KGB INTERROGATION: Wal King

Riding high on a record $608 million annual profit, Leighton Holdings chief Wal King reveals his plans for global growth and the ongoing battle to resist the advances of major shareholder Hochtief.

Robert Gottliebsen: Wal, Leighton and Woolworths are two of the few Australian companies that have been able to finance their businesses by paying suppliers after the money is collected from the customers. What's changed in your business that made a share issue necessary?

Wal King: Well, we have in front of us sort of gigantic opportunities in the mining business and as the business expands we require more working capital. If you look at the volume of work that we have in hand now, which is like $34.5 billion and expected to increase over the years ahead to probably $40 billion, our capital expenditure programmes are increasing, the volumes of actually mining work that we're doing is increasing. Things like iron ore – we’re expecting to move our iron ore production up from more than 100 million tonnes a year to 150 million tonnes a year, so there's just more capital requirements needed to fund the business. In our traditional business which I would say is the mainline infrastructure business, putting aside the PPPs (public private partnerships), building work and most of that other work, that's pretty much self funding. But these projects are getting bigger and bigger and the mining projects bigger and bigger, it's really just a requirement to get more capital in advance of the time that we believe we're going to need it.

RG: Your work-in-progress rose almost 45 per cent in a year. How far in advance does this underwrite your profits and can you keep that sort of growth rate up?

WK: At this point of the year, when we enter the financial year, we normally only have about 60 per cent to 70 per cent of our work committed. We're entering this year with over 90 per cent of our work committed, so our turnover last year was $14.5 billion. Next year we're projecting $16.7 billion. That $16.7 billion is predicated on this 90 per cent committed, so there could be some expectation that the volume levels will rise again. Our long-term plans show that the uncompleted work will rise from sort of the $34 billion to $40 billion and that's pretty much related around known activities. At this point in time we have billions of dollars worth of contracts being offered to us and we're unable to respond because we don't have the people and we don't have the equipment. Equipment is pretty much unprocurable in the big heavy earth lifting equipment [area]. If you were looking for say 200 tonne or 300 tonne trucks it would be two years delivery. So it’s a very unusual period when you've just got so many people falling over to offer you work. Then when you move to the Middle East, Al Habtoor Leighton are the biggest contractor and they've just got an endless sort of demand of projects I suppose coming to us and some of them are of gigantic proportions. We just the other day had an invitation to be involved with a construction of a road from Abu Dhabi to the Saudi border. How people put it to me they said "just a road” and I thought "oh well maybe the road's like 10 kilometres or 20 kilometres long” and when I asked the size of the road it's 360 kilometres of four-lane highway. Gigantic job.

RG: Wal, have you tucked a bit away in these work-in-progress figures for a rainy day should something go wrong?

WK: Well that’s question I can't…you never know where this recorded message will end up. In terms of our accounting rules we're not allowed to have provisions.

RG: But you've been very good at that in the past.

WK: OK, let's say we like to be conservative (laughter).

Alan Kohler: One of the headlines in the coverage of your announcement talked about ‘global domination’. Leaving that aside, I’m just wondering whether you do have a have a long term plan about where Leighton's going in the world or are you just taking it one contract at a time?

WK: Well I don't know where that headline came from because I never really said that. I mean our strategy has continually been based on diversity by geography, diversity by market products. I mean that's goes back a long time and Australia is a relatively small country and it would be very difficult to be just a building contractor, although people have multiples inside that, and have the scale. So we've always believed in being a multi-disciplined contractor operating in resource, contract mining engineering, building, telecommunications, waste management...and so on an so forth. So we have a diversity of products.

Then we have diversity of geography. Our areas of geography are Australia, Asia, sort of India and the Middle East and as you well know we did have Alaska in the United States. We gave that away and I suppose that if had we persevered with it, eventually it would have been successful but it was just taking up so much management time, and particularly my time, that we came to the conclusion that it was better to focus closer to home. And in those products that we have, we take our core businesses to the most remote areas.

