Hobart Airport in trouble?

The Hobart airport owner/operator, the Tasmanian Gateway consortium (TGC) half owned by RBF, the Tasmanian government superannuation fund, is in serious trouble.

Going concern issues were raised in the latest financial statements lodged with ASIC in October 2012.

RBF’s Annual Report tabled in Parliament late in October gave no hint of trouble but the Auditor General let the cat out of bag with his report to Parliament tabled late in November.

First a bit of background.

TGC in which the Retirement Benefits Fund (RBF) holds a 49.9% interest, acquired the Hobart Airport in January 2008.

RBF’s 50.1% partner is Macquarie Bank’s Global Infrastructure Fund (GIF) III, a closed unlisted wholesale fund with part ownership of four global infrastructure assets, Hobart Airport being one.

Macquarie Bank manages the consortium as well as GIF III.

The partners contributed $200 million in cash and borrowed another $175 million to fund the $350 million purchase from Tas Ports, the State owned business.

The unexpected windfall to the State Government quickly disappeared under the errant guidance of ex Premier David Bartlett.

TGC itself only employs 28 people (as at 30^thJune 2012). Revenue increased from $22.3 million in the year that TGC took over to $31.3 million in the latest year 2011/12 which was a slight drop on the previous year’s figure.

The earnings in the latest year fell after slow but steady increases since 2008. The following table reveals the pattern.

 

	2011/12	2010/11	2009/10	2008/09	2007/08
Revenue ($m)	$31.3	$31.4	$28.0	$26.8	$22.3
Expenses ($m)	$13.9	$13.0	$12.4	$12.8	$11.1
EBIT ($m)	$17.5	$18.4	$15.7	$14.0	$11.2
Depreciation amortisation ($m)	$3.1	$3.0	$2.9	$3.7	$2.9
EBITDA ($m)	$20.5	$21.4	$18.6	$17.7	$14.2

 

EBIT is earnings before tax and interest. EBITDA has depreciation and amortisation excluded as well.

EBITDA is a good proxy for operating cash flow for the Hobart Airport business.

Both are used as a measure of earnings where comparisons over time and across businesses are needed.

The significant measure of EBITDA as a % of revenue fell to 65%, little different from the figure four years ago.

Money making machines like Sydney Airport have a % as high as 80%.

Operating cash flow is needed to pay interest, management fees to Macquarie, dividends to the partners and new capital works.

Unfortunately not enough to feed all the hungry mouths.

New capital, plant and equipment expenditure of $33 million over the past four years has all come from borrowed funds and the borrowings are now up to $208 million, due to be renegotiated in January 2013.

The loans are floating rate facilities and normally this would imply lower servicing costs given the fall in interest rates from 9% at 30^th June 2008 to 5% at 30^th June 2012.

However TGC hedged its interest rate.

It did this by entering into an interest swap agreement for most of the original $175 million loan ($172.25 million to be precise), whereby it agreed to receive interest at the variable rate and pay interest at a fixed rate which appears to be about 8%.

It must be emphasised that the swap arrangement is separate to the loan.

The difference between interest paid at a fixed rate and interest received at a variable rate on the hedged amount is included as a finance cost in addition to the variable or floating rate paid on the borrowings.

In effect TGC has been paying interest at a fixed rate of about 8% on $172.25 million plus interest at the variable rate on the balance of the loan which is now $208 million.

Macquarie Bank were paid management fees of $2.2 million in 2011/12, up from $2 million four years ago.

Only $1.5 million has been returned as dividends to partners in four years, RBF receiving $750,000 in 2010.

After interest and fees to Macquarie most of the EBITDA disappeared. There has been a slow build up of the remaining cash from $10 million at takeover to $33 million at 30^th June 2012.

But it will soon be needed, every penny of it.

Whilst the loan facilities are due to be renegotiated in January 2013, the interest swap agreement will last another 10 years, until December 2022.

