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Macbank next domino to go?

August 28, 2008

Michael West - The Sydney Morning Herald

Once Babcock & Brown had toppled it was only a matter of time before attention turned to the Millionaires Factory.

Sensing a structure diminished by its own leverage, conflicts and complexity, the short sellers had already piled in. A surprisingly negative analyst report from rival UBS gave it the kick the shorts were looking for.

All Macquarie's financial engineering imitators - through Babcock, Allco and MFS - have crashed and now the corporate success story of the decade is under pressure.

Could the mighty Macquarie - the deal-making phenomenon which bid for the London Stock Exchange one year and the national airline Qantas the next - be humbled? Not just yet.

Yes, its model is vulnerable and the stock price volatility will persist amid the tug-of-war between believers and disbelievers. In contrast to the rash of Macquarie mini-me mimickers however, this is a far more diverse, better capitalised, better managed and more cunning crew.

That the stock plunged 10% yesterday is simply recognition that, in this time of radically-reduced deal volumes, it had been overpriced and there was no compelling reason to pay up for it. It is odds-on for a bounce today.

Related parties

Still, the bank does have serious issues, not least the stultifying leverage in its underlying assets and satellites, and some fishy-looking asset sales to related parties in MIG, MAP and MCG.

The satellites are more susceptible than the Macquarie mothership and these deliver fees. We can get to this later.

First, there is a significant policy aspect to the bank's predicament: no visibility on short sales. A couple of months ago the "shorts'' would have taken 25 days of daily turnover to cover their positions.

Unfortunately, there is no disclosure of share lending data on a daily basis which could give the market a decent idea of how big the short position is. Further, there should be daily disclosure of both the "covered shorts'' and the "naked'' shorts.

The RBA issued an excellent paper in May saying there was a need to register share lending data at the trade-capture stage, that is it needed to be coded in CHESS.

Off-market transactions need to be disclosed, although this idea is unlikely to glean much support from the ASX whose interest lies in promoting as much trading volume as possible. Another conflict from a profit-driven market regulator, another story.

Their leverage is huge, and although non-recourse to the bank (and much of it contained in the underlying assets themselves), potentially debilitating should cashflows slow too much to service the debts. Hence a round of asset sales this earnings season combined with share buy-backs, and asset writedowns. Macquarie is fighting the clock.

This week, Macquarie Airports sold stakes in Copenhagen and Brussels airports to another Macquarie vehicle, the Macquarie European Infrastructure Fund 3, to pay down some debt and conduct a $1 billion share buy-back.

Last week, Macquarie Infrastructure Group (MIG) announced sale of its M7 Westlink toll road asset, also to a related party, to fund a share buy-back. Selling its growth asset to prop up the stock price is not a good look.

More than half its distribution from MIG, and a decent slug of the Macquarie Airports (MAP) and Macquarie Communications Group (MCG) distributions, still come out of capital, or debt. So, the bank yet persists with its prop up the stock price with a sexy yield strategy.

It must be galling that Transurban has resiled from the Macquarie Model of running heavy gearing and paying distributions out of capital and has lately been rewarded. Since the volte-face from Transurban, Macquarie floated what will likely be its last MacModel toll-road in Australia, Brisconnections, and the unit price is now travelling at 21.5 cents from its $1 issue price in only a month.

The price of adhering to the strategy which once delivered $33-million executive salaries is now getting a tad high. Having ripped a cool billion in fees out of MIG over the years thanks to aggressive gearing and revaluations, the bank has splashed $500 million lifting its stake in MIG from 9% to 16% in the past year. It is racing up the register in the other satellites too.

It is MCG though which is widely regarded as toting the highest risk of the three. MCG has just announced the sale of its Global Tower Partners asset in the US to a related party (MIP II) for $US363 million. Without a hint of irony, some observers remarked that it had fetched a good price.

All three of these major satellites have just announced asset sales to related Macquarie parties. There is a pattern here, and an aroma.

This is the Smiths Crisps of financial engineering, the original and the best, but the buccaneering brand is now backpedalling.

Much of yesterday's share price damage in the mothership was put down to an analyst report from the UBS banking analysts. UBS reduced its rating from ''buy'' to ''neutral'' and its price target from $60 to $48 citing weaker trading volumes, capital constraints and the potential for asset writedowns.

To the casual observer this recommendation would appear to be just another big broker belatedly adjusting its call after the stock had fallen - as has been universally the case in the current downturn. Not so. A "neutral'' on Macquarie from a big broker, especially UBS which derives millions in fees from Macquarie deal flow, is quite a dramatic matter.

The 10% reduction in 2010 estimates from UBS in particular enforced suspicions that the broking establishment was coming to grips with a lengthy drought on the corporate activity front.

Equally interesting was the call from Citigroup on MCG headed "An Expensive Utility'':

''If there was ever a re-confirmation required that MCG essentially is a utility, it came today with the company validating that 90-95% of its current revenue was contracted over the next couple of years.

Unfortunately, unlike utilities, MCG does not have earnings hedge against rising interest rate costs. While we retain our Hold rating on the stock with TP of $3.28 per share, comparative valuation with its utility peers suggest downside risk to $0.73 per share.''

The market would appear to be losing a little faith in the way Macquarie likes to see itself valued, via proportional earnings metrics, on pre-interest costs earnings multiples and so forth.

The process of deleveraging will be painful and the future of earnings growth uncertain. Unless there are some particularly nasty surprises, it should avert the fate of its corporate acolytes.

With 12,000-odd hungry mouths to feed in a depressed global market, though, much depends on an economic recovery - sooner rather than later.