For example, we have in Melbourne that John Holland aviation services business which is probably the second or third independent supplier of aviation maintenance services in Australia. There's no thought of taking that off to the Middle East because it's not what you'd call one of our core competencies or skills. But in our engineering business, our building business, we've taken that off to the Middle East. So the question mark is not where do you find more geography that perhaps suits our core skills and it’s probably at this point of time, based on the resource boom, [there are] a couple of areas are of interest. Africa, we're getting a lot of requests to go into Mozambique for mining coal. At this point we're being rather coy about it and saying "well we'd go there if it's done on a cost plus basis”. We're not going to expose ourselves and there is some progress being made there. The Middle East people are wanting to invest money around the world in places like Morocco. In Egypt. And, in fact, surprisingly back into Australia - they're saying that they're going to do some big property investments here.

And that's really what the Arabs are doing, is storing their money in other parts of the world, and they would much prefer to do it through our companies in the Middle East. Of course, that presents some management difficulties of having a Middle East company come into Australia and obviously it would have to be done in association with our local companies.

The other area that's getting a lot of press and I think probably the press are a bit intrigued, is Mongolia and Siberia. I have met with Oleg Deripaska who is the fifth, sixth, seventh, eighth, whatever richest person the world. He's the biggest aluminium producer in the world and I mean his span of control in Russia is just unbelievable. He employs probably 350,000 or 400,000 people.

He did come down, I've met him and he did say to me "I'll come down and visit in Australia” and he certainly did come down. He turned up a couple of months ago in Australia and I spent some days with him taking around our mining projects. I found him a quite delightful man. A self-made man. He's from south of Moscow. He then said "well you'll have to come to Russia” and a few weeks ago I went up to Russia and went out to Siberia and spent a week talking to his people. There's no doubt there's huge opportunities in the resource business in Siberia and Russia and Mongolia down the track. I mean there's issues in Mongolia. Mongolia is a very large land mass with lots of resources and only about 4 million people so there's no capability there but there's lots of issues that relate to the tenure of lease and the legal situation and even Deripaska says "well Mongolia's not going to open up in the short term”. There's gigantic coal deposits sitting right on the border of China. They've got legal issues to solve so how we work with Deripaska in Mongolia and Siberia is a bit of a puzzle to us at this point of time.

AK: Have you talked about a formal partnership with him?

WK: What I've offered to him is to form a joint venture mining company to pursue mining opportunities. Now he's very interested in modernising. He runs something like 30 mines in Russia and he's coming to the point of view of wanting to modernise those mines and I think he sees us as a means of doing that, but of course if you go to the mine – and this is just a hypothetical situation – if you go to a mine where they've got 1000 people on the mine and we turn up and say well in a smart arse way, "we're going to get rid of 700 of these people and put modern equipment in there”, of course that's the last thing the people in the mine want to hear, so we've got to just work our way through. You go down a few layers and they're still very bureaucratic and you might say a Soviet-style, Communist-style organisation.

Stephen Bartholomeusz: You're talking about some riskier geographies in terms of where you're expanding. Do you approach that differently to the way you might within Asia? Do you do things differently to try and control the risks?

WK: Well, control of the risks in Mongolia or Siberia has to be completely done in joint venture with Deripaska. That is, is it's one company and you know our fates are completely tied together. And the contractual arrangements have to be fully protected. That is done in an alliance with cost reimbursement etc. As we're suggesting in Mozambique …I mean we're not going to go to Mozambique on a hard dollar contract. We haven't made any commitments but if we did go to Mozambique it would be on a fully cost-reimbursable basis so the only residual risk that you have are in terms of the equipment that you might put in there and the people. There's obviously other places where people are trying to get us to go and do work but there is no way that we would do that because of the safety of our people.

AK: Just on Deripaska, has he agreed to allow you to test your methods on one of his mines?

