It came as a shock to everyone last week that a drifting Babcock & Brown Ltd (BNB) share price should trigger a debt covenant breach on capitalisation level that no one knew about. With credibility shattered, Babcock management has since tried to soothe the market with some claim about the covenant not necessarily having been breached. Is this the case? Is it not the case? Who knows? For a listed company Babcock has more secrets than a conjurer.
What everyone does know - with no particular thanks to management - is that the group is sitting on some fairly valuable assets in the likes of wind energy for example that can be sold, if not for a premium, at least at a price. This sets Babcock apart from a operation such as Centro which is sitting on mediocre US shopping malls in a recession.
The result is that after the initial panic sell-off, driven by margin calls, tax selling, and cries of “here we go again”, shares in B&B have bounced back substantially, if not all the way to the covenant breach level of $7.50. Justifying this bounce has been expectation that with Babcock now in the hands of its bankers, and with valuable assets to sell, all is not lost.
Apart from general US investment bank weakness, which had encouraged the drift-down in both Babcock shares and the shares of its larger and more professionally run exemplar Macquarie Group, B&B’s weakness has been rooted in the failure of its satellite Babcock & Brown Power ((BBP)) to attract more than $2.7bn of its required $3.1bn refinancing. It took a while for this bit of information to be extracted as well. Then one can throw in the rather unfortunate timing of the Varanus gas explosion.
“It’s alright,” B&B Power initially assured investors, “the impact of the power outage is not material”. No? So why exactly then did BBP announce yesterday it had taken a knife to FY09 earnings guidance? Oh - because of a longer than expected outage at Flinders and weaker spot prices in Queensland. And because of the Varanus gas explosion.
What did analysts think of this little revelation?
“The company is promoting financial prudence,” says Deutsche Bank, “however we continue to struggle with the consistency of disclosures that this company makes, casting further concerns over management credibility”.
“Disappointing,” says Citi.
“The lack of disclosure gives us limited confidence in the underlying fundamentals,” says Macquarie.
“No need to be here’” says Merrill Lynch.
“Today’s announcement has removed any sliver of credibility that the market was giving the company,” says ABN Amro, while downgrading to Hold from Buy. “We have lost what little faith we had in management”.
Credit Suisse didn’t need to qualify, it just downgraded straight from Outperform to Underperform.
The analysts were also in unison, however, in suggesting that abandoning the second half dividend was a sensible move that really had to happen - there was no way BBP could attract much of the way in equity interest under the current circumstances. Aside from the whole Babcock group potentially being saved by dismantling B&B Wind ((BBW)), Merrills points out, and others concur, that B&B Power’s assets are worth more than the market is currently giving credit for.
While the dividend cut by default de-risks BBP by “providing a much needed equity injection,” as Citi suggests, the Citi analysts also point out that downgraded earnings forecasts are putting BBP perilously close to breaching a 1.5x interest cover covenant that, if triggered, would invoke an “equity lock-down” - a freezing of all distributions anyway.
As BBP shares fall yet another 13% this morning, following a 20%+ fall yesterday, any share price bounce is purely in the hands of day-traders and hedge funds who are happy to take on risk. While many a longer term investor has already bailed, other stranded investors will simply be hanging on with fingers crossed that asset sales can recoup at least something.
For it will be a cold day in hell before longer term investors could ever plough back into BBP, or any Babcock entity for that matter, given the group’s total credibility meltdown. At least not until current management is completely purged. But then it seems there are long term contractual restraints on that front - something else we didn’t know earlier.
The FNArena B/H/S ratio now stands at 1/5/2. UBS is the only Buy, and that can be explained by the average target price of $1.20 (down from $1.51 yesterday) and the current share price of about 62c. Targets range from 64c (Citi - Underperform) to $1.85 (Deutsche - Hold).
