KGB INTERROGATION: Phil Green
Babcock & Brown boss Phil Green explains his frustration with the market rumours that have ravaged the company's share price, and why, even in turbulent times, he's more than comfortable with the group's gearing.
Phil, you've just got back from an international road show on the back of a share price that’s fallen from almost $35 to less than $15 in nine months. How angry and fearful are the investors?
Phil Green: Actually in Europe the sentiment behind us was very strong. Business in Europe is unbelievable strong. As you know we’ve got a heavy exposure to renewable energy and a strong portfolio in Europe and that, in particular, is creating huge interest.
Even our property portfolio...we’ve made a lot of sales and we have a number of properties you know, where we’re under exclusive negotiations with institutional buyers at or above our current book values so you know, the market over there is actually a little confused by what’s going on here.
That’s not to say they’re all obviously jumping in, but I didn’t confront any angry shareholders – remembering that we’ve delivered on everything we’ve promised them. We don’t control the share price. We’ve delivered on earnings. Our development pipeline, our growth in wholesale mandates in the infrastructure space which are uninvested – a lot of which has come out of Europe – give everybody over there confidence in our ability to deliver on our 2008 guidance and we have absolute confidence in it.
SB: Phil, you’ve been more proactive than most of the specialist fund managers in responding to the change in circumstances. What’s the broad Babcock strategy for reassuring investors that the value actually is there?
PG: I think in this market, ensuring and showing the market the liquidity in the assets that we have... We don’t own financial assets – we just don’t have any on our balance sheet of any material amount, and most of what we did have we wrote off at year-end. So our result at year-end was after those write-downs.
We basically own windfarms, real estate, aircraft, a little bit of rolling stock and some other infrastructure development assets. And the infrastructure assets represent more than 60 per cent of our balance sheet and those assets are either sought after by third-party investors. Or the wholesale investors that have mandated us in terms of these unlisted funds actually have done so in contemplation of being the acquirers of some of that development pipeline. So they are expecting us to deliver those assets to them anyway at an independent market valuation.
We’ve seen no evidence of any deterioration in valuation of those sort of infrastructure assets in the wholesale space. We accept that in the listed environment in Australia, really the only place those vehicles exist, there’s been deterioration in valuations, but we think that’s short term and we certainly don’t think it reflects the value that the global investor market place on the underlying assets.
Even in Europe where we do have a small infrastructure fund, it's actually outperformed the market, which is good in terms of investor confidence over there – and bank confidence, I might add, because we have made it very clear that we have commitments to increase our banking facilities that are quite significant, the bulk of that has come from European banks.
SB: So you don’t need to rethink the business model at all in light of what’s happened?
PG: No, absolutely not. Not in terms of our business model, no. We’re not concentrated in financial stocks. Infrastructure is an asset class where asset allocations from global pension funds are increasing all the time, so we certainly don’t want to rethink that part of our business.
Real estate is… obviously there are cycles around the world and we’ve been a successful counter-cyclical investor in the early 1990s in Australia and in the late 1990s in Japan and four or five years ago in Germany and... as we take the opportunity to reposition that portfolio I think we will show the market that we once again are very comfortable in the way we’ve structured our investments in real estate. Even in a potential downturn that we could see, or are seeing, in some markets.
There’s evidence of that – we announced quite a large sale last week in the development area in Australia, but obviously it’s a significant profit on that position, so we’re very comfortable with the business model.
[With] our listed satellites in Australia, there is a clear and significant difference between the current trading price and underlying value. These things are trading at yields twice the historical distribution yield and, yes, while interest rates in Australia are going up a little bit, we need to obviously look at how we’re going to restore market confidence in those vehicles so they trade at their historic distribution yields and we’ve taken that step with BCM [Babcock & Brown Capital Limited].
BBI [Babcock & Brown Infrastructure] has announced that it will look at some non-core asset sales to just reduce our gearing a little bit and emphasise to the market the value of those underlying assets. BBW [Babcock & Brown Wind Partners] is together with us looking at some sales of its portfolio into what is a very buoyant and very liquid renewable energy market in Europe, so we are taking all of those steps at the edges, but the fundamental model doesn’t change and that model has served a number of companies over along period of time very well where the parent company, or the head stock as people call it, is an asset manager.