This means that TGC agreed to pay interest at a fixed rate in return for receiving amounts at the variable rate for 15 years.

Any such future contracted commitments are ‘marked to market’ based on prevailing interest rates and recorded in the financial statements as a liability.

The present value of the future swap commitments as at 30th June 2012 is a staggering $71 million, due to the fall in interest rates.

If interest rates went up instead of down, an interest rate swap agreement may have a positive value, in other words recorded as an asset.

The Notes to Accounts for Tasmanian Gateway Corporation Pty Limited explains the problem and how it has caused the directors to specifically mention going concern issues.

The current borrowing facilities of the Company ($208.75 million) will expire in January 2013, and for this reason the external borrowings have been classified as current. Whilst the hedge agreements in place do not expire until December 2022, they are expected to be terminated during the 2012/13 financial year and as a result the mark to market liability has been classified as current.

The ongoing viability of the consolidated entity and its ability to continue as a going concern and meet its debts and commitments as they fall due are mainly dependent upon the consolidated entity being successful in:

1.      Receiving the continuing support of its financiers; and

2.     Achieving forecast operational performance and generate sufficient future cash flows to meet its business objectives and financial obligations.

The directors believe that the consolidated entity will be successful in the above matters and, accordingly, have prepared the financial report on a going concern basis. At this time, the directors are of the opinion that no asset is likely to be realised for an amount less than the amount at which it is recorded in the financial report at 30 June 2012. This is mainly due to the following factors;

1.      The directors expect the consolidated entity will achieve positive operating cash flows;

2.     The process of refinancing the external debt of the consolidated entity is well advanced and a successful financial closes is expected;

3.      If required the shareholders are willing to provide additional equity contributions.

Accordingly, no adjustments have been made to the financial report relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the consolidated entity not continue as a going concern.

RBF are willing to put in more funds if required.

It is a little unusual to see an interest rate swap contract taken out for 15 years when the loan itself was to be renegotiated after 5 years, especially seeing that RBF’s partner, the Macquarie managed Global Infrastructure Fund III was expected to have a life expectancy of only 10 years, were it to follow the pattern of its older siblings.

GIF I has been wound up and capital returned to investors after the sale of its underlying infrastructure assets. GIF II’s assets have been partially sold and some capital returned to investors and it was expected that GIF III’s life span would only be 10 years from 2007.

It certainly begs the question of what RBF’s intention are/were following the exit of its partner given that an interest rate swap contract was taken out until 2022.

Macquarie designed financial structures are always ridiculously complicated, unnecessarily so in most cases.

Fees extracted by investment bankers assisting both buyer and seller in 2008 amounted to $15.8 million, more than one year’s EBIT.

The purchase of RBF’s interest in TGC came just before the end of the boom.

RBF was late on the scene; most of the better performing infrastructure assets had already been snapped up, repackaged and sold to wholesale funds.

GIF III remained open for 3 years but eventually was closed with only four assets in the portfolio. This signalled the end of an era for the famous Macquarie model

The price paid for the airport was 27 times EBITDA (which puts the EBITDA at about $13 million at the time of the sale negotiations in 2007, which seems about right seeing the 2008 EBITDA was $14.2 million as per the above table).

Other industry funds at the time were rumoured to place an upper value limit of 15 times EBITDA.

TGC paid almost twice as much as others were prepared to pay

RBF Annual Report lists the current value of all RBF’s investments ( see page 15-16 https://secure.superfacts.com/attachments/Form/RBF_AnnualReport2012.pdf). TGC is listed with a value of $110 million, an increase from the original $100 million but a fall of $4 million in the last year.

If a 50% share is worth $110 million, 100% must be worth $220 million. Given $208 million is owed to banks plus possibly another $70 million to bail out of an interest rate swap contract, the strip of bitumen with a few buildings at the end would have to sell for $500 million plus.

Hobart airport watchers were amazed that the book value of RBF’s share of the airport was still in excess of the bloated purchase price.

