Babcock & Brown shares closed at $6.00 last night – only marginally above record lows as the company announced a “shock” profit downgrade. BNB stated that interim net profit (for the six months ending 30 June) is expected to be 25 to 40% below the 2007 figure of $250 million. That will mean that 2008 full year earnings will be less than the $643 million booked in 2007.

The result appeared to be a surprise to BNB, whose beleaguered CEO, Phil Green, only last month confirmed that earnings would grow at 14%.

However, the downgrade wasn’t unexpected by the market, which had already written Babcock shares down from $33 to around $6.50. At Crikey, we joined the skepticism of Babcock, especially with regards to its significant property investments. In June, we noted that:

In its 2007 Annual Report, BNB claimed that “the portfolio is performing well, benefiting from the current turmoil in the home mortgage market in North America”. This appears to be a somewhat bemusing comment, given that since Babcock spent around $1 billion to acquire US residential properties the US residential property market has dropped by around 14.4% according to the Case-Shiller index.

Unsurprisingly, Babcock’s profit forecast yesterday noted that:

The decline in the interim result is primarily due to non cash impairment provisions flowing through equity accounted investments, in particular real estate and Everest Babcock & Brown and provisions taken against real estate and other Corporate & Structured Finance assets.

The profit downgrade also raises significant doubt on the basic competency of the highly paid Babcock executive team. While the write-off itself isn’t surprising, Babcock’s previous confidence was. Eric Johnson in today’s Financial Review made a salient point, noting that:

[The] bankers [who agreed to waive the market capitalisation clause in Babcock’s debt facility] have a right to feel upset, unless in their private briefing they were sent a different message on asset valuations and profits.

 “If they told their bankers $750 million was unlikely…how come it has taken so long for us to know,” one fund manager asked yesterday.

Bankers are by rights a reasonably cautious lot, especially in the midst of a credit crunch. It would appear inconceivable that they would agree to waive the market-cap clause unless Babcock confirmed the underlying profitability of the business. That means that Babcock either misled their bankers (by standing behind the $750 million forecast despite market conditions) or simply had no idea as to the underlying weaknesses in their myriad of businesses.

Babcock’s failure is made even worse by the fact that the write-offs related to its holding in Everest Babcock & Brown (whose share price has dropped by more than 80%) were patently obvious. As was the poor performance of its real estate assets.

Babcock’s credibility is in tatters. Phil Green and his merry band of followers will be hoping that this profit downgrade is not the first of many. Fat chance.

Peter Fray

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