disbelief.

The sudden death of so much wealth last week would have left all concerned hollow-eyed, staring at walls, unable to come to grips with what happened. Surely it was just an aberration, a bad dream – on Monday everything will be back to normal; buyers will see the value in their magnificent creation and bid the stock back to $10 and more.

Why only two weeks ago, at the annual meeting, they showed some marvellous slides, did they not, about how well things are going? And didn’t they admit to some little problems with the B&B Power refinancing? But that cancer was all cut out, and therapy worked. Everyone seemed so happy.

Many of the team were around in 1987 so they may have bypassed disbelief and shock, having seen it before, and gone straight to some of the later phases of grief, such as anger, denial and bargaining.

And it’s at this phase they will probably stay for a few months, ranting in the office about hedge-fund bastards, refusing to accept what has happened and more likely, since they are all pragmatists, spending their days bargaining and cajoling investors and bankers into supporting them again.

Over the next six months the Green team will be wheedling for their lives in an uneven siege against hedge funds.

The shorts are now highly motivated to keep the Babcock & Brown share price below $7.50 since they now know that this is the trigger price for Babcock’s banks to force debt repayments in the middle of October that must be made within 90 days. If the share price is still under $7.50 in four months, they win big.

In order for that not to happen, someone has to be prepared to buy. The management team clearly is prepared to, but do they have the resources? Or can they persuade someone else to do so?

First step: Talk the banks out of triggering the review event.

Phil Green’s statement last week, which admitted that once the market capitalisation falls below $2.5 billion ($7.51 a share) the banks have the option of calling for a review, said they don’t have to and might not.

He went on: “The consultation period is designed to allow discussions, including whether in fact any action at all is required – as the market capitalisation clause can cure itself through natural movement of the markets.”

Classic denial. And: “Our lenders are more focused on fundamentals than the daily share price movements. The group’s fundamentals continue to be in robust shape, particularly in the infrastructure business.”

It brings to mind a certain pet shop owner, who said to John Cleese: “No no, he’s not dead, he’s, he’s restin’! Remarkable bird, the Norwegian Blue, isn’it? Beautiful plumage!”

To which Cleese replied: “The plumage don’t enter into it. It’s stone dead.”

Babcock & Brown is not stone dead, of course, but its fundamentals are definitely not in “robust shape”.

Those fundamentals involve the use of readily-available debt to overpay for property and infrastructure and put the assets into funds that have unbreakable 25-year management contracts with B&B that involve very high cash fees based on market capitalisation, and make distributions to investors out of asset revaluation reserves that have little to do with the cash flows of the assets themselves, in order to keep the market caps up.

Here are some of the ways in which these fundamentals are no longer robust:

  • The cost of debt has risen and it is no longer readily available.
  • Economic slowdowns everywhere have reduced infrastructure returns.
  • That means base fees are much larger fraction of each fund’s margin between toll income and debt servicing costs.
  • Performance fees no longer exist.
  • Asset revaluations are no longer credible.

Babcock & Brown’s battle against the credit crunch plague has a long way to run and could still go either way.

Many investors will be hoping the management does not have to confront the final phases of grief: Guilt, resignation, depression and acceptance.

This first appeared in Eureka Report


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