Babcock & Brown — once a strapping, cocksure investment bank — has been reduced to a withered wreck, on the cusp of death, kept alive with life support being applied by its financiers.

The Age reported yesterday that “a delisting event has occurred [with Babcock] shares suspended from trading for more than 20 consecutive business days, meaning Babcock & Brown’s noteholders are entitled to request repayment.” Babcock’s survival in any form is now dependant on its subordinated noteholders agreeing to a restructure which will provide them with little return.

Given Babcock’s perilous state, several of its listed satellites have mysteriously stated that they will continue to investigate the possibility of internalising their management (currently, those satellites pay tens of millions of dollars to Babcock & Brown for management services and financial advice). Internalising management involves paying real cash to buyout the management agreements with Babcock. While most management agreements have not been publicly disclosed (in full), the agreements which have been made public indicate that termination is possible in the event that the manager (generally a wholly owned subsidiary of Babcock & Brown) becomes insolvent or enters administration or if the Babcock’s ownership of the manager falls below 75%.

Given Babcock’s somewhat dubious current financial position, it would be advisable for the Babcock satellites, such as Babcock & Brown Infrastructure, Babcock & Brown Capital and Babcock & Brown Wind Partners, to wait and see whether Babcock slips into administration. (Admittedly, the legal situation is slightly unclear as to whether the management agreements may be terminated in the event of a parent of the manager becoming insolvent or entering administration, as opposed to the manager itself).

In any event, instead of waiting for Babcock’s death and seeking a determination, Babcock & Brown Capital announced to the ASX on 11 February that “discussions with Babcock & Brown regarding the possible internalisation of BCM management are continuing in good faith”, with the company set to update shareholders prior to 27 February. Last November, BCM announced that it would pay BNB a total of $50 million to terminate their existing management agreement.

Similarly, BBI chairman, David Hamill, told the Sydney Morning Herald that BBI “directors had been working out a way to terminate the company’s management agreement with Babcock & Brown’s subsidiary. It would hold talks with Babcock & Brown in coming weeks.” Last year, Babcock & Brown Communities has bought out its ten-year management agreement with BNB (for $17.5 million) and the business has been partially sold to Lend Lease.

The value of the management agreements is significant. The Babcock & Brown Communities management agreement, which was the least onerous, cost $17.5 million and the BCM buy-out has been pitched at $50 million. Considering the fees paid by BBW, BBI and BBP last year (outlined below), the difference between the agreements being terminated due to insolvency compared with the agreements being ‘bought out’ would not be trifling. For example:

  • Babcock and Brown Power paid management fees of $22.4 million and financial and advisory fees of $83.4 million for a total of $105.8 million. (It is fair to suggest that BBP unit holders didn’t exactly receive value for money, given that BBP as an entity is currently worth a total of $45 million, down from $2 billion);
  • Babcock and Brown Wind Partners paid Babcock & Brown management fees of approximately $2 million and advisory fees of $153 million;
  • Babcock and Brown Capital paid various Babcock entities (including Babcock Capital Management, Babcock & Brown Securities and Babcock & Brown Australia) management and advisory fees of $27 million. As noted above, the cost of buying out the management agreement is $50 million; and
  • Babcock and Brown Infrastructure paid management fees of $21.9 million to Babcock in 2008 as well as $11.4 million for “management services”. These “services” included “investment, management, consultation and advisory services.” BNB also charged BBI $115 million for financial advisory services during 2008. In total, BBI paid Babcock and Brown a total of $147 million in 2008 (BBI’s current market capitalisation is currently $190 million).

While unit-holders in the satellites (which included highly paid fund managers) arguably have themselves to blame for their predicament (the funds’ prospectuses clearly outlined the fees which were to be paid to Babcock), it would also be fair to suggest that those unit-holders have suffered enough pain already without needing to spend millions buying out the management agreements from a near insolvent BNB.

In a final touch of absurdity, BCM is being advised by none other than Babcock & Brown itself (and UBS) with regards to the costly and possibly unnecessary termination of its management agreement with Babcock & Brown.

Peter Fray

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