We take it a little bit further by being a financial adviser and structurer as well so… I’m not saying we don’t use a background of intellectual property in investment banking and financial structuring to enhance our business model, but that model I think has proved very effective and will continue to prove so... perhaps even more effective in this market. Is there an argument in this market to de-gear a little bit? Sell some assets? Absolutely, and we’ve taken that view since August last year.
Robert Gottliebsen: Phil, at December 31 your listed assets were about... in the books, they were just under $1 billion and the market value at December 31 was also about $1 billion. What would it be now in rough terms?
PG: Probably about $800 million.
RG: You talked about your gearing. I think at December 31 the gearing on a look-through basis was about 78 per cent. Would you agree that while nine months ago that wasn’t a problem, in today’s environment that’s just not sustainable.
PG: Well, Robert, look-through gearing on our balance sheet is not really call it a KPI... it’s not a simple analysis because we manage to our corporate gearing, which... at the moment is running at under 50 per cent right. So we’ve actually brought the gearing down, probably happy to keep it at 50 per cent.
Let me explain why. If for example, in our aircraft operating lease business we have a partner, and we’ve had that partner for nearly 20 years, that partner’s contractual agreement in the joint venture is to provide us with 100 per cent limited recourse debt for the aircraft that we buy and warehouse for syndication into the global markets. So we buy the aircraft. They go on [our] balance sheet, but they take 100 per cent of the financial risk. Now that increases our look-through gearing, but we have no risk to that transaction. So the answer is why would we terminate that joint venture to get our look-through gearing down? That deal has worked really well for both parties because they’ve been able to rely on it, and we’ve been able to give them an exclusive flow of opportunity which [has] worked brilliantly for 20 years. And they’re very comfortable and we’re very comfortable.
RG: Why don’t you, when you’re making that sum, say that the look-through gearing, on a recourse basis as distinct from a non-recourse basis, is something less than 78 per cent.
PG: We do. That’s what we mean by our corporate debt.
RG: Yes yes, but the…
PG: All of the debt that is look-through that raises our gearing from 50 to 78 is all non-recourse.
RG: OK. Now why…
PG: Now I agree we probably need to... we thought that was well understood and we think it is well understood by the analysts right?
But to the extent that you guys, for example… we’re not hiding anything. We can show the deals where... you know, if you take probably not even non-recourse... we have some deals where we have no equity at risk. Obviously we have some deals where we’ve got no recourse debt at 90 per cent leverage – where we’ve got a little bit of equity at risk –and then we have some deals where... we’ve got enough equity at risk where, yes, they’re non-recourse, but the gearing is roughly in line with our corporate debt. It might be 60/40 in which case, obviously, you’ve got a lot of equity to lose if you hand back the keys to the bank. But there’s three classes of deals. There’s also one with no equity. There’s one where the bank’s got more problem than us if we hand back the keys.
RG: Why do you think your listed notes yield around 30 per cent. Do you think that might have something to do with the 78 per cent look through gearing?
PG: Look, we think that in this market there is an enormous amount of dislocation in valuation. We think they probably trade at that because of very low liquidity. I mean if you look at the volumes, the amount of actual debt that’s traded over the last month at that price, I don’t think it adds up to a lot in a month.
RG: Why don’t you buy them back? At that price.
PG: Because we don’t want... because at this point in time, you know, we want to preserve our liquidity to grow our business… on the one hand you say you say we should be de-gearing, on the other hand you want us to increase our gearing.
RG: It’s just the amount – the 30 per cent tells you that the... it’s a very high figure and anybody…
PG: Robert... Robert... in this market if people want to judge the sustainability and the strength of our business off the back of where our hybrids trade on very thin volumes then that’s their judgement. All we can do is deal with our business, run our assets, manage our balance sheet in the way that we think is most effective.
There may be a point in time where... the best thing we can do with our cash is buy back our notes. ...We manage our balance sheet the way we think it’s best managed and at the moment notwithstanding where those are trading, the rate of return that we get on supporting our development business in wind energy is still much higher than buying back those notes.
