Earlier this the week, the world’s most famous short seller, Jim Chanos, founder of Kynikos Associates, told the Ira W. Sohn Investment Research Conference in New York that of all stocks around the world, he liked our very own Macquarie Bank as a “short”.
Chanos’s comments didn’t impress Macquarie Bank CEO, Allan Moss, who hit back on Tuesday, noting that:
[Macquarie’s] business is a lot more than infrastructure and real estate, although infrastructure and real estate are very important.
[What are Macquarie’s businesses?] Well, they’re tollways. How bad does it have to be, really, before the people in this room get on the bus? How bad does it really have to be in economic terms before you cut down on water?
Sure, if there’s a water restriction you may water the garden less, but how bad does it have to be before actually you cut down on water simply because you can’t afford it?
How bad does it have to be that you won’t switch on the TV to get the signal from the communications tower?
But Moss’s explanation did little to appease Chanos, who spoke to PM last night and reiterated his criticism of the Macquarie model, claiming that:
The underlying economics [of the Macquarie model], in my opinion, are flawed. Being the top bidder for these assets and then flipping them into the trusts leads to an unsustainable economic engine at the trust level. And when that breaks down all of the fees and whatever’s being paid begin to break down.
Chanos also noted that part of Macquarie’s business is dependant on using accounting standards to re-value assets and consider the higher valuation as income:
If you look at the financial accounts of the trusts you’ll see that in almost all the cases the companies are using Australian re-valuation accounting which is legal under gap in your country to write up the value of the assets annually and put that through operating income and into equity.
Moss’s explanation didn’t really address Chanos’s point. Chanos didn’t suggest that the revenue earned by Macquarie’s satellites (such as toll roads or water assets) would drop; rather, that Macquarie’s profits were not being driven by organic revenue growth. Rather, Chanos claimed that the Macquarie model is driven by unsustainable arbitrary valuations being placed on assets.
Greatly simplifying what Chanos seems to be saying and transferring the Macquarie model to basic real estate, Macquarie is in effect, buying a house for $500,000, then transferring it to another vehicle (say, the “Macquarie House Group”) six months later. The Macquarie House Group then notices that rents have risen and the housing market is solid. MHG then revalues the house upwards to $600,000 (remember, six months earlier, no one was willing to pay even $500,000 for that same house).
The shareholders in Macquarie House Group are happy – their investment is worth around $100,000 more (less fees). Macquarie shareholders are happy because their investment banking group was able to charge a fee for the initial purchase, a fee for the sale to the vehicle and management fees to run the Macquarie House Group. In fact, everyone is happy. Well, until the assets owned by the Macquarie House Group stop going up. (Or in real life, until infrastructure assets such as water and toll roads stop appreciating and the river of fees dries up).
Chanos’s view certainly isn’t universal. JP Morgan analyst, Brian Johnson, was critical, noting to PM that “a lot of money is being lost basically shorting Macquarie Bank over the years. And while the model is certainly not without risk, the fact is the size of this potential market is absolutely massive.”
Chanos does have form though. When he first shorted Enron in October 2000, the disgraced Houston-based company was still a market-darling, having just announced 30% earnings growth and had just been named as “America’s Most Innovative Company” by Fortune magazine for the sixth year in a row.
Less than 14 months later, Enron filed for bankruptcy and Chanos had the last laugh. Time will tell if his instinct is accurate again.