Babcock In The Hands Of The Gods

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            [3] => ((BBI))
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This story features MACQUARIE GROUP LIMITED.
For more info SHARE ANALYSIS: MQG
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Shares in beleaguered investment bank Babcock & Brown ((BNB)) are again down around 25% today in early trade in what has become a wholesale slaughter. Not only is B&B dealing with panic, it is also fighting against hedge funds who are shorting the stock below the $7.50 pivotal price. And because we are now in June investors are taking tax losses on the company ahead of the end of financial year, or are simply being margin called. Confidence is lost.

The problem with a “run on a bank” is that they tend to be self-fulfilling. Whereas B&B had simply been dealing with refinancing issues one minute, without any critical liquidity concerns, the move down through $7.50 has moved the goal posts entirely, and brought out the blood-lust.

Once the shares fell below $7.50 (and they are trading around $5.15 this morning) a clause was triggered which provides B&B’s senior lenders with an option to review their loans. The investment bank can continue to access its debt facility, but any dividend or debt distribution payments can only be made with the permission of senior lenders for a period of four months.

The problem is that this clause has only just been revealed by management. Credibility is now shot. It is one thing for shareholders to dump the shares, but it is another if counterparties pull their funds as well. If that happens, then It’s Bear Stearns for Babcock & Brown. This is very much not what the senior lenders want, but B&B’s fate will now be in their hands. The B&B brand is crushed, and future earnings trajectory uncertain. If B&B can return its capitalisation to above $2.5bn ($7.50) within 120 days, then it is saved. But that’s a long way back.

Babcock & Brown may never have reached this point if it weren’t for Lehman Bros in the US. Lehman has been under pressure ever since Bear Stearns went under, but through a combination of management disclosure and reassurance, and the market’s knowledge that the Fed’s investment bank emergency facility lies ready, Lehman had managed to scare away any doomsayers. That is, until it pre-released its second quarter profit this week.

Analysts had remained wary of Lehman’s capital position even as Wall Street was more confidently buying the stock. Under most scrutiny was the seemingly low level of distressed credit security write-downs Lehman had offered to date. As doubt grew, the share price again began to wane. Then Lehman came out and announced a much bigger than expected US$2.8bn loss, and a much bigger than expected US$6bn capital raising.

Respected investment firms piled into the US$6bn offering, believing Lehman to now be an undervalued going concern. However, the shattering of confidence did not save the share price. The market has continued to hammer Lehman this week, sending the share price down to around US$23, or 18% below the capital rasing price.

The end result was that Lehman’s chief financial officer and charismatic spokesperson, Erin Callan, was ritually sacrificed last night, along with long-serving chief operating officer Joseph Gregory. Callin had appeared often on CNBC, and in analyst conference calls, talking up the outlook for the investment bank. The second quarter result contradicted her enthusiasm and, as with Babcock, destroyed Lehman’s credibility.

It has been Lehman’s ongoing demise and its general effect on US financials which have sent Australia’s two investment bank majors – B&B and Macquarie Group ((MQG)) – spiralling again these past two weeks. Then came the issue with subsidiary fund B&B Power ((BBP)) of a refinancing shortfall, and potential call on the parent, and finally the WA gas explosion which has caused earning cuts for BBP as well. Someone up there doesn’t like B&B at the moment.

Put it altogether, and B&B slipped through its $7.50 trigger, thus opening the floodgates. The stock is now no longer trading on break-up asset value, it is trading on survival risk. Merrill Lynch, Citi and UBS all reduced their Buy ratings to Hold ratings this morning on that basis. Valuation models have reverted, such that Merrills dropped its target price from $24.00 to $7.50, and UBS from $25.00 to $6.80.

Citi has stuck with its $13.55 target at the moment, but increased its risk (volatility) assessment from High to Speculative. Credit Suisse has also cut its target, from $18.80 to $12.00. Clearly these targets do not carry much meaning at present.

According to reports from CNBC, Lehman Bros has now gone into damage control, ignoring the Fed facility so far (which is only a loan facility, not a bail-out facility) and actively entertaining offers for the firm. Private equity leader Blackstone is reputedly looking at acquiring 20-30%.

As I am writing B&B’s share price has now fallen under $5.00. Is there a white knight in the wings for B&B? Why did Macquarie just raise $600m when it already had sufficient capital? As B&B has always been known as Macquarie’s “Mini-me”, the fit is obvious. If Mac can pick up fire-sale assets from B&B then there is no time like the present.

Other funds in the B&B family have seen their share prices hit in unison, with the likes of B&B Infrastructure ((BBI)) being slammed down well below its asset value. And these are not low-quality shopping centres we’re talking – BBI and BBP, for example, both own highly sought after assets. If it’s a difference between life and death, it’s hard to see the ACCC really having much objection.

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