While the sky high debt levels and frantic deal-making make analysing its funds a nightmare, the Babcock business itself is not difficult to understand. The company buys assets and then sells those assets to a managed fund. It collects fees on the way in, on the way out and for ever and a day.
Understandable but unsustainable
After a couple of days research, I’d describe it as understandable but unsustainable. My brother, an engineer, likes to argue the point with me, but infrastructure funds have their place. They should, however, be safe, conservative, income-producing investments. That would make them the opposite of the Babcock deal-making machines.
Take a look at the table below, which summarises Babcock’s revenue for the year to 31 December 2007.
|Revenue by type||Year ended
31 Dec 07($m)
| Year ended
31 Dec 06($m)
|Base fees from assets under mgmt (AUM)||217||118||84.7|
|Advisory fees from AUM||340||326||4.1|
|Performance fees from AUM||51||64||(19.9)|
|Other operating income||99||97||1.2|
|Operating Leasing trading profits||186||65||186.1|
|Third-party advisory fees||25||45||(44.7)|
There are two striking aspects. The first is that Babcock hardly generates a cent from external clients. The $25m in advisory fees collected from unrelated parties is barely enough to cover managing director Phil Green’s $22m pay package. Almost 99% of its revenue comes from its own balance sheet or funds managed by Babcock.
Revenues at risk
The other striking aspect is how much of the revenue is potentially unsustainable. I saw the odd fee in my time at Macquarie, but the level of advisory fees collected from Babcock’s own funds is truly out of this world. The funds paid $340m for ‘advice’ on top of the $217m in base fees and $51m in performance fees. The funds also bought assets off Babcock for $410m more than Babcock paid for them (development activity) and, as far as I can tell, the $186m ‘Operating Leasing trading profits’ also relates to the sale of assets to a Babcock managed fund. If the supposedly independent directors of the funds became truly independent, up to half Babcock’s revenue could be at risk.
The rest of Babcock’s revenue relates to base fees, performance fees and income generated from its own investments – it owns stakes in the listed funds it manages (co-investment income) and assets it holds on its own balance sheet (principal investment). They can presumably kiss the performance fees goodbye but, assuming they keep hold of the management contract, the base fees should be worth something.
And, assuming Babcock has paid sensible prices, the assets it owns should generate a return, meaning overall this business should be able to generate a profit (before paying interest on its debt at least). But is there some sort of significant competitive advantage?
Easiest game in the world
While the sharemarket was enjoying its meteoric rise from 2003 until 2007, Babcock’s business was the easiest game in the world. But, now that the tide has turned, the $750m record profit forecast for this year – presumably on the back of asset sales – should be the last hurrah.
At less than 3 times those earnings and a discount to book value, you don’t need a future anything like the past to make some money. You can, however, give up on the idea that there’s a nice wide moat around this business
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.