MacBank, Babcock to feel Wall Street fallout

So the next cab at the rank is Lehman Brothers. With the extraordinary events occurring in the US in the past couple of days – and the likelihood that others such as insurer American International Group will follow – it’s a time in which caution will probably pay when it comes to financial stocks of any description.

It looks certain that US investment group Lehman Brothers will be allowed to go bust. If parts of it can be sold, they will, but that might not be possible. With Bear Stearns, US authorities were prepared to bail it out because they thought they could stop the collapse, but they’ve decided they can’t keep doing that now; there’s no more money.

It looks as though the Bank of America has agreed to buy Merrill Lynch. The figure is said be $US44 billion. Another big issue is the looming collapse of AIG. They’re trying to prop that up, but it’s such a massive company they might not have enough money. It has $US1 trillion worth of assets and therefore debts on its balance sheet, and is trying to get $US50 billion out of the US government. It’s extraordinary.

Macquarie Group, Babcock & Brown. Now the implications for this in the local market, I think financial stocks are going to continue to be hit fairly hard, in particular Macquarie Bank and Babcock & Brown, because they’re the two local investment banks. Macquarie has shed more than 10% to just under $40, while Babcock has dropped almost 16.8% to $1.58.

Babcock, of course, has been hit very hard in the past few weeks, and people keep blaming short sellers for this. Well, what’s happening in the US is telling you it’s not about short selling; it’s just about fundamental problems with business models. It is not short selling that has led to the decline in Babcock’s value, and it’s not short selling that’s led to the decline in Lehman Brothers; it’s too much debt. (For a wider discussion on hedge funds role in stock prices, see today’s feature by Chris Gosselin, Don’t blame the hedge funds.)

What’s happening in the US probably has more implications for the wider market here than specific takeovers, but personally I wouldn’t be betting on a turnaround in the Macquarie Group or the Babcock & Brown or the Allco share prices any time soon, because what’s happening in the US is telling you that the financial sector is in severe trouble.

The big issue is that Macquarie Bank could be the last man standing in Australian investment banking, certainly in the listed sector. Is the Macquarie model broken? The answer is that we just don’t know yet; it’s very hard to tell.

Certainly, local investors’ fears were not limited to Australian investment banks today. National Australia Bank lost 4.8% to $22.82, ANZ lost 2.2% to $16.87, Westpac lost 1.6% to $23.15, Commonwealth lost 2.3% to $41.98 and St George lost more than 2% to $30.34. Funds manager AMP lost 8.1% to $6.83 and AXA 3.2% to $5.37.

Octaviar has been dead since MFS went into a trading halt some months ago. City Pacific is another firm on death watch. I was up in Queensland on the weekend, and I can tell you the amount of stock that is for sale up there – commercial and residential – is not looking good for the Queensland property market, and of course that directly impacts on City Pacific and MFS/Octaviar.

St George Bank/Westpac Banking Corp. However, the Westpac/St George merger looks most likely to go ahead. The reality is that St George can’t afford for it not to go ahead. St George would not be able to raise money profitably at the moment because it has a lower credit rating than the major banks and under the deal Westpac would give it its credit rating as a subsidiary. If there’s anybody out there thinking that there will be a higher bid for St George, they’re wrong: it’s definitely not going to happen.

ABC Learning Centres. ABC Learning has a huge cloud over it; it’s still suspended. The drums are saying that it may not trade again either. I don’t know that; it’s just the impression I get.

Indophil Resources. Moving on to the slightly healthier resources sector, in particular one company, Indophil Resources. It looked like it was all over last week, but now it’s back up again. The asset in this case, the Tampakan copper/gold deposit in the Philippines, is obviously of great attraction; a new consortium, including members of the old Stanhill consortium, has emerged to now buy the asset, but the reason they’re not making a takeover bid is because Xstrata has a 20% ownership stake, and Indophil will block the bid.

But what is interesting is that if you sell an asset, you only need 50% approval by your shareholders, and Xstrata can’t block that unless they make a bid for the whole company. So Indophil Resources is well and truly back in play. They say they’ll sell the asset for the equivalent of $1.28 a share, but some tax and costs would be payable out of that. So it looks like you get somewhere between $1.12 and $1.18 a share, maybe a bit more depending on negotiations with the tax authorities. The ball is back in Xstrata’s court to do something. Indophil has moved back up to about 95–96¢, so it’s a pretty interesting play here. Much harder for Xstrata to block this one.

I think Indophil shares aren’t trading higher because people are worried that Xstrata might do something again to block it, but it’s much harder to block an asset sale than a takeover. So that’s one where I think, if you own shares, probably you’ll get your money back now, and it shows that because the asset was a genuinely valuable asset, people do want it.

The other thing that’s happened is that one of the members of the consortium, or a new member, is Alsons. Alsons is controlled by the Alcantara family in the Philippines, which is where the deposit is, and they should be able to smooth the way to get government approval to develop the asset. So, they’re a much better partner. Xstrata might not have a problem with them being involved.

