The recent protest vote against the Transurban remuneration report was apparently based on the perception that performance hurdles for executives were too low. The hurdles are based on EBITDA (earnings before interest, tax, depreciation and amortisation). This measure is entirely inappropriate because it obviously ignores any recognition of debt and its consequences.
This article attempts to set the record straight as to the real financial performance of Transurban, which may not have been properly understood by investors. It is based on an analysis of Transurban by the author recently published in the United States by the peer-reviewed Journal of Business Evaluation and Economic Loss Analysis (Berkeley Electronic Press).
The use of EBITDA would have the effect of directing investors’ attention away from the consequences of a huge increase in borrowings when Transurban acquired the M2 Motorway for which it unwisely paid $2.4 billion.
Moreover, for decades, particularly in the US, the economic literature has prescribed the ratio of cash at bank to total liabilities as the most appropriate and best predictor of insolvency well ahead of the event. When applied to Transurban, the trend to insolvency is unmistakeable. In 2005, the predictor ratio was 11.4% and had fallen to 2.7% in 2009. In plain language, the liabilities have been increasing at a faster rate than the cash at bank.
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The executive directors and other key management personnel on a total income (cash and benefits) of $18.4 million would have been unlikely to draw attention to the potential for insolvency or other disturbing aspects of their business. Take for example the debt service costs. Over the period 2000-2009, 80.6% of all toll revenue was used to pay interest on the borrowings.
So, where did the money come from to pay distributions to investors? It came from an undisclosed form of arbitrage, possibly using interest rate swaps based on debt. For years this risky financial tactic was disguised by misleading claims that the distributions were “paid out of debt”. The practice is continuing, emphasising the failure of the Transurban Group to generate enough toll revenue.
Transurban’s assets consist of Melbourne City Link, M2 Motorway and part ownership of four other toll roads in Australia and one in the United States, the Pocahontas Parkway. Perhaps the most significant finding is that these assets were grossly overvalued in 2008 by between $1.9 billion and $2.6 billion compared to the valuation claimed in the accounts.
Transurban shares are therefore grossly overvalued on the basis of net asset backing, and a properly informed market would have recognised this overvaluation and reacted to it. Overvaluation should disqualify Transurban from raising extra debt capital. It is also in the interest of superannuation funds not to increase their equity stake in such a business.
Transurban is destined to join the worldwide queue of over-valued toll roads mired in debt and based on misleading financial models. It is to be hoped that the Productivity Commission’s new rules will ensure that the entire overpaid board of Transurban responsible for its undisclosed financial position be terminated.
John L Goldberg, Faculty of Architecture, The University of Sydney 2006