Tuesday, 7 April 2009

Hobart airport sale


The Airport sale continues to attract sporadic comments. After reviewing the deal, there doesn’t appear to have been any gross breaches as has been alleged by some.  Just a series of events that were beyond the usual experiences of most of the participants. The Govt did ok, by default rather than good management although they’ve been terribly evasive.  Lennon’s legacy. Some of the proceeds may eventually return to RBF should the airport investment disappoint and lead to an increase in the unfunded superannuation amount required to be paid by the Government. Parliament provided little scrutiny, the Libs dithered and the Greens went searching for the sensational headline. RBF probably paid way too much and have been too defensive as if trying to hide something. The paper shufflers did handsomely out of the deal.

What is interesting is it provides a good example of how privatisation works and how the Macquarie model operates. At a macro level Governments may receive a cash boost, but from an overall social viewpoint, total debt simply increases. And that is what has brought the world to its knees.

Super funds’ investing in heavily geared entities is a recent phenomenon. Fortunately the glory days for such behaviour appear to have come to an abrupt end. Trustees were under pressure to emulate their peers whose performance was boosted by forays into unlisted geared entities.

Trustees although not bound by the continuous disclosure requirements of listed Companies, nevertheless owe it to their Members to keep them informed. It is not evident that RBF has done this with unlisted investments. By their nature unlisted entities tend to be a little more secretive.

RBF don’t particularly appear to enjoy the spotlight but their unfunded liability is one of the largest liabilities of the General Government sector, so they must inevitably figure in any discussion and be willing to cop a few questions. The latest Mid Year Report on the State’s finances projected a further $450m increase in the unfunded liability during 2008/09 as a result of the global turmoil. So it is not unreasonable from time to time, to look at their investment performance, one which is largely responsible for the increase in the unfunded liability.

Mr Aird announced the intended sale of Hobart Airport in his 2007/08 Budget Speech in June 2007. The Budget did not include any projected sale proceeds nor any selling expenses, but Mr Aird was reported in The  Age on 9th June 2007 as saying “ the government sale of Hobart International Airport should fetch upwards of $40 million to help fund costly infrastructure projects”.

“Mr Aird told ABC TV a figure of $40 million would be "a bit light on" as he prepares to off-load two other State owned assets, the Printing Authority of Tasmania and the Southern Regional Cemetery Trust, announced in Thursday's budget.”

To be fair to Mr Aird, his $40 million was undoubtedly a net figure to be received by the Government, after payment of loans owing by Hobart International Airport Pty Ltd of approximately $42 million. He possibly expected a sale price of $85 million, and maybe even hoped for $100 million. Adele Ferguson in The Australian on 5th July 2007 suggested a sale price between $117 million and $140 million.

The Department of Treasury and Finance awarded a tender to Carnegie Wylie on 16th August 2007 for divestment advice in respect of the Airport sale. The tender amount was $1.5 million. A selling commission of 1.5% was roughly the going rate at the time, so it is reasonable to assume a sale price of $100 million was envisaged. The successful tender announcement did however indicate that the estimated value of the contract was between $1 million and $1.9 million.

The eventual final sale price was $352 million plus adjustments at settlement date. The price included stamp duty (normally paid by the Buyer) and loan repayments of $42 million to Tas Ports and Tascorp (the State’s Finance GBE). With the unexpected windfall, did the divestment advisers get a bonus? Mr Aird never explicitly told us.  But Treasury and Finance’s Annual Report for 2008 on p 175 admits to a $6 million increase in appropriation to fund Government business divestment costs. The 2008 financial statements dated 12th August 2008 were prepared even before Parliament had considered supplementary appropriations pursuant to the Public Account Act for 2007/08, which the House finally did late on the 30th October 2008. It was approved by the Legislative Council on the same day, shepherded through by Mr Aird in 2 minutes flat, but wasn’t finally approved by the House until 18th November 2008. Detail about the breakup of divestment advisor costs were given privately to some members on the 19th November 2008, but were never recorded in Hansard. The public were never told.

