Macquarie's toll road finance model crashes

Link to article here.

Macquarie along with its partner, Cintra, bought the rights to the Indiana Toll Road and Chicago Skyway. Macquarie has been a bidder on several Texas toll road projects. A Macquarie subsidiary also bought dozens of Texas newspapers in the path of the Trans Texas Corridor. A Wall Street analyst who sounded the alarm on Enron, Jim Chanos, also warned about Macquarie’s business model, which is to pay shareholders from debt, not actual earnings.

Doubts over Macquarie’s model
August 28, 2008
The Australian Business

A RELATIVELY benign analyst downgrading was the initial impetus to yesterday’s 10 per cent plunge in Macquarie’s stock price, but the sustainability of the model is the issue.
UBS, which happens to be one of the biggest traders in the stock, issued a downgrade yesterday, accompanied by a 2 per cent cut in its 2009 year earnings estimates and a 10 per cent cut in its 2010 estimates.

Two other firms, Goldman and Citigroup, already have the stock on hold and the report in itself was not exactly revolutionary.

UBS talked about potential asset write-downs on Macquarie’s $7.1 billion equity investments and the 12 per cent of revenue it generated from shifting assets from fund to fund last year.

It also figured that surplus capital was closer to $500 million than the $3 billion claimed by Macquarie in May’s annual results release.

The bank, for its part, notes that just 20 per cent of its earnings are derived from its listed funds and this includes advisory fees and the like and that, unlike a Babcock or an Allco, it is actually a regulated bank.

So what makes the stock fall so hard on the back of an analyst’s report that states the bleeding obvious?

The answer is: market sentiment and the growing doubts that Macquarie can continue with its program of shifting funds from its listed funds to its unlisted funds at director valuations, which don’t look anything like market valuations.

For 18 months or more, Macquarie has said there is patient capital aplenty (sic) for the type of quality infrastructure stocks it owns.

But over the last 18 months, valuations have come down and at some point investors in these funds will be asking why they should pay $x for an asset, which is valued in the market at $y, just because Macquarie said it was worth $x.

Then there is the issue of distributions, which Chris “Che Guevara” Lynch at Transurban put to rest a month or two back, when he said the toll road company would only pay dividends out of earnings. The folk at Macquarie Communications played this line earlier in the week, noting cash earnings totalled $325.3 million and distributions were $238.7 million, so they were covered 137 per cent by cash earnings.

Fair enough, but the problem is that calculating cash earnings seems clouded by a few one-offs.

There was a figure of $119.5 million in what was called non-current deferred revenues that was included, even though that description suggests the bank can’t actually get its hands on the cash right now.

Then there were charges for depreciation, amortisation and other items totalling some $54 million, when a separate entry in the accounts noted depreciation and amortisation was more like $330 million.

There will be an explanation for this, but the point is, the distribution cover may not be what it seems.

Macquarie Communications, like MAp before it, has started shifting assets out of listed funds into unlisted funds. No problem here so long as the unlisted fund investors are happy with the valuations used. As happy as they might be with Macquarie valuations, in this market they will at the very least be starting to ask more questions.

That’s the issue which seems to dog Macquarie now: its earnings sustainability.

The market value of four vehicles, the head stock, Macquarie Communications, MAp and MIG, have fallen by $22.2 billion from the highs in October last year to a combined value yesterday of $23.5 billion.

The bank itself is sticking to its statements in May which is just as well because the evidence from the US says those who hit the panic button first have proved the smartest.

When Bear Stearns put itself up for sale at $10 a share earlier this year, some claimed it had sold too cheaply. Debt investors got their money back and no-one is attacking the $10 a share valuation.

Likewise at $US25 a share when Citigroup raised $US12.5 billion, the smarties said it was an undue dilution of equity. This week Citi is trading around the $US17.60 mark and survival looks better than even bigger dilution.

The point is, the first mover’s advantage doesn’t mean its all over for those wanting to shore up their books.

Macquarie’s future doesn’t rest on a couple of days’ share-market trading, but with Allco and Babcock now effectively gone, it was natural that all eyes would look critically on Macquarie.

Strong should go

IAG chair James Strong is up for re-election at this year’s annual meeting and he is telling anyone who would listen that he wants to stand again but will step down some time in his next term.

One could politely suggest that, as with ANZ’s Charlie Goode, Mr Strong would be better off leaving, now that he has the company in safe hands.

Mr Specialty Focused himself, Mike Wilkins is an extremely safe pair of hands as chief and in contrast to the aforementioned Mr Goode, Strong has recruited well to have a board with talent to spare to replace him.

Former AMP and Aviva executive Phillip Twyman would seem just one person capable of filling Strong’s shoes.

As noted yesterday, John Morschel is ready, willing and able to takeover at ANZ when Goode leaves, so it also makes little sense for him to hang around any longer.

This concept of one more election smacks of inviting disaster and should be dealt accordingly if either of them above try it on.

Smarts and duds

THIS reporting season has presented many challenges for investors despite what on the surface looks to have been a relatively benign set of numbers.

Tax rates have fallen from a long-term average for industrial companies of 28.5 per cent to 26.5 per cent, which may not be sustainable against a legislated tax rate of 30 per cent.

On Macquarie numbers, interest costs in the June half increased over 30 per cent, in part because the smart companies bought debt raisings forward to get the money while they could and obviously on higher interest rates.

On Goldman numbers, earnings before interest and tax margins fell from 14.7 to 14.1 per cent and are obviously heading south.

Westfield reported a 35 per cent fall in headline profits, but this was due to a write-down in property values. In operating terms, Frank Lowy posted an impressive 14 per cent gain.

Lowy presents a good case in point because the market seems happy to allow him to pay out more in distributions than he actually earns, in part because his track record means they trust him.

Last year’s $3 billion equity raising was obviously superbly timed before the credit crunch hit.

But the trick is to increase income enough to maintain its development programs, but that is outside Lowy’s hands to some extent given the varying states of global economies.

Then there is the attempt to join his friends at Simon Property to convince Liberty’s Donald Gordon to either let them buy some assets or his company.

That play for the likes of London’s Covent Garden and part of Earls Court would seem to be a long-term game which perversely would be helped if the global economy got worse rather than better.