Babcock's robust self-worth

Institutional investors and analysts who thought that the huge fall in the share prices of Babcock & Brown and its satellites would trigger huge changes in the group's corporate governance practices should think again.

Senior management at Babcock & Brown do not accept that the root cause of the huge gap between the sharemarket value of some of its funds and net assets is because of a 'corporate governance discount'.

That will disappoint those in the market who believed the recent turmoil surrounding the group would cause a rethink of its approach to management contracts, performance fees and its management of conflicts of interest.

Babcock & Brown's senior management says it can't control the share market but is focused on improving fund performance. Management also maintains that recent movements in fund share prices are not that different from those experienced by companies and trusts invested in similar assets. It says it has earned credit from the market for its management of conflicts.

The only immediate obvious concession to complaints about corporate governance shortfalls has been the commitment to appoint independent chairman to each of the listed satellite funds. That process is virtually complete.

The Babcock & Brown mothership in Chifley Tower in Sydney's CBD will continue to determine the strategic direction of the various listed and unlisted funds, notwithstanding the requirement that every purchase or sale of an asset be approved by a majority of independent directors in each fund.

There was an expectation in some quarters that strategic reviews being conducted by Babcock & Brown and several of its managed funds would include efforts to provide more flexibility in management rights, with the inclusion of a clause allowing Babcock & Brown to be removed as manager.

However, the work being done by various investment banks is focused on the options available to restore value.

Options being examined by Deutsche Bank and Goldman Sachs for the whole group include selling assets, bringing in third parties to co-invest in assets, revisiting the capital management policies, privatising and delisting funds or putting them all up for sale. Deutsche and Goldmans have been told to "hasten slowly" and are not expected to conclude their work until Christmas.

Separate strategic reviews are being done at the fund level by other investment banks including ABN Amro for Babcock & Brown Communities. They have much shorter time-frames.

There are no plans to revisit the length of management contracts, many of which run for 25 years thanks to ASX waivers of listing rules.

The Babcock & Brown view is that these were disclosed at the time of listing in accordance with requirements laid down by the ASX and ASIC. The contracts are of a long duration to match the supply contracts of the infrastructure assets. If investors don't like them, they can sell out.

Management fees and the alignment of the interests of the manager with the interests of investors have been contentious issues. But there are no plans to go beyond changes made some time ago.

Babcock & Brown last year introduced fund appreciation rights as part of its deferred remuneration component for staff directly and indirectly responsible for the funds. It responded to criticism by modifying its contracts so that fees are not "front-end loaded” due to rapid increases in market values.

The group will continue to use independent valuations for all related party transactions and all such transactions will have to be voted on by security holders. Related party transactions of a material value will continue to be the subject of independent experts' reports. They will continue to be a feature of how the group operates because the group believes that the best deals brought to Babcock & Brown funds will be found by Babcock & Brown.

Senior management of the group say corporate governance can always be improved, but as a fund manager the key issue is performance. The group is already moving to address the huge gaps between underlying asset values and current market trading prices such as the 50 per cent buyback of all issued capital by Babcock & Brown Capital.

One option to reduce trading discounts is to bring in third parties to co-invest in fund assets. This would have the benefit of validating existing valuations as well as reducing gearing in those funds that have excess leverage such as Babcock & Brown Power (BBP).

However, one analyst said this sort of approach would not necessarily help with a fund like Babcock & Brown Infrastructure (BBI), which has independently valued assets and no problem with its financing or leverage. It is trading at a 35 per cent discount to NTA.

If there is any mea culpa by the senior management of Babcock & Brown it is in relation to BBP. That fund has been heavily beaten up and is now trading at a 73 per cent discount to NTA after it revealed additional refinancing requirements a month after making bullish comments in a public forum.

The view from the Chifley Tower is that BBP was slow to recognise the speed and depth of deterioration in credit markets, which impacted the timing and terms of its recent refinancing. BBP's problem is that it has too much debt. However, it has raised about $780 million through asset sales in the past two weeks.

Just as Babcock and Brown is not taking a backward step on many of the thorny corporate governance issues, the group sees no end to the opportunities to package up infrastructure assets with stable cash flows and secure long term contracts.

However, the group says its growth will come in Europe and North America where the demand for such assets is growing and the preference is for unlisted funds.

Huge market discounts for Babcock & Brown assets in Australia have not dampened the group's self-belief. It regards itself as one of only a handful of organisations globally with the scale, expertise and capacity to lead and manage complex infrastructure deals.