Audit is a mystery to most people, even accountants. The Auditor General was able to sign an audit clearance for the Department of Treasury and Finance on 30th September, six weeks before the supplementary appropriations were approved by Parliament.

Treasury and Finance reported in their 2008 Annual Report that $604,000 of the appropriation amount had remained unspent. The Airport divestment had only cost $5.4 million in advisor fees.

But what was actually sold, who was the buyer, and how did they structure the deal? And who were the winners and losers?

The operator of the airport is Hobart International Airport Pty Ltd (HIAPL). HIAPL leased land from the Commonwealth with about 90 years left on the lease. It owns the buildings and the other leasehold improvement. All shares in HIAPL were owned by Tasmanian Ports Corporation Pty Ltd, a State Government GBE. The sale process involved disposal of all the shares in HIAPL.

The buyer was Tasmanian Gateway Corporation Pty Ltd. (TGC).This entity became the new Parent company of HIAPL replacing Tas Ports.

But nothing is straightforward when the Macquarie Group becomes involved.

The Parent company is a wholly owned subsidiary of the Head Company, Tasmanian Gateway Holdings Corporation Pty Ltd (TGHC). TGHC is 50.1% owned by the Macquarie Global Infrastructure Funds IIIA and IIIB (GIF III), unlisted infrastructure Funds managed by Macquarie Group, and 49.9% owned by the Retirement Benefits Fund (RBF).

GIF III and RBF contributed $200 million in equity to TGHC, which in turn lent most of it to the TGC. TGC then borrowed an extra $175 million to complete the purchase of the airport. It may be easiest if the structure was set out in a chart, which also shows the money flows wwhich occurred at settlement.
The Macquarie consortium established another entity, Tasmanian Gateway Property Corporation Pty Ltd (TGPC), wholly owned by the Head Company, TGHC. As part of settlement, TGPC paid HIAPL an option fee of $15 million in respect of the transfer of part of the lease of the undeveloped airport land for a 40 year period.

HIAPL’s net profit before tax for the full year 2008 was $10.4 million. Adding back interest, tax, and depreciation, the EBITDA was $14.5 million, an ok result. The EBITDA for 2007 was approximately $ 11.3 million, but 2008 experienced a full year of the benefits of capital upgrades at the Airport which were completed during 2007. Shares in HIAPL changed hands on 1st Feb 2008. Only 5 months’ profit ($5 million) was earned under new ownership.

HIAPL changed very little with the new owners. Debt of $6.9 million owing to Tas Ports and $35.9 million owing to Tascorp was replaced with $48.2 million borrowed from TGC, the new Parent Company.

It may be easiest when analysing the results for TGC, the Parent Company and for TGHC, the Head Company, simply to look at them as a consolidated Group, the consortium, and look at their combined figures for 5 months, including their share of profits from HIAPL for that period.

But first an aside about a common feature of the Macquarie model. Investor’s equity is often contributed as Redeemable Preference shares (RPSs) which attract a fixed rate of return and can be redeemed out of profits or the proceeds of another share issue. It’s a good quick way of returning profits to shareholders. Depending on the terms of the issue, RPSs are therefore sometimes treated as debt in the accounts and interest on them is recorded in the P&L.

In the case of the consortium’s contributed equity of $200 million, $45 million was treated as debt, accruing $3.3 million in interest at 15% pa for the 5 month period. The amount of ‘shareholder debt’ at 30th June 2008 was therefore $48 million. And the bank debt was $175 million. Total debt was therefore $223 million at 30th June 2008.

With so much debt and only $5 million of profits from HIAPL to service it, the consortium made a loss of $3.7 million. If the interest on ‘shareholder debt’ is ignored the loss was only $458,000.