Portman Mining. Portman has received a mop-up bid, with US iron ore producer Cleveland-Cliffs bidding for the remaining 14.8% of the WA group is does not already own. The bid is $21.50 a share. What’s interesting is Cleveland-Cliffs is paying as much to buy the remaining stock as it did to get 80% at $3.60 a couple of years ago. It just shows how much more valuable iron ore stocks have become.

Back a few years ago, the then chairman George Jones was against the original bid, saying it was too cheap. He was spot on.

The bid’s been declared final and is dependent on getting over 90%, which means one-third of the remaining shareholders will need to accept it. The company will get an independent expert’s report, but I think it will probably go through.

At $21.10, it’s probably not worth buying. Your upside is 40¢, so that’s only 2%. Your downside is a few dollars again, if for some reason the bid doesn’t get up, if the shareholders go against it. So there’s probably not enough in that one, but it does show that iron ore stocks are still very attractive.

Origin Energy. Origin is now trading without a bid; BG walked away from its $15.50 a share bid, so the stock is really now trading on the back of its $US8 billion deal with ConocoPhillips, and the company has promised to release the independent expert’s report that values that deal at close to $28 or $30 a share. But really it’s up to the market now to decide. The deal is a good one, but as we saw when Santos signed a joint venture deal with Malaysian group Petronas a few months ago, its shares shot up, and then they fell back because they’re financing LNG projects that won’t bear fruit for some years to come.

It’s hard to know what to do with Origin: it’s no longer a takeover situation, it’s had validation of its assets; probably the independent expert’s report will be worth reading, but it’s now more of a fundamental long-only play rather than a change of control play.

British Gas. What will British Gas, or BG, do from here on in? A lot of people think they will make a move on Queensland Gas, of which it already owns just under 10%. Queensland Gas is in the throes of completing its takeover for Sunshine Gas and its share price has moved up a lot in the past weeks on the BG speculation and on the back of the Origin/ConocoPhillips deal. Does BG need to buy Queensland Gas? Probably not, but it still might do so anyway. It seems to be at the moment that joint ventures seem to be the way to go, rather than takeovers, and often that achieves the same result; the bigger company gets to finance a specific asset, and the smaller company gets to monetise the value of that asset that it probably couldn’t develop itself. This is what we’ve seen with Origin and Santos. In any event, Queensland’s coal seam gas reserves are substantial and valuable.

Macmahon/Ausdrill. This is a real race down to the wire. Macmahon has said it won’t extend its bid beyond September 29, unless it goes unconditional. At the moment, the bid is conditional upon 50% acceptances. Ausdrill founder and managing director Ronald Sayers bought another 5% on-market last week; he now owns just under 20% of the company. The board owns another 10% or so, so there’s 30% that will not accept the bid and 70% that can accept the bid, so it’s going to be pretty close.

Ausdrill is trading at $2–2.10 a share. The bid is worth almost $3, so it’s trading at a big discount. The market’s telling you the bid isn’t going to go ahead. Some people say Ausdrill is now so cheap that it’s worth buying just on its fundamentals, and that may well be true. But it’s a risky bid. Macmahon has painted itself into a corner. It can’t increase the bid beyond 1.65 of its own shares per Ausdrill share and it now can’t extend the bid unless it decides to go unconditional. It might go unconditional if it gets to around 35–40%, so you just have watch the acceptances in the next couple of weeks. If they’re not flowing in, then you can assume the bid will fail.

WA election. Sticking with mining, the Liberals are now in power in Western Australia, after the Nationals threw their support behind Colin Barnett on Sunday. There are two interesting things to emerge out of this: the commitment to boost mining royalties and spend them in the regions, and the new Premier saying he’s in favour of legalising uranium mining.

I’m not sold on Nationals Leader Brendon Grylls saying 25% of mining royalties should be set aside for regional projects. It’s nonsense: tax goes into central revenue and it should be spent on the clear priorities of the day. Anyway, the Nationals have got some sort of commitment to spend more in the regions, the mining companies may end up paying a bit more in tax, and they’ve said that they don’t like the BHP/Rio takeover, but there’s nothing they can do about it.

I was surprised to hear Barnett saying he was in favour of legalising uranium mining there because it’s not like he’s got a clear majority and I think the WA electorate is a bit mixed on uranium mining. Having said that, it is something that the Liberal Party has run on as a platform, so presumably the Nationals must agree with it.

Anyway, we’ve seen today that the news has had an impact on stocks: Toro Energy and Energy & Minerals in particular gained on the news, alongside Paladin Energy. So you’ll probably see a few more floats or capital raisings by West Australian-based uranium companies. They haven’t said how many mines, and all that sort of thing, and I’m not even sure whether the Federal government has to approve it or not, but it is a bit of a change.

Aristocrat Leisure. Is it a target? It probably is. Aristocrat operates in a sort of global oligopoly as to the making of poker machines, and it’s one of the world’s most sophisticated in the sense that they’re very good at knowing how to persuade people to pump their money in. The problem, though, is that in the past it was felt that if the world went into recession, gambling was a recession-proof industry, and it hasn’t proved to be like that.

