Tuesday, July 15, 2008

"Australia's toll road companies are unsustainable unless the Government continues to prop them up with subsidies..."

Toll roads to nowhere

'In the absence of full disclosure it is tempting to suspect that a government could play fast and loose with taxpayers and ignore the long-term consequences'

--Goldberg's report

July 16, 2008

Michael West
Sydney Morning Herald
Copyright 2008

Three years ago, a 75 year-old academic from Sydney University, Dr John Goldberg, issued a paper claiming Australia's toll road companies were unsustainable unless the Government continued to prop them up with subsidies under its infrastructure bond scheme.

Goldberg was rubbished by the operators Transurban and Macquarie. How could all the broking analysts, institutional investors and other experts be wrong, and this bloke right? PricewaterhouseCoopers, auditor and consultant to most of the stapled infrastructure structures, was also wheeled out as an expert to debunk Goldberg's contention that the toll road model was flawed.

It got worse for Goldberg. Without telling him, the University of Sydney's Vice Chancellor Gavin Brown caved in to a demand from Macquarie to disassociate the University from Goldberg's work.

Documents obtained under Freedom of Information laws show a request to Brown from the former bank's lobbyist and Federal MP Warwick Smith: ''We request that the University of Sydney publicly disassociate itself from Dr Goldberg's paper and the grossly irresponsible remarks he made on the ABC's 7.30 Report on October 20, 2005''.

Brown duly issued a release putting distance between the uni and its academic, an honorary associate in the School of Architecture, Design Science and Planning on the grounds that he was honorary and not on salary any more.

Goldberg pressed on with his papers, predicting Sydney's Cross City Tunnel and the Lane Cove Tunnel projects would implode. They have. Overly bullish traffic forecasts and extreme debt loads were to blame, as Goldberg had forecast.

His thesis was that the projects' traffic forecasts were structured to fit with the financial model, not the other way around.

The original subjects of Goldberg's work, Melbourne's City Link and Sydney's M2 have not imploded. Macquarie sold the M2 two years ago via the Sydney Roads Group spin-off and Transurban subsequently acquired it, adding Sydney's M2, M5, Eastern Distributor and Westlink M7 to its suite of assets anchored by City Link.

Taking its toll

Even before the credit market iced over, listed tollroad shares were on the wane.

The savage blow to anything with leverage over the past year hit them hard. And then, last month, Transurban's new chief Chris Lynch conceded his business model was unsustainable. He took the axe to distributions (which were made out of capital rather than cashflow), raised equity and revealed a plan to `de-leverage'.

That government subsidies were drying up as concessions from the infrastructure bond schemes drew to an end had not helped. There may have been flaws in Goldberg's work, as Transurban had claimed three years before, but the guts of it - that the model was flawed - appeared right.

Although Transurban dropped its model - the Macquarie Model as it is called - and the Cross City and Lane Cove Tunnel projects both had blown up, Macquarie - as always, a mile ahead of the curve - bid aggressively for the Airport Link deal in Brisbane and won.

Now the Queensland Government is forging ahead with its deal with the Brisconnections (Macquarie) consortium to develop the Airport Link. Same model: promoter fees out upfront, distributions paid back to unitholders out of their capital, then debt years before cashflow materialises, and no funding alternatives made available for public debate.

And how's this for a response on oil price as a variable to consider over the next five decades?: "Oil price assumptions make up part of vehicle operating cost assumptions. Vehicle operating costs include many factors, such as tyres, servicing, fuel, depreciation and debt servicing etc - oil prices are not a separable assumption. ''

That is a departure from the other operators whose line is, yes, oil price assumptions were factored into our traffic model but, no, we won't be revealing to the public what our oil price assumptions are because they don't matter. The price of petrol, you see, doesn't have much of an effect on motorists' behaviour and therefore toll revenues. ''Inelastic,'' apparently.

MIG in the cross-hairs

Nobody appears to have told investment bank Goldman Sachs, though, as a piece of research from last Friday on Macquarie Infrastructure Group's latest traffic numbers downgraded its recommendation thanks to ``the impact of higher petrol prices ... (and) a slowing economy''.

''Even the jewel in MIG's crown, H407, has felt the impact of higher petrol, prices having now recorded two consecutive months of negative traffic growth (-2.2% and -3.4% respectively), '' said the report.

The Toronto 407 is reputed to be the best infrastructure asset in the world, a massive highway with no regulatory constraints on raising tolls.