The consortium incurred a management fee of $833,333 during the 5 month period. This implies a full year fee of $2 million, which is likely to be the fee paid to Macquarie Group at the rate of 1% pa on the contributed equity of $200 million.

Not surprisingly, the management fee remained unpaid as at 30th June 2008. Cash was scarce. Also unpaid at 30th June 2008 was TGHC’s investment of $100 in TGC being the issued capital of TGC. Cash was indeed scarce! The $2 million managers from Martin Place must have overlooked organising payment of the share subscription.

The interest bill for 2009 will probably be $7.2 million on the ‘shareholder debt’ and $13 million on the bank debt, (where rates were fixed probably 3% higher than now). Plus a management fee of $2 million. It will be tough.

The price of $352 million offered by TGC came as a surprise to most observers. The rumored second bidder was only $96 million. It’s often been said that Macquarie Group wouldn’t overpay for an asset. That statement unfortunately belies the true situation. The Macquarie Group makes its money by buying and on-selling assets into both listed and unlisted structures. It makes its money on the deals and the ensuing management fees. It only retains an interest in assets for strategic or PR reasons, not for investment reasons.

Actually Macquarie Group via Macquarie Capital Group Limited acquired a 20% interest in TGHC at settlement which it sold to GIF III on 20th June 2008, according to Mr. Aird in answer to a Question on Notice. But this was probably to stop the deal from falling over. GIF III was slow to attract investor’s funds (see below), maybe it could only afford 30% at the time of settlement.

TGC was incorporated on 15th October 2007. Presumably it knew at that time it was the successful tenderer. TGHC was incorporated on 4th December 2007. The consortium was starting to take shape. But on 6th December 2007 two other companies with almost identical names (without the word ‘Corporation’) but owned by other parties were incorporated. Mr. Aird told Parliament that they were owned by an unsuccessful bidder. It’s a little hard to believe that an unsuccessful bidder would have incorporated 2 companies at that late stage purely on spec. The original deal maybe was about to fall over. In the end it didn’t, and six days later the tender was awarded and the contract of sale signed.  But something happened at the eleventh hour.

Macquarie Group’s interest in the Airport deal, on the buyer’s side, was to see the price as high as possible, it earns a fee on the deal as a %, and a further fee probably based on the amount of contributed equity under management. It’s not interested in keeping the price down. It doesn’t retain an ownership interest as a rule. It disposed of its 20% interest as soon as possible. The investors in GIF III and the members of RBF are the actual owners of the Airport. Macquarie Group is only the manager.

Hence with consultants for both Buyer and Seller having no incentive to keep the price down, the price inevitably went up, and up. It must have been a difficult decision for RBF, particularly as some members of the RBF Board were nominees of the Minister, the Seller.

And what fee was received by the Buyer’s advisors?

TGC’s 2008 financials contain a note (Note 21) that purchase costs directly attributable to the acquisition of shares were $10.35 million. This is in addition to $352 million paid at settlement. These extra acquisition costs appear to be the fee paid to the Buyer’s advisors.

Usually stamp duty is an additional acquisition cost paid by the purchaser, but in this case the sale price included stamp duty. The contract of sale indicated that the estimated stamp duty was $600,000. This presumably was the amount of stamp duty (at 4%) on the $15 million option fee which formed part of the purchase price. The sale contract did not envisage stamp duty on the remainder of the purchase price, but when Treasury received the sale proceeds from Tas Ports, they allocated $11.8 million to an account styled ‘revenue in advance’, which was additional stamp duty on the transaction pending finalisation by the State Revenue Office, that was not foreseen by those who drafted the sale contract. This could well be 4% on $295 million, which is the value of the shares in HIAPL that were acquired by TGC.

The fees paid to the Buyer’s and the Seller’s advisors therefore totalled $15.8 million. Not bad for a few buildings at the end of a bit of bitumen. More than one year’s net profit. Plus an ongoing management fee of $2 million pa, not for managing the Airport, simply for managing the affairs of the consortium and having a few long lunches with bankers, whose co-operation would appear to be crucial.