You’ve got two issues with pokies: one is that it’s often more to do with what governments will let you do, rather than what the market demands. In Victoria, for example, there’s a limit of 28,000 machines and in New South Wales there’s 100,000-odd. Different states and territories in America have different rules, so it’s got more to do with what governments let you do.

Second, casino turnover is down as the economic downturn bites. The so-called “grind market” – the local market in such places as Las Vegas – has not been good and that’s why we’ve seen Crown’s share price decline. So would you automatically buy Aristocrat? In the current circumstances, I don’t know. It is one of the world’s big players in poker machines, but spending on pokies has been going down, so it’s just hard to say. Private equity could be interested in it – nice reliable cash flows – but the share price has come off a lot because it’s perhaps not as recession-proof as people thought.

Computershare. Share registry group Computershare is on the lookout for acquisitions, and is said to be particularly interested in buying Bank of New York Mellon’s transfer agency division. The thing I can’t understand about Computershare is why it bought the UK childcare business Busy Bees Childcare Vouchers from ABC Learning a little while ago. I just don’t understand why Computershare would do that; it just seems to have very little to do with share registries. In any event, with share registry businesses, their value goes up when the market is bullish and it goes down when it’s bearish, and maybe Computershare is prepared to think well into the future and think that now is a good time to buy. And as I said, the prices of financial assets are getting cheaper, not more expensive right now.

Tom Elliott, a director of MM&E Capital, may have interests in any of the stocks mentioned.

nTakeover Action September 8-12, 2008
Date	Target	ASX	Bidder	(%)		Notes
11/09/08	Abra Mining	AII	Hunan Nonferrous Metals	73.07		Unconditional. Closing Sep 19.
10/09/08	Anzon Australia	AZA	Roc Oil	57.36		Anzon Energy UK scheme approved by shareholders.
10/09/08	Ausdrill	ASL	Macmahon Holdings	11.44		Closing Sept 29.
4/09/08	Babcock & Brown Communities	BBC	Prime Retirement & Aged Care Property Trust	0.00		Seeks up to 40%.
9/09/08	Bellamel Mining	BMM	Norton Gold Fields	66.96
3/09/08	GoldLink IncomePlus	GLI	Emerald Capital	29.44		Seeks 45%. Ext to Oct 1.
8/09/08	Incremental Petroleum	IPM	Cooper Energy	4.90
11/09/08	Indophil Resources	IRN	Stanhill Resources	15.93		To lapse Sept 22.
11/09/08	Midwest Corporation	MIS	Sinosteel	60.50		Closing Sept 15.
1/09/08	Mineral Securities	MXX	CopperCo	94.70
11/07/08	Olympia Resources	OLY	Territory Resources	73.53
2/09/08	Origin Energy	ORG	BG Group	0.13
11/09/08	Portman	PMM	Cleveland-Cliffs	85.20		Mop up offer.
3/07/08	Rio Tinto	RIO	BHP Billiton	0.00		Early termination of Hart-Scott-Rodino anti-trust waiting period.
11/09/08	Roma Petroleum	RPM	Queensland Gas	80.01		Closing Oct 17.
20/08/08	Sunshine Gas	SHG	Queensland Gas	15.00		Pre-bid agreement.
nScheme of Arrangement
24/07/08	Australasian Resources	ARH	Resource Development International	66.37		Resource Devel associated with Clive Palmer who holds 66.37%.
22/08/08	Espreon	EON	Vectis Group	19.80		Vote mid-Nov.
5/09/08	Extract Resources	EXT	Kalahari Minerals	39.11		Vote Nov 6.
11/09/08	Independent Practitioner Network	IPN	Sonic Healthcare	71.50		Shareholders approve scheme.
19/08/08	Sapex	SXP	Linc Energy	19.42		Vote Sep 26.
13/08/08	St George Bank	SGB	Westpac Banking Corp	0.00		Vote Nov 6. ACCC clearance.
nBackdoor Listing
9/09/08	Mark Sensing	MPI	TMA Group	82.00		Vote Oct 22. TMA would have 82% on completion.
nForeshadowed Offers
4/08/08	Asciano	AIO	TPG Capital consortium	0.00
28/08/08	Berklee	BER	Manumatic	0.00		Heads of agreement on $10.9m sale of business.
5/09/08	Bravura Solutions	BVA	Ironbridge Capital	0.00		Discussions continue.
28/07/08	Felix Resources	FLX	Several expressions of interest	0.00
28/08/08	Oaks Hotels & Resorts	OAK	Archer Capital	0.00		Non-binding indicative proposal.
19/06/08	Pelorus Property	PPI	Pelorus unlisted funds	0.00		Group merger planned.
16/06/08	Staging Connections	STG	Several parties	0.00		Non-binding proposals. Due diligence proceeding.
12/09/08	Vision Group	VGH	Unnamed parties	0.00		Not pursuing sale.
22/08/08	Warehouse Group	WHS	Woolworths	0.00		Seeks to appeal court refusal of takeover clearance.

Source: NewsBites