In its report on the same data, ''Breaking the Myth'', Citigroup wrote

''The recent under-performance from MIG's assets has broken the myth that toll-roads are largely immune to economic slowdowns.''

Macquarie Equities research too talked about the impact of "price elasticity''. Most of the tolls had been jacked up and motorists, hit by the petrol price too, were apparently fed up.

The oil price is now $US100 above its level of three years ago. It is time the operators and Governments come out and say what their oil price assumptions are. We are talking about long-term leases here. In the case of Brisconnections, which floats in a few weeks, the concession lasts for 45 years.

In the absence of full disclosure it is tempting to suspect that a government could play fast and loose with taxpayers and ignore the long-term consequences by getting an infrastructure project up and defraying the costs to future generations.

Meanwhile, speculation rises as to what Macquarie will do about MIG. With the unit price wallowing at $2.18, a mop-up is on the cards. When new chief executive Nick Moore, the architect of the stapled-security infrastructure model, faces shareholders for his debut annual meeting in Melbourne later this month, you can be sure the issue will be up for debate.

There is a lot of retail money in MIG and other Macquarie trusts chasing the yield while institutions have deserted the story in droves and unit prices have languished. All alternatives will have been canvassed by the bank to address this listless price performance. If they can see a profit in it they will privatise and either split up the assets or slot them into a wholesale fund.

Part of the underperformance has been due to poison pills in the MIG triple-security structure designed to ward off predators. That there are no potential suitors then to challenge Macquarie for the rights to manage MIG does not help the unit price. Neither do current economic conditions but it is unlikely the bank can leave things as they are.

The pain promises to hit the profit pool given satellite trust unit prices, not only in MIG but in Macquarie Airports and Macquarie Communications, have fallen well below book value. That not only means writedowns, but also falling fees.


Moves afoot

The Macmothership has been soaking up stock in all three this year. Something is on the boil. It is now up to 16% in MIG.

This buying however has done little to keep the price up and calls are growing for something to be done to close the yawning gap between stated net asset backing and the foundering unit price - a gap which now stands at $2.41 per unit.

Macquarie needs some hungry pension funds onside before it makes a move on MIG. It can hardly fund a move from its own balance sheet but it could do it with a syndicate of funds at the right price. With the demise of the listed funds model, retail investors don't matter as much as they used to. In the world of wholesale funds, institutions do matter.

As the bank needs to preserve its social contract with the institutions it would look to concoct a structure which offered them rollover relief. Although Macquarie would be a price-taker rather than a price-maker in this negotiation, it may still rip out a couple of hundred million dollars in transaction fees.

A lawsuit by Ontario Teachers Pension Fund filed in the NSW Supreme Court may even be a tactical ploy in the negotiating process. Ontario was Macquarie's first big institutional supporter and did well out of MIG during the fund's heroic era. And Macquarie isn't in the habit of announcing bad news unless that news is so material as to constitute a slam dunk breach of continuous disclosure rules.

The risk with a mop-up, this most palatable of potential plays, is that it would entail an admission that the bank's listed infrastructure model (despite Brisconnections) was dead. Perversely, though, this admission could underpin the other trusts on the proviso that a bid might be coming for them too.

Another risk is corporate governance. An in-house bid would present a nightmare for an "independent'' director.

Whatever the case, Nick Moores' former 2IC in the investment banking department, Michael Carapiet, was recently appointed to the MIG board. It's unlikely he's there for a love of tarmac. The signs of corporate activity are amassing. Macquarie has hardly been talking the MIG story up of late ... and it would like nothing better than to cut the short-sellers to shreds.

The Citigroup analysts put it this way last Friday:

''In our view, the stock is screaming for an action from the management to reduce the gap between the share price and its Net Asset Value of $4.59ps. While cutting distributions to a sustainable level of 10cents ps would be a good start, given it is already priced in the share price, other option could be to move the listing of the stock to the US and realise the cost of capital arbitrage (US 10-year bond yield of 3.8% pa versus Australian 6.3%). Still other avenues could be the full privatisation or part-sale of its assets in order to crystallise value. Regardless, some action is needed to justify those management fees. `'

The likelihood is Macquarie will make a corporate move this year to resolve the crisis which has beset its model - unless there is a lot the market doesn't know.

If John Goldberg's success in picking infrastructure failures extends from the Cross City and Lane Cove Tunnels to Transurban and MIG, watch out.


© 2008, Sydney Morning Herald: www.business.smh.com.au

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