The shareholders of TGHC are RBF and GIF III. Who is GIF III? Just another unlisted investment vehicle managed by Macquarie and owned by various wholesale investors and super funds.

The Macquarie GIFs have been fixed term 10 year investment funds, closed as soon as sufficient funds are raised. They buy interests in certain infrastructure assets, crank them up, reduce the costs and then sell them before the expiration of 10 years. The cash is then returned to investors. GIF I and GIF II were successful and investors reportedly happy with their returns. However GIF III, started in Dec 2006 as a 10 year fund, is still open to new investors. It would be fair to say they are having trouble attracting sufficient investors. Macquarie’s website reveals

“GIF III is an unlisted 10 year closed end fund with a focus on infrastructure or infrastructure-like assets in the OECD and OECD-like countries. GIF III is currently open to new investors.


GIF III aims to invest in assets that exhibit a sustainable competitive advantage over other participants in the relevant sector, add value to investments through active management and return funds to investors once investments have been divested.”


GIF III has four investments in infrastructure assets.


·       24.4% Retirement Care NZ the largest aged care infrastructure provider in NZ.

·       6.6% Global Tower Partners the largest third-party operator of wireless towers in US.

·       50.1% Hobart Airport.

·       27.9% Pisto, an oil storage transportation and distribution business in Europe.


One would expect investors world wide to be clamouring to get a piece of those assets, but GIF III is still looking for initial investors. It is due to be wound up in 2017.  A short term investor (GIF) struggling to attract investors after a quick buck, in partnership with a long term investor (RBF) with lots of members in for the long haul. An odd couple.

The structure of the airport deal very much mimics lots of other deals over the past decade. Macquarie Group, and some of their failed clones such as Allco and Babcock and Brown built up massive businesses by buying infrastructure assets, bundling them up with scary amounts of debt (and management fees to match) into various listed and non listed entities, with at least one to suit any retail or wholesale investor, super fund or other punter who lined up to participate. Investors have been told ad nauseum that assets such as airports, toll roads etc were such indispensable components of today’s world that shares in them were essential for any well balanced, long-term super fund.

And some of the early infrastructure investments have proved to be sound investments. But the quality deteriorated, partly because the supply of such assets dwindled and the greed and recklessness increased. The Macquarie styled BrisConnections fund epitomises the greed and absurdity of the model. Having run out of suitable assets to buy and resell, the Macquarie Group via BrisConnections received a license to build a toll road between Brisbane's airport and its northern suburbs. It was floated on an instalment basis similar to the Telstra floats, this time in 3 tranches. The first instalment of $1 was used to reward the promoters even before construction commenced. The share price quickly fell to 1/10th of one cent, the lowest quote available on the ASX. The low share price may seem attractive but any shareholder becomes liable to pay a further 2 instalments of $1 each. The Company is in gridlock. Day traders, who inadvertently bought at such a low price thinking there was nothing but upside, are unable to pay the instalments and the banks want their loans repaid.

Mark Hawthorne in The Age on 28th March 2009 in a succinct summary of the BrisConnections debacle wrote

“The capital raising for BrisConnections is very much the famed "Macquarie model" in action, with huge leverage involved. The $4.8 billion project cost is funded by $3.2 billion of debt, and gearing of about 65 per cent.

It was also a typical Macquarie model in another way — for putting together one of the worst-performing floats Australia has seen in decades, the investment bank picked up $110 million in lucrative fees.

That includes an advisory fee of $56.1 million, a sponsor development fee of $12.5 million, an equity underwriting fee of $28.2 million and a dividend reinvestment plan underwriting fee of $14 million. Macquarie will also be BrisConnections' exclusive financial adviser for a decade”

It was not simply the high level of debt that has been a problem. Often borrowed funds were used to fund distributions to investors. This was an approach pioneered by Macquarie Group which found favour with many promoters, but which is now largely discredited. Just another variety of Ponzi scheme. Not as bad as Bernie Madoff or MIS promoters like Great Southern, but clearly unsustainable.

