Roads to hell paved with debt

August 28, 2008

Ian Verrender - The Sydney Morning Herald

There will come a time in the not-too-distant future when ordinary people will look back on this era, shake their heads in wonder and ask: how on earth did anyone ever think toll roads were sexy?

From the tulip bubble in Holland in the 1630s through to the dotcom boom of the late 1990s, otherwise rational minds have discarded logic and joined the frenzied mob in whatever investment fad promises fabulous wealth.

Without fail, they always end in tears. And so it is with the infrastructure boom.

Yesterday, Macquarie Group found itself under concerted attack from hedge funds as its shares fell 10 per cent to $41.61.

That's wiped out all the gains from the bull market and left senior executives floundering in a sea of confusion about how to stop the rout.

In part, the renewed attack on the Silver Donut is in part the fault of Babcock & Brown, the deeply-flawed and heavily-indebted infrastructure group.

When B&B's bankers effectively seized control in a bloodless coup last week - sidelining Phil Green and Jim Babcock while they figure out how to retrieve their $50 billion in loans - the attention inevitably swung towards the last bastion of financial engineering.

Macquarie is not a Babcock & Brown. It has a huge global banking operation that will ensure its survival. But its growth strategy of the past decade has been built on buying infrastructure, loading it up with debt, selling it off to investors in tax-effective listed trusts and then "managing" the assets - with fees extracted every step of the way.

Even dividends and distributions were paid with debt rather than earnings.

With the business model now dead, Macquarie's future growth has evaporated. And every group that imitated the Macquarie model, such as the listed property trusts, is now in trouble.

Macquarie's early response was to start buying units in its deeply-discounted satellites, spending as much as $500 million alone on Macquarie Infrastructure Group.

Lately, the plan has morphed into a strategy to delist the satellites from the sharemarket and resell them into unlisted funds. But events appear to be overtaking the plan.

There are now serious doubts about whether it has the cash reserves to privatise the assets. A stockbroking analyst from UBS concluded yesterday Macquarie Group had between just $150 million and $500 million in excess capital - well below the $3 billion claimed by Macquarie.

That started the hounds barking and was enough to concentrate the minds of hedge funds.

Another to run into a roadblock yesterday was Transurban, which started life as the successful developer and owner of Melbourne's CityLink toll road.

It is a fairly simple model that goes something like this: cars drive on a road; they pay a toll.

The operator pays the government a concession for the right to build and operate the road for anywhere between 25 and 100 years. That invariably requires large borrowings that ensure losses in the early days. But as time goes on and the loan is paid down, the company becomes increasingly profitable.

Transurban did well out of CityLink. But as toll road mania swept the land, and then the globe, Transurban's boss Kim Edwards scouted around for expansion opportunities. First he took Sydney - with a takeover of Hills Motorways M2 and a half share in the Macquarie-controlled Westlink M7. Then he bought a major slice of the M1, M4 and M5 from Macquarie. And then it was off to show the Americans a thing or two.

Each deal meant more debt to buy assets in an inflated market. And to keep the punters happy, Edwards pumped up the dividends with - a little more debt.

Transurban's newly-appointed Chris Lynch, the former BHP executive, has inherited this mess and taken swift action. He's raised extra equity and, luckily, has a strong backer in the Canada Pension Plan. He's also slashed the dividend which left investors with a bitter taste.

Lynch, a no-nonsense former AFL player from Broken Hill, says he wants to transform Transurban back into a "fair dinkum" company. He's going to have to.

So are numerous others who bloated themselves on cheap debt and now are stuck with overpriced assets no one wants.