James Thomson: Hi Phil, these market conditions must be creating a few opportunities or bargains that you can see out there. Is that the case and are you moving to take advantage of some of them?
PG: Oh you know, in a very small way obviously we took a little bit of an option I suppose over the Rubicon Trust last week. I wouldn’t say it’s... we took a position there that, with further work, we’ll see if there’s real value or not. Clearly we believe some of the assets that we purchased over the last couple of months, and we haven’t bought a lot, do represent very good value. But as the credit markets have deteriorated, we are probably more inclined to realise assets that are very liquid and be circumspect about where we invest in a major way over the next few months. You may see some deals. I don’t think you’ll see a huge volume of deals. As we said in our guidance we actually don’t need to do any deals on our balance sheet this year... other than maintain our development pipeline in order to meet our guidance and I would suspect that we’ll be much more active in the second half than we will be in the first half.
JT: And Phil everyone’s been talking about Bear Stearns. What's your take on that?
PG: I can’t comment on Bear Stearns other than to go back to the point that we don’t own financial assets. We don’t distribute financial assets. We don’t underwrite financial assets. We’re not in that sense a traditional investment bank. We’re not actually an investment bank at all. And I’m not saying that for the first time and I’m not saying that because it’s trendy. We’d never describe ourselves as an investment bank.
And we’ve never dealt in any material way in financial assets so you know... if you go back to Bear Stearns, you go back to August last year it was the collapse and Bear Stearns' bail out of the CDO hedge fund that started the collapse. So it shouldn’t be a surprise with what’s occurred over the last six months that Bear Stearns had very little opportunity to really reverse those issues... But nobody wants to see these organisations get into difficulty.
Across the board in terms of our business we’re not a large user of securitised debt. We’ve generally been a house that relied on banks. And I think it’s part of the reason we’re seeing such strong support from the very, very large majority of our banking network.
SB: Phil, Babcock’s has been one of the most heavily shorted stocks in this market. I think you’ve suggested elsewhere that we need more disclosure of covered short selling. Why not just ban it until the markets stabilise?
PG: Look at the end of the day, I’m all for free transparent and fair market trading. I have never been on record – and if there’s somewhere that I am it’s a misquote – saying that I’m looking to ban short selling.
SB: No, I wasn’t suggesting that you….
PG: Market manipulation, false rumours, collusive trading, whether it be on the short side or the long side, should be monitored. To do that you need the same transparency and the same rules of disclosure on the short side as you do on the long side.
SB: There were lots of rumours Phil, as you are well aware, about margin calls and the like which clearly you’ve refuted. Do you think that was just the market speculating or was there something more sinister at hand?
PG: Well you know, the speculation.. I can’t comment on people’s motivation. That’s to be judged objectively, but in a world where the world knows the history of Babcock & Brown, it knows that three years ago we raised $500 million in an IPO and sold down 33 per cent of the company and the partners didn’t buy any stock. Most of the people that own stock had been there with the company from almost day one and had earned their stock and that was very clear in the prospectus. Then the idea which was being rumoured, saying that stock that was coming out of escrow was all leveraged and had to be sold, was not only wrong, it was incredulous, but it didn’t stop people from spreading that rumour. Okay?
So I don’t know what people’s motivations are. If you want to find out, go and talk to the brokers that issued the emails and made the phone calls and ask why they did it and on what basis they made that speculation. Even, you know, the way it’s reported now, where it keeps repeating the rumour that I refuted – we came out with a very clear statement that we’d surveyed our senior executives and aggregate across over $1 billion of holdings it was under $50 million.
SB: So there were specific brokers issuing actual research on this Phil?
PG: No, not research, but emailed statements that we were seeing that were getting forwarded to us. I wouldn’t say... it didn’t come from their research analysts. It came from their trading floors. I think that’s why ASIC are now looking at some of that stuff. Now I don’t know what motivates them. I don’t know who’s behind it and nor do I really want to go into it and as I said, it’s not in the context of fair and open transparent trading in this market, whether it be long or short.
SB: Did you refer those emails to ASIC?
