19/03/2008 - 22:00

Briefcase: Private equity perils exposed

19/03/2008 - 22:00


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Briefcase, in another guise, was strident in its opposition to last year’s private equity bid for Australia’s major airline and former national carrier, Qantas.

Briefcase, in another guise, was strident in its opposition to last year’s private equity bid for Australia’s major airline and former national carrier, Qantas.

Qantas is a prime piece of Australia’s transport infrastructure network, whose influence stretches well beyond its boardroom and the shareholders of that company.

Just like its telecommunication network, an efficient and cost-effective national transport network, be it rail, road, ship or air, is vital to the overall financial health of the nation and any benefit derived from that network stretches well beyond the individual user or customer.

All Australians derive a benefit from the existence of Qantas and indeed any working airline link, no matter if we fly or not.

Just imagine for a moment where Qantas would be today if Allco and its clever hedge fund mates in the US had had their way with the organisation? What position would Qantas be in today if it had been hocked to the hilt while sub-prime madness, lifted its funding costs and made renewal of that debt all but impossible? I can tell you that Virgin Blue does not have enough planes or pilots to service the market and it’s a long way to walk between Perth and Melbourne, which might have been the only other way to make that journey.

Allco is currently struggling for survival and many of its highly leveraged supporters in the Qantas deal are also on the bones of their collective bums, or have gone completely out the door.

Thankfully, a couple of local fund managers stood up and were counted on this matter while another fund in the US was so incompetent that it could not even get its forms in on time, thus saving Qantas from a near-death experience in the current market.

I say they all deserve an AO for services to transport.

••• In the past, Briefcase has been critical of Babcock & Brown (BNB), characterising it as being one of the pea-and-thimble brigade, shuffling assets around on a table without actually creating anything new, while adding a bit of debt here and slicing off an asset there before repackaging the whole lot and reselling it on the basis of a manufactured yield, while pocketing a huge fee and ongoing management rights.

The one thing I will concede about BNB is that those running the show are smart and they know about value.

BNB showed great foresight in 1997 when it bought the shell of the federal government’s old investment arm, AIDC Limited, picking up bits and pieces from that largely floundering organisation.

Well, last week, BNB also picked up about 5.1 per cent of each of Allco’s Rubicon Trusts at bargain basement prices, representing between 25 and 30 per cent of the stated net tangible asset backing of each trust.

Briefcase is not in a position to estimate the real value of these trusts, but would hazard a guess that the current market price is a fair estimate to BNB’s entrance price, and looks to be a bargain basement, bottom-of-the-market deal.

If BNB is able to secure management of these trusts, it will have set up a gravy train of fees which it can ride for many years.

BNB’s move is symptomatic of the value now appearing in many sectors of this market.

Briefcase is not calling the base yet, but expects more of this ‘vulture’ buying as stocks get sold down to unsustainably low levels and true value appears.

Last week the market found resistance at previous support, around 5,400, but the US banks report next week, which will not be a pretty sight, and Australian banks will follow suit in May, so a lot of money will stay on the sidelines until that news is out.

••• Bottom picking is a dangerous pastime, but a rising level of caution in this market leads me to believe that we may now be just 400 points or about 8 per cent away from some sort of base.

Reading the tea leaves (charts) indicates to me that the All Ords Index could find support at around 4,750 points (a little above my previous estimate of 4,600), which, given recent market action, could be little more than five or six days of negative trading.

While the recent market retreat continues to involve the banks, the big resources companies have now begun to contribute on the downside, as I said they might last week.

Most funds will now be focused on bank profits, to be reported during May, so as to judge the extent of their lending book impairment.

Briefcase would like to point to the potential economic impact of the impending arrival of peak oil production, or more correctly, the impact of falling oil supplies on global economic activity, post peak oil.

Peak oil is that time when global oil production begins to decline.

So far, the world has consumed about 1 trillion barrels of oil, mostly in the past 100 years.

Geologists say that this is about half of the oil which can easily be recovered from our planet.

Over the past 28 years, the rate of new oil discovery has fallen increasingly below the rate of oil consumption, so defined reserves in the ground have been depleted.

A growing realisation that the end of cheap oil has arrived will have long lasting impacts on all of us.

The impact of peak oil on the whole fabric of our globalised world economy is the $64 question.

Briefcase is sure that the current system, which relies on cheap transport to make it all work, will come under strain, as new transport technologies struggle to fill the gap in the time frame required.

So my summary is that, once peak oil arrives and is recognised and the enormity of its impact is assessed, there is potential for major economic dislocation and a long-lasting global economic shock as higher energy costs are factored through to every aspect of the economy.

If we wanted to be super negative on the current bear market, we might surmise that the consequences of peak oil will take over from sub-prime madness as the driver for recession.

With this in mind, I have long recommended a heavily overweight position in oil producers, not that these stocks have performed any better than the market over recent months, but I firmly believe that they will outperform in the longer term.

••• During March, the market faces an added headwind from companies going ex-dividend.

This action alone promises to move the market 3 per cent to 4 per cent lower.

While this bear market does look to have further to run, the good news is that every day of negative trade is one closer to the bottom.

••• • Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.



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