Infrastructure assets are often described as defensive assets characterised by steady income streams and secure capital growth. They are grouped by asset consultants as ‘alternative’ assets (as distinct from shares and property). But there is an unerring similarity between all asset classes when they are laden with debt. The market currently seems to have discovered a new way of classifying assets. It classifies them according to the amount of debt being carried.

No matter what the quality of an asset, it won’t be a good investment if the returns are insufficient to meet the often considerable debt obligations and management fees.

And then there’s the possibility of asset write downs. Scott Rochfort in the SMH on 17th December 2008 wrote as follows

“Macquarie Infrastructure Group has slashed the value of its toll road portfolio a further $2.1 billion, blaming the "current dislocation" in the world economy for the big write-down.

Barely four months since the group cut the value of its portfolio from $10.2 billion to $8.6 billion, while presenting its full-year accounts, MIG warned yesterday it expected its valuation to be about $6.5 billion at December 31.

It is the starkest admission to date by any Australian-listed toll road operator that the sector is not as safe as once assumed.”

The structure of the Hobart Airport consortium is very similar to Sydney Airport. There are equity contributions, some of which are Redeemable Preference Shares which will be redeemed when the time is opportune but meanwhile are treated as debt for accounting purposes. Then there are the bank loans. Scott Rochfort, again, in the SMH on 5th March 2009 commented on Sydney Airport’s latest result. He said, inter alia

“Sydney Airport has added to the jitters surrounding the state of its financial health, after it reported a $146 million loss and a blow-out in the interest bill on its $8.1 billion of debt.

Its full-year accounts show its income fell well short of its interest bill last year, offering a possible explanation why its major shareholder, Macquarie Airports, announced last week it would divert the bulk of an intended $1 billion share buyback as an equity injection into the airport.

The airport reported earnings before interest and tax (EBIT) of $460.7 million for the year - $47.9 million higher than the previous year.

Despite the rise, it was still $195.1 million short of the $655.8 million in costs Sydney Airport incurred financing its massive pile of debt, which includes $1.5 billion of preference shares which attract a fixed 13.5 per cent dividend rate.

One factor that has helped strengthen the airport's balance sheet against its increasing debts has been the rise in the valuation it has put on its asset values. In one striking example, Sydney Airport's operators' licence - which it treats as an intangible on its balance sheet - increased in value from $544 million on June 30 2003 to $1.9 billion on December 31.

Sydney Airport's $8.1 billion of debts - shown in the latest accounts - are more than six times what they were when the asset was sold by the Howard government to a Macquarie-led Southern Cross Airports consortium in June 2002. When the airport was first privatised in 2002 it had borrowings of $1.2 billion.”

This newspaper story drew a response from the CEO of the Airport Russell Balding who replied, in part

“The Sydney Morning Herald story titled "Interest bill on $8 billion debt pushes Sydney Airport into the red" misrepresents the financial health of the Sydney Airport business. Sydney Airport is in a strong financial position, generating EBITDA of $653 million in the year to December 2008 of which $250 million remained as excess operating cash after all external debt service.

 Sydney Airport's interest payment, as reported in its statutory results, and described in a number of paragraphs in the directors' report, includes shareholder dividends on redeemable preference shares which are paid after all costs (including debt servicing) are met.   Importantly, the airport's net senior debt level after the agreed shareholder contribution will be approximately $4.5 billion. The total debt figure contained in the financial statements includes the redeemable preference shares, which are held by all shareholders and are treated as debt for the purposes of the financial reports.”