WK: Yeah, they've sort of come and offered up a mine and it was a very difficult mine and I did have some look at it myself when I was over there and we came to the conclusion that the mine was unviable. It was a copper mine. And it was in an area that the earthquake risks were just like off the Richter scale. I mean they talk about 10 Richter scale earthquakes. So we really didn't progress very far. He paid us some money for looking at the mine and we found it all too difficult – that particular mine. One of the difficulties in understanding the breadth of his operations in Russia is that he has so much and understanding the geographies, the types of mines and minerals and metals that he has is a really big challenge. He does in fact have the biggest construction company in Russia also. He bought the previous Soviet Ministry for Construction which in the former Soviet time used to do all the heavy construction in Russia. So we just really need to work through and find a particular mine that suits him and suits us and go into it in a fully-protected basis. We may never be able to get to a deal because of our insistence of being protected. But we see that as a future development rather than being a current development, that's a two to three year period. In the meantime we've just got so much work to do with…it's not needed and we shouldn't be diverting huge amounts of resources across there anyhow.

RG: How big is the Middle East going to be in five years time. Is this going to be a really massive operation that starts to get towards Leighton Australia proportions?

WK: Well it's a big operation now. We employ like 40,000 people. The scale of what's on in the Middle East [is big] and if you gentlemen are interested we're going to run a trip up there next March to have a look around some of the activities up there. The scale of all of this is just quite unimaginable and the problem that we all have with the Middle East is that we take a conventional situation and apply conventional logic to it.

That is, you might say "the company has a limited amount of money” or as individuals we have a limited amount of money and we look around for investment decisions...maximise the rates of returns and so on and so forth. I call that a conventional logic thinking pattern but in the Middle East conventional logic doesn't apply. They have so much money, they decide to do these things and invest so you've got to say well...everyone goes there says "well this is not going to last” but that's not the view of people up there. They've just got such gigantic amounts of money they're going to continue to invest around the world and buy companies. They're going to invest in real estate around the world but they're also going to continue to develop opportunities in the Middle East. On Saadiyat Island in Abu Dhabi there where we’re sort of the prime contractor we’re currently building [is], would you believe, a construction camp for 40,000 people and it's just of mind bending proportions. In the public infrastructure on Saadiyat Island the Abu Dhabi Government is going to spend $US25 billion and that's just the tip of the iceberg.

So there's the opportunities, the questions for us is, how we cover off our risk. We do a lot of the work on a management basis or fee basis and [the question is] how you get the resources. The numbers that we're employing in the Middle East are expected to go on up to 60,000 people. Now that's a lot of unskilled workers, semi-skilled workers and supervisors and engineers and [the question is] how you progress forward without diluting our culture? Now when you talk to those people up in the Middle East, when we think about recruitment overseas...here in Australia we think about recruiting from Canada or regional South Africa or somewhere – all the Anglo countries. Those guys don't think that way. They talk about recruitment. They go and look for English-educated engineers and supervisors in India, Syria, Lebanon and those parts, so it's just a fascinating culture and I suppose the big thing for us is can we maintain control of it without exposing ourselves?

SB: Wal, you talked about the numbers a moment ago. Marius Kloppers says that the biggest challenge for BHP in terms of its pipeline, and in particular those bits of the pipeline that are in risky geographies, is finding project managers, people who’ve actually run a project before. At that level are you constrained in terms of the people you can put in at the top?

WK: Well no doubt you're completely constrained by people and we're a people business and you know, the bigger the risk in terms of geography the less likely that you are to get A grade players. In the current environment or in any particular environment in any particular industry, even in your industry, you know if you're an absolute A-grade player you don't have to go too far from home to have an excellent job and be well remunerated. So a top project manager, why the hell is he going to go and live in Guyana or Mozambique or somewhere where it's a shitty place to work and social conditions are not good? All those sort of other risks. So when you go into these places you've got to pay a disproportionate amount of money for probably someone that's not necessarily an A-grade player. You might get the A-grade player at the top of the heap if you pay him enough money, but sure as hell one person is not a project. You need many, many people and engineers who in fact lead those projects. So these risky geographies present a lot of challenges.

