Macquarie Bank’s £8bn deal to take over the UK’s Thames Water in October is the high point of a landmark year for the Sydney-based group as it rolls out globally the model it has developed in its home market in the past decade.
Little known outside of banking or infrastructure circles until relatively recently, Macquarie is now firmly on international radar screens as an aggressive acquirer of assets and its model is being scrutinised, and in some cases copied, by long-established industry giants, such as Goldman Sachs, Morgan Stanley and UBS.
Behind it stands a legion of other Australian niche property, infrastructure and structured finance specialists that are also increasingly active in international markets. These range from investment houses Babcock & Brown (B&B) and Allco, the local groups most similar to Macquarie, through to the likes of Hastings, Westpac’s infrastructure investment subsidiary, and property groups such as Westfield, Stockland, Centro and Lend Lease.
Just days before sealing the Thames deal, for example, Macquarie sold the UK’s South East Water to two Hastings funds for £665m. A couple of weeks earlier, a consortium including Commonwealth Bank of Australia’s fund management arm and Melbourne-based Industry Funds Management agreed to take over AWG, the parent company of UK water group Anglian Water, for £2.3bn.
“It is extraordinary how broad [Macquarie’s] footprint has become already,” says Huw Jenkins, chairman and chief executive of UBS’s global investment bank. “We will continue to see it, and this type of financier, appear all over the world. Without a shadow of doubt, Australia has been an early developer [in this segment].”
The Thames acquisition, which involves £4.8bn in equity and £3.2bn in debt, is by far the biggest for a Macquarie-led consortium, dwarfing last year’s E7.1bn acquisition of France’s APRR motorway network, which was previously the largest single investment in which the Australian group had participated. It comes, however, at a time when some analysts have questioned aspects of Macquarie’s model and that of other local structured finance specialists.
Global footprints
The sheer number and size of the deals in which Macquarie and others are involved and the growing share of global transactions have surprised outsiders and focused attention on risk management practices. Macquarie’s assets under management, for example, shot up 45% to A$140bn ($107.8bn) in the year to March and staff numbers rose by 25%.
There have also been concerns about the underperformance of some of the bank’s listed funds and about it missing deadlines for selling on assets. And analysts are assessing the impact of higher interest rates on the structured finance model; increased competition as global heavyweights seek to invest in infrastructure; and the long-term sustainability of dividend pay-outs to investors in funds.
The Macquarie formula
Nevertheless, the Thames transaction is set to follow a typical Macquarie formula – one that enables it to reap multiple fees. The UK utility is being bought by Kemble Water, a consortium led by the bank and including two of its infrastructure funds and other investors. The bank will earn fees both for advising the consortium on the transaction and from refinancing Thames, as well as from managing the Macquarie funds that will hold stakes in the utility.
“This deal is more of the same but bigger,” says Brian Johnson of JPMorgan, Australia’s top rated banking analyst and a long-standing supporter of Macquarie. “It tells you that the model is not broken.”
Macquarie itself appears confident. In September, it upgraded its earnings guidance for the first half, after being cautious earlier in the year due to the volatility in global equity markets. It said profits would be up at least 20%, putting it on track for its first billion-dollar profit and its 15th consecutive record full-year result for 2006/07.
“There have certainly been a lot of transactions and a lot of momentum in the business,” says Richard Sheppard, deputy managing director. “But we have been carefully planning our strategy and signalling it to the market for a long time now. There is nothing sudden about this.
“We are not immune from adverse market conditions,” he adds. “Our volumes would be hit in a downturn but we would not suffer substantial trading and credit losses because of our very conservative risk management.”
Space for competition
The bank says there is room for competitors both because of the growing popularity of infrastructure as an asset class and also because investment opportunities are multiplying as more governments around the world seek private sector involvement. “Infrastructure and other assets with these types of characteristics (that is, long-term stable cashflow) have seen demand grow, but there is also increased supply,” says Mr Sheppard.
