Babcock's thin lifeline

Babcock & Brown will survive for now even though its shares have pierced the $7.50 trigger point for the banks to review the group's lending arrangements.

It is simply too big to fail, at least until every avenue for a restructure and recapitalisation are exhausted.

As buyers desert the trading screen and the parent company spirals helplessly, almost self-fulfillingly, towards the "review'' threshold, the contagion has engulfed every Babcock satellite, possibly throwing up a few trading bargains.

The banks won't let Babcock fall, yet, even if the banks exercise their right to "review'', after the stock closed at $6.90 today .

Not only does Babcock control an array of essential services in energy and transport but both the mothership and its satellite stocks are owned by hundreds of thousands of small investors. Many of these are elderly investors who acquired the stocks for the handsome yield.

Pity it was a manufactured yield in most cases, paid, that is, from capital rather than cash flow.

When the present mayhem in the financial engineers is past and they are either dead or recapitalised and restructured the Macquarie-inspired advent of a trust structure that allows distributions to be paid out of capital will be deemed a policy disaster.

It has already claimed Centro, Allco, Rubicon and MFS, and now Babcock is perilously close to falling into the hands of its banks.

Just how close is the subject of intense scrutiny today as Babcock shares fell through $7.50 in afternoon trading.

The selling was heavy and appeared to be retail-led as CommSec has dominated selling volumes for the past two days. Further selling from major shareholder Barclays Group may have contributed again to the slide.

Speculation today centred on Babcock being attacked by hedge funds shorting Babcock into oblivion, but BusinessDay called around and there was no "borrow'' in the stock, or stock that is which was available to short.

A spokeswoman told BD she was confident the banks were not going to call the review. "There were comments this morning from our banks. They are not necessarily going to call it.'' Were they to call it, Babcock would still trade on for four months until the review were complete.

The spokeswoman also said that besides the 333.3 million shares on issue now there are another 50 million held in Babcock & Brown International Proprietary Limited (BBIPL), which represents another 13% of issued capital.



She confirmed that these shares could be converted into ordinary equity and be included in the trigger point calculation for the banks - as could some 33 million zero-priced options and other pre-IPO options priced at $5 at the float.

With the BBIPL stock, the price of the review event would come down to around $6.58 per share. That would mean that Babcock shares would have to trade above $6.58 at the four-month point.

Babcock's woes are, to a point, self-fulfilling as the $7.50 mark had been disclosed as the review point and buyers appear to have vanished in the panic.

Most of the selling, then, is coming from existing shareholders. Some of it will have been investors who took up stock in the Babcock placement in April pitched at $13.65 a share.

Other selling may be margin call-related as the stock's securities lending is pitched on a loan-to-value ratio (LVR) of 75%. The further it falls, the more forced sellers have been flushed out.

There is a likelihood that hedge funds who have been able to borrow stock may "cover'' today - or buy back their short positions if they are already short - or simply buy the stock for a bounce.

Longer term, the picture is more cloudy. It is clear the business model is broken and the market has little faith that management can replicate its track record of earnings growth by knocking out deal after deal and snipping big fees. Moreover, the combined entities and the assets they hold account for more than $50 billion in debt.

No plugging is more vigorous that in Babcock & Brown Power today. The stock was caned after it came out of a trading halt mid-morning and closed 31% down at 90 cents.

While BBP's banking syndicate has agreed to the $2.7 billion refinancing, there remains another $300 million to $400 million to be found, from somewhere, for working capital requirements. And that somewhere looks like it could well be the parent.

The fact that BBP has been hit with worries about gas supply thanks to the explosion at Apache's Veranus plant in WA does not help things.

But it is ratings agency Fitch that has also whipped up concern among banks and institutions. While Fitch has assigned a BBB rating on the $2.7 billion secured facility - a notch above junk status - the devil is in the rater's detail.

The investment grade rating covers the facility of $2.7 billion. Fitch gave the facility an investment grade rating of BBB minus. However, equity investors should also pay attention to the Fitch 'Issuer Default Rating' for BBPF, which is a non investment grade rating of BB+ - junk status in other words.

Equity holders rank behind debt providers in the event of a wind-up so Fitch is suggesting they pay attention to the elevated risk.