Not so said the Auditor General in his report dated 22 November 2012. Pages 12 and 253 of http://www.audit.tas.gov.au/publications/reports/report2/pdfs/2012agrv2.pdf discloses that RBF’s investment in the airport was written down by $50.5 million in 2011/12.

Who to believe? The RBF or the Auditor General? My money is on the latter. If correct, RBF’s detailed list of funds under management (FUM) is misleading. What other figures are wrong? Is the total correct? Are the Board going to table an addendum?

The recent wash up of the Centro case was a reminder to Directors to bring a switched on awareness to the Board table. How can a Director not notice that an investment that has just lost almost half its value is incorrectly listed in the Annual Report?

In summary, since acquisition over four years ago, new borrowings have been required to fund all new capex, only $1.5 million returned to owners, three quarters of the operating cash flow appropriated by the financiers by way of interest, management fees and swap payments with the balance saved for use as a part payment to financiers to help remove the onerous obligation of a 15 year swap agreement with 10 years to go.

Owning an asset with monopolistic characteristics and a lack of regulated prices is every rent seeker’s dream.

During the growth of the bubble economy and the subsequent post GFC aftermath, there are many examples of how all the rentier returns have, or will, end up in the pockets of the financiers.

The Hobart airport stitch up will become a case study for finance students in the future.

RBF were desperate to get a piece of the infrastructure action and they paid dearly for it.

For Macquarie Bank it must have been like stealing candy from a baby. They knew they were overpaying for the airport asset, but it wasn’t their money, so they weren’t concerned on that score. They make their money on the deal, the financing and the ongoing fees.

The higher the price the better.

Funds management is sometimes portrayed as a science, but it’s often a case of adhering to benchmarks, following the herd and making investment decisions on the basis that’s what everyone else is doing.

If the asset allocation consultant recommends a particular asset class and an investment banker reckons paying 27 times earnings and fixing an interest rate for 15 years is a good idea, then that’s what invariably happens.

Overall RBF are only managing about $4 billion of FUM. It’s a small fund by industry standards. About 40% of FUM relates to defined benefits schemes (closed to new members since 1999) and 60% to the defined contribution or accumulation scheme.

The defined benefit schemes paid out more in benefits than they received in contributions, most being the unfunded amounts from the Government. Expenses and unrealised losses exceeded income. The result was FUM went backwards by about $50 million or 4%.

Of the FUM 16% are classed as ‘alternative investments’. Included here are infrastructure assets such as the Airport.

RBF’s annual report is misleading. The split of ‘alternative investments’ in the financial statements between the defined benefit and defined contribution schemes cannot be reconciled with the $657 million of FUM listed as ‘alternatives’ in the FUM section in the Annual Report.

The point here is that to the extent that the airport is an asset of the defined benefit schemes, and it proves to be a dud investment, then the Government will just have to contribute more as its share of the unfunded benefit.

Repay some of the sale proceeds in other words.

To the extent that the airport is an asset of the accumulation scheme any losses will be borne by Members.

The only clues as to how the airport loss is split between defined benefits (DB) schemes and the accumulation scheme are on pages 264 and 270 of the Auditor General report. It appears that just over 50% of the loss relates to the DB schemes which the Government will eventually cover. The rest of the loss will be borne by members of the accumulation scheme.

There are however still a few unanswered questions.

A few uncertainties too about the refinancing of secured loans, opting out of the swap contract, and/or whether the going concern issue can be addressed.

Will RBF have to contribute more? This seems likely. If the value of the airport has fallen and the amount owing to lenders has risen, it’s odds on the financiers will make a margin call for more funds.

The revised value still looks optimistic. If a 50% share is worth $63 million as the Auditor General’s report suggests, then 100% is worth $126 million. Adding the bank debt of $208 million and possibly another $70 million to get rid of the swap contract less the surplus cash of say $20 million, then the implied value is still approaching $400 million, about 20 times earnings.

One thing for sure is we haven’t heard the last of the Hobart Airport.