Friday, August 21, 2009

Aussies Down Underwater

Macquarie Model Makeover Continues
Infrastructure Fund Weighs an Asset Split, Separation From Its Parent

Meanwhile, MIG has cut the value of its global toll-way portfolio, including two U.S. projects, amid the economic downturn. The fund cut the value of its leases on the Chicago Skyway -- the first privatized U.S. toll road -- by 37%, to A$148 million as of June 30, compared with a year ago, and it cut the value of its leases on the Indiana Toll Road by 72%, to $A98 million; the Indiana road is shared with Spain-based Cintra SA.
—The Wall Street Journal

Well, John Corzine’s moment has passed.

Three and a half years ago we here at NotMakingThisUp urged the then-newly elected Governor of New Jersey to start hitting bids on every toll road he could scrounge up in his troubled state.

Those bids on toll roads, airports, and anything else with a long-lived annuity stream, were coming largely from one investment bank: Macquarie Bank Ltd, which we described as the “It” Guy of the leveraged financial cycle.

Unfortunately, it was the denouement of the cycle that nearly took down an entire developed world, and Macquarie has not escaped the damage unscathed, thanks to the fact that the bids Macquarie was making on the toll roads and airports were utterly absurd.

Hence our suggestion that Mr. Corzine look into selling the New Jersey Turnpike.

That he did not was no surprise, given the peculiar attachment American voters have to aging infrastructure. Nor is it a surprise that Macquarie now finds itself writing down the value of its leases by up to 72%.

After all, Macquarie was—well, instead of regurgitating the gist of the original virtual column, we’ll reprint it below.

But before readers get the impression that we have some sort of institutional bias against denizens of the Australian continent, we’ll state for the record that some of our best friends are Australian—at least, one of our favorite analysts and blog writers is.

His name is John Hempton, and he writes a blog called Bronte Capital, at the following URL:

(If you haven’t paid attention to the Bronte analysis of the Australian healthcare system—in light of our recent musings on the current healthcare debate here in the United States—you should. It’s called “Health Care Reform and the Single Payer – An Australian Perspective,” and it was published yesterday.)

In the meantime, here’s what we advised Mr. Corzine one big long financial cycle ago:

Tuesday, March 28, 2006
How to Solve the New Jersey Budget Crisis

Until last year…few had heard of [Allan Moss] or his investment bank, Macquarie Bank Ltd. That’s when Moss, 56, decided to go on a $14 billion acquisition spree.—Bloomberg LP.

Every cycle has a financial star—the “It” guy whose name is sprinkled throughout serious Wall Street Journal articles and whose picture graces breathless Fortune Magazine cover stories about whatever current finance craze is fattening the bonuses of Wall Street bankers.

Now, Macquarie seems to engineer a new international deal every month—most of them purchases of public utilities…. The plan has helped the bank deliver 14 successive years of record profits….

Frank Quattrone was the “It” guy during the Internet Bubble of the late 1990’s—the most powerful investment banker in Silicon Valley—and only recently made the news for getting both a guilty verdict and a lifetime ban from the securities industry overturned.

Michael Milken was the “It” guy during the Leveraged Buyout Bubble of the late 1980’s—the most powerful junk bond financier of hostile takeovers in history—and has successfully resurrected his reputation through smart business deals and aggressive funding of results-oriented cancer research.

Both Quattrone and Milken had unique insights which they used to exploit market inefficiencies on a scale nobody else had dreamed of doing before. Eventually, of course, everybody else woke up from their nap and decided they wanted a piece of the action—and pretty soon everybody was doing it—sparking asset inflation, irrational behavior and collapse.

Macquarie’s success has also lured much bigger investment banks, including Goldman Sachs Group Inc. and JPMorgan Chase & Co., into planning their own multibillion-dollar “infrastructure” funds.

What Macquarie figured out was this: it could buy public utilities such as airports, bridges and toll roads, package and resell those assets to Australian asset managers looking to redeploy the cash being accumulated by that country’s far-sighted and highly successful public pension plan, and take out fees along the way.

