Australia's Next Top Model


A year is a long time in business, but in the case of Australia’s listed infrastructure trust (LIT) and listed property trust (LPT) sectors it is almost their entire lifetime. A glance at the list of The Diplomat Global 100 reveals that almost 20 per cent are property and infrastructure trusts. Until the debt crisis, these listed entities were seen as defensive stocks, offering excellent yields, with global tentacles. But now, their once-lauded business models have been thrown into jeopardy as investors become increasingly intolerant of complicated businesses laden with debt.

Indeed, the dominance by property and infrastructure trusts of The Diplomat Global 100 reflects the development of a real global niche. Over the past five years, having grown fat on Australian property and infrastructure assets, these businesses formed consortiums and bought big overseas. Many own major pieces of infrastructure, including airports, tollways, gas pipes, sewerage companies, and big shopping malls.

However, there are now serious questions about the sector’s future. All eight of Macquarie Bank’s infrastructure and property trusts, two Babcock & Brown infrastructure trusts, plus the other eight that make up the sector in The Diplomat Global 100, have seen their share prices fall sharply in the past six months, and some are battling to survive. These include David Coe’s Allco Finance Group (rank 69), and one of the three property trusts it bought and managed, Rubicon Europe Trust (rank 83).

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The problems facing LITs go to the core of their business models. Macquarie Bank (rank 9) and Babcock & Brown (rank 20) have spent years buying offshore infrastructure assets – such as a long-term lease on a bridge, road, airport or power station – then packaging the deals, gearing them up, and selling them to one of the specialised funds that they manage. They entice retail investors to invest in them with the lure of “yield”, while taking management and performance fees.

Macquarie made its name as a long-term holder of big infrastructure assets, and its chief fame comes from toll roads. Interests in a host of them – from the Chicago Skyway to Britain’s M6 Tollway; from Highway 407 in southern Ontario to the Indiana Toll Road, the so-called Main Street of the Midwest – repose in the Macquarie Infrastructure Group (rank 23), the oldest and biggest of the bank’s 31 specialist infrastructure funds.

But the Macquarie and Babcock models rely on large sums of debt. As global financial markets have seized up and become more risk averse, their share prices have been battered by investors wanting to get out as well as hedge funds shorting stocks that promote “yield”.

Charlie Aitken, head of equities at Southern Cross Equities, recently said, “The hedgies (hedge funds) have had tremendous success in Australia shorting ‘yield’. Yield was meant to be defensive but the hedgies have successfully smashed the banking, LPT, asset manager, and diversified financial sectors. They have shorted the yield sectors and crushed share prices. ‘Yield’ reliant on debt-funded business models has been particularly attacked, and there is nothing surer than that the hedgies are lining up for an attack on the infrastructure sector where asset revaluations will be negative, funding costs rising, and most ‘distributions’ are paid out of borrowings.

“I just get the feeling the infrastructure bubble is going to burst in a world of much tighter credit markets and negative revaluations. If ever there was a sector ripe for hedge fund shorting it is the Australian infrastructure sector.”
Opaque problems
The LPT sector was the best performing investment asset class for a decade, but lost almost a quarter of its value in the year to January 31. Part of the reason is that the once simple LPT structure, known for its straightforward, income-earning capabilities, has morphed in recent years into complex stapled structures – structures that wrap up fees from funds management with the performance of property assets.

As long as banks lent cash, LPT fund managers bought properties to satisfy investors’ hunger for higher returns. This addiction to higher returns sent them searching overseas, often buying overpriced properties in the UK, Japan and Europe, and loading them with debt.

Soon, investors found that yield can be a trap when too much debt is involved. Indeed, when Centro Properties Group (rank 86) announced results in December, it became clear that yield can sink to zero under heavy debt.

Now investors, made wary by the yield trap, are turning a more cautious eye upon the cashflow trap in the LIT sector.

Brett Le Mesurier, banking analyst at Wilson HTM, believes the recent credit market crisis has accelerated a rethink of the Macquarie Bank and Babcock & Brown business models.

“In the listed trusts, what was happening was a high proportion of cash flow was going out in fees, which wasn’t a good look,” Le Mesurier said.

Le Mesurier says the LIT parents are responding by moving to the unlisted sector. The reason is simple: unlisted funds don’t require a prospectus. The value of the fund is not marked to market daily because they are private and the fee structure is more skewed towards a higher base fee and lower performance fee.

Le Mesurier says a further problem is that some of the financially engineered companies are secretive and keep investors in the dark about how all the pieces of the financial puzzle fit together. “Even the best brains would have little hope of putting together the true situation. Why? There is often leverage on leverage,” he says.

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