Australia | Aug 09 2006
By Greg Peel
Sydney Roads Group (SRG) is an unusual company. While fledgling infrastructure funds have been buying up assets, the company that started the whole business over a decade ago when it invested in the M2 toll road, Macquarie Infrastructure Group (MIG), has moved into some kind of “phase two” by spinning off some of its assets into a fairly benign yield vehicle in order to appease its investors.
It is the nature of the commercial world that the company that innovates first will enjoy the spoils until the copy-cats arrive. This describes Mac Infra to a tee. By setting up a listed fund to allow investors to draw an income for what used to be the domain of government (ie public) ownership, a toll road, Macquarie Bank set in trail a revolution in investment that thrust the once small investment bank into the world spotlight. It took some time, but now Macquarie’s model has become all but ubiquitous – globally.
As a reward for such innovation, Macquarie had set itself up a new model for income derivation – performance fees. While performance fees had been around already in the fledgling hedge fund market, where the successful management of money in the cut and thrust world of financial markets indeed deserved reward, no one had tried it before with such a straightforward asset – a road.
It is now history that early investors in Mac Infra did rather well, but that Macquarie Bank did very well thank you very much. By the time Macquarie had expanded its infrastructure assets, and implemented its model across a range of different assets, and by the time the copy-cats had moved in and established a foothold, Macquarie’s performance fees started to look like a bit of a scam.
There was an awful lot of bleating coming from those who never would have had the foresight or intelligence to create such a model in the first place, let alone pull it off, but it had reached the stage within a competitive market that Mac Infra’s fees were now looking like a case of extracting the Michael.
This was not a situation Macquarie needed to put up with. Poor sentiment was holding back not only its Mac Infra vehicle, but its other similar funds as well, and investors were getting antsy. There was a simple solution. Macquarie had already extracted a good income from its toll road assets, and they were now becoming “mature”. No great shakes then to spin them off into a simple yield vehicle, with no more performance fees, and shut everybody up.
Thus Sydney Roads Group was born – it listed last week. SRG has a 71.4% interest in the Eastern Distributor, 50.0% in the M5 and 50.6% in the M4. Under the public-private partnership (PPP) model that the NSW government has so unspectacularly embraced in recent times the roads will eventually revert to government ownership. Hence the “maturity” of these assets. The M4 deal, for example, ends in 2010.
The roads may also be considered mature given that the initial days of toll expense outrage are behind us, and everyone who wants to use the roads does. (This is not, of course, the case for the Cross-City Tunnel, but that’s another whole kettle of fish).
The fact that the roads are mature provides the investor with both advantages and disadvantages.
For starters, there’s not a huge amount of upside in traffic numbers now that everyone is familiar with the toll roads’ benefits/costs. Upside would largely relate to population increases and, possibly, the falling real price of cars. Of course this can easily be offset by petrol price increases impacting on the public’s driving habits. Public transport use is already showing such signs, although in some cases public transport is not an option.
Nor is this the case for commercial traffic. Commercial traffic numbers will be beholden to economic growth.
Everybody knows that if you build a road to alleviate traffic congestion, it will eventually become congested. Having reached congestion saturation point, if they haven’t already, SRG’s roads will suffer from limited traffic upside. On the other hand, any fall in traffic numbers is less likely if there are enough drivers clamouring to get on.
Having said that, management has plans to add another lane to the M5, and expects 8.1% traffic growth on the Eastern Distributor as more traffic feeds off the Cross-City Tunnel.
(One must assume that, eventually, and if the criminal road diversions are finally reversed overhead, Sydney drivers will begin to embrace the CCT. Unless there just aren’t as many people who want to cross town as originally expected. SRG has no direct interest in this particular toll road, however.)
So what does SRG offer investors? On the plus side, stable cash flows and a 7.5% yield, about 50% franked. Low long term volatility. Some upside potential, maybe.
On the downside there will be initial problems that will keep the unit price under pressure. Firstly, Mac Infra has run off with $400m. Secondly, SRG inherits a further $150m in capex and debt repayments over the next three years. Thirdly, international investors in Mac Infra will have no need for the franking credits and will likely divest the spin-off.
As is the case with all international infrastructure assets, there is always the chance of a takeover. But while the rest of the world has seemed happy to let Macquarie run around and buy up all their assets, can you imagine if a foreigner came in and wanted to buy OUR toll roads? There’d be blood in Macquarie Street.
So how do the brokers see it?
Austock (Hold) echoes the views of most that SRG is largely dull, but worth holding on a long term yield basis. This value would be under threat from rising bond yields, but there is little commitment from economists anywhere as to where these are going. Austock has set a target of $1.18.
GSJB Were (Marketperform) is similarly cautious, but suggests buying below $0.95 and selling above $1.15 (the issue price).
You could probably buy units from UBS customers at $0.95, as that’s the target the broker has set to accompany its Sell recommendation. UBS is not a fan, and suggests SRG should trade at a 17% discount to valuation.
JP Morgan, on the other hand, is rather upbeat. Morgan’s analysts do rather make a habit of crossing against the lights. In this case they are prepared to accept all the upside stories, and arrive at a target of $1.31.
SRG is currently trading around $1.03.