Late last week, investment bank, Babcock & Brown released its 211 page Annual Report for the year ending December 2007. It’s often a fair assumption that the longer the Annual Report, the more the company wants to hide nasty stuff.

One of the best indicators of a company’s health is its operating cash performance. This is especially pertinent where the business is as confusing and opaque as Babcock (largely because accounting profit is more pliable than a good piece of play-dough, but cash is cash).

While Babcock trumpeted a large boost in earnings, from $308.6 million to $525.1 million (an increase of 70 percent), return-on-equity up by 33.5 percent and EPS 50.1 percent higher, operating cash flows actually were negative to the tune of $506 million. Part of Babcock’s strong profit performance was due to revaluation of assets upwards by almost $200 million.

Then there is the fact that BNB is highly geared, with assets of $15.6 billion compared with liabilities of $13.1 billion. $3.5 billion of BNB’s assets are real estate investments in Europe and Japan.

All this is hardly news though. Since late last year, the market has grown increasingly sceptical of financial alchemists like Allco, Babcock and even Macquarie in the prevailing environment of high interest rates and slumping real asset values. The market now values Babcock on a price-earning multiple of around seven.

Conveniently for Babcock executives like CEO, Phil Green, executive bonuses are not based on share price performance (or adjusted for post-balance date price falls), rather, they are dependant on a mix of return-on-equity, earnings-per-share and pre-tax profit (as well as a number of fuzzy KPI’s like “leadership” and “general management”). The complex formulas serve to befuddle any pesky shareholder who complains that $22 million is a little rich to run a company whose share price has halved in the last year.

To its credit, BNB moved slightly away from providing short-term cash incentives and instead, delivered fully vested shares to executives (Green’s cash bonus decreased from $14 million in 2006 to $4.8 million in 2007).

Since listing on the ASX in October 2004, Babcock’s share price has increased from $7.98 to $12.71 (just over 58 percent). During that same period, the All Ordinaries index has risen by 57 percent (while commercial and residential property has increased by even more). Therefore, Phil Green has been paid a total of more than $50 million to run a company which has basically tracked the broader index.

This is a complete indictment on BNB’s remuneration committee, which has needed to produce a 26-page Remuneration Report to vindicate the fact that its CEO (who just happens to be a member of the Remuneration Committee and attended all seven meetings last year) is being paid a fortune to produce a return for shareholders which barely beats the index.

Disclosure: The writer has a short economic interest in BNB

Peter Fray

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