Analysts concur. “For years, property trusts were the only listed high yield investments available. This has expanded into infrastructure funds and hybrid capital in more recent years,” says Anthony Sweetman, UBS’s head of mergers and acquisitions in Australia. “There was, and continues to be, a shortage of product relative to demand, hence the reason that yield-driven vehicles and hybrid capital issuers have found no shortage of backers.”
Pioneers’ advantages
While competition is increasing, analysts say the experience accumulated to date by Australia’s infrastructure investment pioneers – which have shown themselves to be active managers of their assets – still gives them considerable advantages. Macquarie bought its first toll road, Sydney’s Hills motorway, in 1994. Allco and B&B, initially leasing specialists, date back to 1979 and 1981 respectively.
“Most of the world thinks they [Macquarie] are an investment bank,” says JPMorgan’s Mr Johnson. “But they are really an integrated investment bank and infrastructure asset manager. They are very good at revenue stressing and are not afraid to raise fees.”
Nevertheless, there is concern about some of the prices that Australian groups are paying for overseas assets and the proportion of some portfolios that these now represent. “Australian groups were the largest foreign buyers of US (non-residential) property last year. Have we really understood how to manage shopping centres in Louisiana that quickly?” asks Graham Bradley, chairman of both HSBC Australia and Stockland, a leading local property group.
“While it is wonderful to see our industry growing into international markets and using our knowledge of securitisation, I have concerns about how well we understand some of those markets,” he says.
Regulatory caution
Regulators have sought to inject some caution, according to Michaela Anderson, director of research at the Association of Superannuation Funds of Australia, the peak industry body. “Infrastructure is harder to invest in [than traditional assets such as equities and bonds],” she says. “There isn’t the same liquidity and there are also issues with valuation.”
But, as deals have become larger, there has been a move to ‘club deals’ – bids involving consortiums, says Phil Green, chief executive of B&B. In part, this is a response to the high fees charged by intermediaries such as Macquarie and B&B, and institutions’ desire to invest directly in infrastructure and property. But it is also a way for deal originators to reduce risk while still expanding aggressively.
“Transactions are getting bigger and there is a need to bring in additional partners,” says Macquarie’s Mr Sheppard. “We work closely with some of our competitors.”
B&B moved its headquarters from the US to Australia and listed on the Australian Stock Exchange in 2004, partly to cash in on the ‘Macquarie factor’ in the sense that the local market understood the two groups’ model more than any other. One of the main differences between the two, however, is that B&B does not have a banking licence. That means it foregoes part of the fee chain that Macquarie generates but it also avoids the potential conflicts of interest, a growing issue for investment banks involved in private equity style deals.
Because it does not have to worry about upsetting potential banking customers, B&B says it is freer to pursue hostile bids. It also invests in green-field projects, such as wind farms and other alternative energy projects. “A much greater proportion of our balance sheet is involved in developing opportunities than in securing transactions,” says Mr Green. “Macquarie is more of a pure financial player in these things.”
Looking ahead, high on analysts’ list of issues with the segment is the fact that some funds are borrowing money to finance distributions, essentially front-ending the returns. “We continue to believe that this remains a key issue for these stocks and query whether the market is yet to fully understand the implications that low cash coverage of distributions can have on a stock’s ability to grow or, worse still, to fund its distributions, particularly in a rising interest rate environment with increasing credit spreads,” financial services company Goldman Sachs JBWere said in a recent research note.
Interest rate worries
The biggest single concern, however, appears to be the impact of rising interest rates. “The biggest risk is definitely interest rates,” says Jeff Emanuel, banking analyst at UBS in Sydney. “Macquarie makes the point that these assets have natural price hedges because if rates go up, inflation is going up and they are long-duration, inflation-linked assets. But there is a valuation impact on the assets that is net negative and that can hurt their ability to raise funds.”
Peter Morgan, investment director at 452 Capital and one of Australia’s best known fund managers, says that many infrastructure investments have not been tested on a long-term basis, giving the example of toll roads in a high petrol price environment. Risk could also be priced upwards more sharply than inflation, he says.
“If the price of debt rises, it is going to be interesting [for the financial engineers],” says Mr Morgan. “They will be operating to a different dynamic from the one that has made them so successful in recent years.”