Most Americans first heard of Macquarie last year, when they led a group which paid $1.83 billion—approximately 40-times revenue—for the 7.8 mile Chicago Skyworks. As Bloomberg quotes an admiring fan of Macquarie:

“Macquarie is usually able to bid more aggressively for assets because they have more sophisticated financing capability.”

More recently, Macquarie won the bidding for a 157-mile toll road in Indiana, paying $3.85 billion for an asset that generated $95.6 million in revenues in the 2005 fiscal year. That’s also 40-times revenue. As Bloomberg’s admiring fan says:

“They finance with debt. I don’t know how they do it, but they’re able to finance at lower cost of capital than other people.”

The impetus behind Macquarie’s willingness to pay 40-times revenue for an asset that could be rendered obsolete by any variety of means—acts of God, acts of State Legislatures, or drivers’ unwillingness to pay tolls when they can drive for free elsewhere—comes from the very brilliant notion that such long-lived assets neatly match the long-lived nature of Australia’s pension liability.

As insights go, that’s a powerful one—and ranks right up there with Mike Milken’s discovery that, contrary to popular perception, junk bonds provided better returns, on average, than non-junk bonds, because the default rate on junk was, on average, lower than generally assumed by bond investors at that time.

Like Milken, Maquarie has revolutionized a source of financing which others now seek to emulate and exploit.

And, like junk bonds, internet stocks, and all financial fads that start off from a logical premise, it will get out of hand.I am sure the Maquarie folks are as brilliant as their reputation, and that they know what they’re doing. But I’m not convinced that everybody else who wants to get in on the action now, by buying toll roads or airports or bridges or whatever else bankers decide to monetize, knows much more than the simple fact that it is, for the moment, a highly profitable way to leverage up the public infrastructure.

If I had a bridge to sell, I’d sell it right now.

And if I was John Corzine, the ex-banker and new governor of New Jersey dealing with a massive budget problem, I'd be getting the Goldman Sachs bankers working on a deal book for every road in the state.

Suddenly that New Jersey Turnpike is looking mighty valuable.

© 2006 NotMakingThisUp, LLC

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


Random Old Utilities Analyst said...

The amazing thing is that the Cintra/Ferrovial guys were even crazier then MIG. Look at the BAA disaster.

I think the original unlevered IRR on the Indiana Toll Road was like 2% and then they levered it 8x and they thought it was a GREAT deal.

Racerone said...

Interestingly, I heard an ad on the local AM radio urging drivers to choose the Toll Roads (Skyway and Indy Toll Road are part of the same highway), as an alternative to 80/94. Anyone who has sat in horrible Chicago traffic already there are 2 options. Running advertisements struck me at the time as a desparate move on the Toll Road's part.

Tim said...

Is Macquarie's original logic still intact? (i.e. That their pension liabilities matched the duration of the expected cash flows)

If that's the case, isn't this just a paper mark-to-market that really isn't relevant? Is the economy really changing driving habits so dramatically as to change the expected cash flows over 40 years?

SavageHeart said...

Here's how it's supposed to work: First you announce a financial crisis so dire that no one can figure a way out of it. Then you travel the state telling the people of the disaster that awaits them. And only then, when all of the news stories have been written and all of the interest groups have started to bombard the politicians with phone calls and e-mail, do you propose your solution.

Corzine did it backward. First he gave us the solution. Then he gave us the problem. The solution was to borrow so that he would not have to make the cuts that he announced yesterday. If the Legislature had backed his plan, he would have had $1 billion more in budget slack.

And by the end of his speech yesterday, the governor hinted that he still believes his toll-and-spend plan can be brought back from the dead.

Money without intelligence is like a car without a road.

Random Old Utilities Analyst said...

Tim - The problem is not the logic behind infrastructure as an investment class (in theory its essentially an inflation protected bond - in practice not quite so much but not an absurd idea )- the problem is the leverage. MIG bought these things at prices that only made sense because the credit bubble allowed them to pile absurd amounts of debt at incredibly low prices predicated on business plans/forecasts that read like something out of Candide. The only way these are not permanent impairments is if the credit bubble returns. (Note - these things all have to be refinanced at least every ten years because of the way they originally sold the debt, additionally the original IRR's were predicated on bringing forward future cashflows by releveraging the early and often) If you want to see why refinancing these things is a problem take a look at BAA.