SB: Is that a natural brake on your rate of growth?

WK: We didn't see too much brake in the existing geographies that we're working, putting aside Mongolia and Siberia in the three to four year period, but you've got to keep in the back of your mind that this sort of endless resource boom here in Australia and the never-ending crises for instance will moderate as new geographies open up.

For example I talked about Mongolia. Mongolia's got such a gigantic coal deposit sitting right on the doorstep of China. Now if geographies like that open up coal into China , that is going to moderate the price increases in Australia and volumes and so on and so forth, so every resource boom in history has ended in tears. And you'd say "well why is this one not going to end in tears?” Of course, at the moment there's just capacity constraints on around the world. Probably half the world's population is growing where it hasn't in the past so all these things, they can't bring capacity on quickly enough particularly in things like iron ore to mitigate against the price rises. Now they are struggling to bring on iron ore projects around the world but there's huge iron ore deposits in Guyana and various other places, in Russia etc.

So the question is how quickly that they can bring those on so I don't think that there's any sort of brake on growth in the short term, [over a] two or three year period. I mean it's [about] available opportunity. Iif you’re moving the company forward, should you be thinking about these other geographies like the coal mining business in Mozambique? Someone will do the work and should we be there? So it's more a medium-term issue of continuing to take the company forward and positioning it. Because eventually whether it’s three years or five years the resource boom will subside in Australia as other products come on around the world.

AK: Would you be thinking about taking over or making a takeover offer for Hochtief to protect yourself from somebody getting control of Leighton via them?

WK: Well I mean it's been talked about endlessly and when Hochtief [is getting] involved with us in 1983 I think there were 10 times our size. We're probably 10 times their size now. We've had numerous proposals to do something with Hochtief from every merchant bank in the world but the problem is they own more than 50 per cent of the company and they're not going to allow anything like that to happen.

AK: Well they obviously aren't interested in diluting down. They're going to cough up their share of the capital raising aren't they?

WK: Well they're always interested in increasing and it's an endless fight with us to stop them increasing because I mean it affects our credit rating. Recently we were quietly downgraded but the reason we were downgraded was because of the poor credit rating of our parent and S&P put that in the headline. No, they're not going to be diluted down and it's a continual battle with those guys. They have virtually no influence on the company but it's a continual battle keeping them where they are. They would like to creep up of course and take more of the profits.

AK: They have no influence on the company?

WK: No, virtually no influence.

AK: But they can stop you obviously taking them over.

WK: Of course. Well they've got more than 50 per cent.

AK: So where is this relationship heading?

WK: Well I don't think it's heading anywhere. I mean it's been like this for 10 years.

AK: What if somebody else takes over Hochtief — how would that go?

WK: Many people have looked at that including Macquarie and of course there’s only been, well in the history of Germany how many takeovers? Two hostile takeovers? Two.

AK: Two hostile takeovers in the history of Germany?

WK: Well in recent history. Prior to that little guy running around with a moustache there might have been some others.

AK: Maybe Oleg Deripaska should have a look at it.

WK: Well, Deripaska owns 12 per cent of Hochtief but there's no doubt Deripaska has looked at it but I think….

AK: How long has he owned 12 per cent?

WK: Probably a couple of years. Two or three years. But he also does own 25 or 30 per cent of the big Austrian company called Strabag. And Strabag is working in various projects but Deripaska wanted to involve us in construction in Russia with his construction company but I said "no, we're not interested in that”. And there's big construction opportunities in Siberia and other parts and railway lines. He sent me a letter a couple of months ago.

AK: Has he indicated whether he's interested in increasing his share of Hochtief?