As stated above, the Sydney story has been repeated in Hobart, perhaps with the Southern rendition being a little less convincing. In 2008 there’s was not quite enough profit to cover interest payable on the external debt let alone the RPSs. This was despite over $2 million in one off interest earned in that period. Investors will definitely require capital growth. And that depends on the Airport’s turnover and what multiple of earnings a Buyer might be prepared to pay. But having paid near the top at 27 times EBITDA, the current consortium might struggle to achieve enough capital growth to justify the extra risks. Sydney Airport insiders have been reported as saying the Airport is worth a multiple of 18 times earnings. Other observers put the multiple at between 10 and 13. Whatever the figure, the Hobart multiple will surely be less.

But what does all this mean to a RBF member?

RBF at 30th June 2008 had funds under management (FUM) of $3.5 billion. It looks after 2 accumulation style funds (the Accumulation Scheme and the Investment Account) as well as 5 defined benefit funds (the principal one being the Contributory Scheme which is now closed to new members). FUM were roughly split 50:50 between the accumulation funds and the defined benefit schemes. A member of a defined benefit scheme need not be troubled by investment returns as his benefit is usually determined by factors such as years of service, amount contributed, final salary etc. A member of an accumulation fund is however at the mercy of investment returns.

The portfolio of alternative investments (which includes the Airport investment) increased by approximately $200 million during 2008, 64% being the defined benefit funds’ share with the balance being the share relating to the accumulation funds. The defined benefit funds increased their investment in alternative assets from 10% of their total assets to 17%, while the share for accumulation funds grew from 8% to 12%. The Board’s investment strategy allows for altering the mix of asset classes between the various investment options available to investors. It is not clear if a particular asset class, or indeed a particular asset, can be allocated entirely to the defined benefit funds. To the extent that the Airport is an asset of the defined benefit funds, and it turns out to be a complete dud, then defined benefit scheme members will not suffer. The Government will simply have more of a shortfall in its unfunded amount. In other words it will simply have to repay some of the $352 million received when it sold the Airport. Just another example of moral hazard providing a useful fall back position for RBF.

At about the same time as the Airport deal, RBF made another investment in an unlisted investment vehicle, Retirement Villages Group (RVG), in this instance jointly managed by Macquarie Group and FKP Property Group. FKP reported a staggering $20.1 million loss in respect of its remaining 15.8% share of RVG for the 6 months ended 31st December 2008. It is not clear what % share is owned by RBF, but RBF lists its investment in RVG at $72.2 million at 30th June 2008. During the last 6 months, FKP’s interest was diluted from 20.1% to 15.8% when it didn’t participate in the $235 million capital raising required to pay down some debt. The new debt raising would probably have come as a surprise to RBF so soon after they joined the syndicate. It is not known whether RBF chose to contribute extra funds.

All this begs the question as to how RBF members are able to make an informed decision as to whether to direct their super investment into a particular asset class with even less information at their disposal than a shareholder of a listed company. The newsletters and other member handouts are not dissimilar to some of the more banal outpourings from retail funds. The TGC and RVG investments may only represent 5% to 6% of total assets of RBF, but they comprise 15% of the asset class Property and Alternative Investments which incidentally also includes the burnt remains of Myer’s Hobart store.

To be fair, RBF’s past investment record has been perfectly acceptable. Property and Alternative Investments was the best performing asset class over a 3 and 5 year basis, in 2008, the return was 10% when Aussie shares did -15% and international shares did -18%. But the latest 12 months return (until 28th February 2009) for Property and Alternative Investments is only 1%. It is not clear to what extent asset write downs have occurred.  MTAA the top performing super fund in terms of performance over three, five, seven and ten years revalues unlisted assets on average every 3 1/2 months.

Whatever write downs eventuate, it is likely that RBF will approach investments in infrastructure assets and retirement villages with much more caution in the future. The RBF were probably mesmerised by the sharp suits from Martin Place. The significant shift into Macquarie style unlisted property and alternative investments occurred just before the start of the downturn.

Time will be the judge. Pretty soon most likely.


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