PG: We’ve identified to the Exchange and to ASIC, I think it’s on public record, that we believe that there’s been misinformation intentionally distributed around the marketplace. That’s all we’ve done. We’ll leave it to the Regulator... I’m more interested in talking about our business. I’m not really interested in talking about that. It’s really for us to run our business and deal with ensuring that our business is strong and profitable and at the end of the day, the one thing that the hedge funds and the short sellers say which is absolutely right is if we do that, we’ve got nothing to worry about.
RG: What you’re experiencing has been experienced by others in these bear raids. It’s a pattern. The question I’d like to put to you…
PG: ...and you know, I feel very sorry for investors. There’s a lot of small investors in our satellites in particular who were quite conservatively leveraged. The funds pay a healthy percentage of their distribution in tax deferred. It’s a nice investment and some of them probably leveraged on a margin basis and they’ve been caught in this downdraft and they’re the people that have been hurt. And I feel to the extent we are actively trying to speak out about this, it’s really to protect those people.
RG: Phil if I could take you back to your notes, given that they’re at 30 per cent, why did you dabble in Rubicon? It really frightened the market. You’ve got other things on your agenda and suddenly you splash out on a difficult situation?
PG: Well Robert, I mean splash out? We spent $4 million. That’s splashing out?
RG: No, no...
PG: We’re a $5 billion dollar company, but honestly if you think you can... I think our senior management team have been doing a really good job of running this business. In the second half of last year when the market was saying 'you guys can’t deliver, you’ve got no chance of delivering', we outperformed expectations. Okay? We’ve never underperformed our guidance.
But the market thinks that they can do a better job of running our business than we can. I haven’t heard anybody say that I should have spent $4 million on buying back our notes and not $4 million on Rubicon. Maybe you think we should have. And maybe we should have. Maybe in hindsight we’ll have made a $4 million mistake. We take $4 and $5 million positions all the time. Not every one of them turns out to be the right position, but so far, more have turned out to be right than wrong. Otherwise we wouldn’t be where… you know, we wouldn’t have generated the profit we did last year and the year before, nor the profit we think this year – 40 per cent of our balance sheet is in wind farms. I haven’t heard anybody say that’s poor concentration in the current macro environment.
RG: With the benefit of hindsight again, do you think that you and Singapore Power paid too much for those Alinta assets? What’s your view about that given what’s happened in the whole market?
PG: Well I suppose in the context of what the alternative bid would have looked like in this market, it's hard to argue that you know, with the absolute benefit of hindsight it wouldn't have been nice to pay less. Do we think we bought bad assets? Do we think that they are worth what we paid for them? The answer is we think they are, otherwise we wouldn’t have bid in the first place.
In hindsight, given market conditions could we have got them for less? Maybe. I mean even the sort of Russian roulette clause with AGL, at the end of the day we had to make a decision in the timeframe. We found out two or three weeks later, as did the market to the surprise of the market, that AGL’s balance sheet and position was much worse than we thought it was. That wasn’t just a surprise to us, that was a surprise to the whole market. Right? Now do we believe we paid too much for those assets? Or do we believe they’re worth what we paid for them? Absolutely. In hindsight could we have maybe got them cheaper? Possibly.
RG: And one final question from me – is it possible for the GPT joint venture to be wound down on the current market as GPT have announced they’d like to do.
PG: Is it possible to be wound down? Absolutely. I mean the European property market... the Europeans aren’t sitting there in stunned shock over there. I mean the reason the central bank is not aggressively cutting interest rates is quite frankly at this point in time there’s no reason they should.
Maybe over time things will get a little bit worse, but Germany looks very resilient. As I said earlier, and this applies to both our assets and joint venture assets, there are a number of buyers in the market for assets and you know, this is not a fire sale. We are working with GPT and when we say wind down the joint venture, there will be.. it was announced a year ago that the joint venture now had a finite term.
The pace of wind-down will be a judgement between us and GPT based on the state of the market... while I’m not talking for GPT, I think we have a high level of confidence that we will outperform... that as we sell assets we will deliver GPT profit over their original cost. And we’ve seen nothing in the market, particularly in Europe to suggest otherwise and I suggest that will become evident over the next little while.
SB: Phil, we appreciate you making yourself available, and your candour.