WK: He's never indicated that to me and I don't think he will. I think he's more interested in what we have to offer and provided he has some sort of relationship with me he doesn't need the relationship. He sent me a letter a couple of months ago. I mean when you looked at the letter you'd think it was a Nigerian letter. There's a mine here I want you to start that does some 40 million tons, 60 million tons, 80 million tons and at each point I want to build a railway line 600 kilometres long and there was about six points in the letter and you look at it and you think this looks more like a Nigerian letter than reality.

RG: Wal, just bringing you back to Australia. At what rate are construction costs rising and will they continue to rise at that level?

WK: The nature of the inputs is very erratic and a lot's been blamed on labour and actually labour is pretty much controlled. I mean labour has been sort of 5 per cent or so. It's really not labour, it's the other inputs that are of an erratic nature and I suppose when BHP get a 70 per cent increase in iron ore everyone claps their hands and then they're really pissed off when it comes back in the price of steel that goes into one of their projects when the steel goes up 50 per cent. So steel's gone up like 50 per cent this year. Explosives have gone up like 40 or 50 per cent. Anything that's energy-related or iron ore-related has had gigantic increases. Now the way we're managing that is that in the Middle East it's all cost-reimbursable. In Australia there's a lot of jobs that we will not take on the risk of those erratic things like structural steel and explosives and so on so forth. So it depends on the type of job that you're looking at. There's no simple answer to say "how much is the increase?” Building costs are probably increasing, the typical sort of downtown high-rise building there's probably an increase in the order of 10 or 12 per cent per annum but if you go out into some of the other projects there's been these sort of gigantic overruns with some of these resource companies have all been moaning and groaning about, a lot of that increase has been perhaps 30 or 40 per cent they’ve have overrun. And that's been significantly due to structural steel. A lot of these big resource projects have gigantic amounts of steel in them in terms of crusher plants and cleaning plants.

RG: Wal, what are the risks of the government caving in to the building unions and dismantling the building industry curbs on union activity which could change all this if they do that?

WK: I think the unions would like to go back to the dark ages, particularly in places like Victoria where you could not get more than about 30 weeks per year of work and you had the terrible conditions like if the temperature went over 33 degrees everyone stopped work even if you were working inside a building. If you had a 33 degree limit in the Northern Territory you'd never get anything done. Policies like ‘one in all in’ and a lollypop man standing outside in the traffic and three drops of rain fell on his head and everyone went home - those bad old days have sort of disappeared but there are certain elements in the unions that want a return to those particular periods. I think the government know the consequences of lifting the cap on all of this, then going back to completely disturbed times so that I think the threat's there and perhaps the desire by some of the unions, but in a practical sense I think it's going to be very difficult to turn the clock back. They might turn it back five minutes but they're not going to turn it back five hours.

RG: If Gunns get the money and gain government approval will you build the pulp mill?

WK: Why do you guys keep asking me about this pulp mill? We've got big headlines…

RG: That's why I'm asking you because I saw the headlines.

WK: Some guy said to me "are you going to build the pulp mill” and I said I'll give you the same answer that I gave three years ago, the same answer that I gave you two years ago and the same answer I gave you one year ago: I think it's highly improbable. And of course they leapt on that and I think it was sort of plastered all around Tasmania and Gunns are giving me a bit of a bagging that I'm uninformed and misinformed and so on and so forth.

At the end of the day I don't know what their feasibility studies say and what they can fund and not fund, but all I can say is that there is a significant impediment to getting that done from a financing perspective and a process perspective and a completion perspective and theoretically we have a contract between…a joint venture between John Holland and MacMahon sitting there. We're not specifically doing anything on it. We're just waiting and at the end of the day we'll see what comes of it. It's very difficult for us to say is it going to happen or not happen. We don't have a contract in front of us. We don't know what the terms and conditions would be. We have a sort of status like ‘preferred contractor’ which is I suppose a bit like having a preferred girlfriend. I mean, where's it going to go from here? That's the big question mark.

AK: Thanks very much Wal.

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