BABCOCK & BROWN'S SHAREPRICE MELTDOWN

UNCLAS SECTION 01 OF 02 CANBERRA 000623

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON AS
SUBJECT: BABCOCK & BROWN'S SHAREPRICE MELTDOWN



1. (U) Summary: Australian investment bank Babcock & Brown
(B&B) lost over half its share value in the week of June 9
over concerns it could not manage its debt load. B&B stock
has been recovering this week. The Australian Securities
Exchange has said there is no sign of market manipulation;
regulators have been quiet. B&B is a large operator in North
America and Europe as well as in Australia, in particular in
infrastructure andenergy. End summary.


2. (SBU) Babcock & Brown (B&B) is Australia's second-largest
merchant (investment) bank with an emphasis on infrastructure
funds and significant investments in the United States and
Europe in addition to Australia. Its operations in North
America are significant - in 2007 35% of B&B's global
revenues of A$2 billion (A$1 = US$0.94 approximately) came
from North America, and about a third of its A$56 billion
worth of managed assets are in North America, including major
ethanol and wind energy projects and the consortium to build
and operate the Miami Access Tunnel in Florida. It also has
real estate and transport projects in North America.


3. (SBU) B&B followed in the footsteps of its larger
Australian rival Macquarie Bank in buying infrastructure
assets and then spinning them off into separate companies
that hired B&B for long-term management contracts. Babcock
made money from charging a transaction fee for the original
purchase as well as the sale, as well as handling the bond
issuances in addition to the management fees. In addition,
B&B was then able to list a number of these companies on the
Australian Stock Exchange. This model generated significant
revenue streams, making B&B very profitable and allowing
rapid expansion - Babcock and its related companies hold
assets around the world estimated as being worth between
$60-80 billion. However, B&B depended on very significant
leverage, first to do the deals themselves and then to
operate its companies. This has made it very vulnerable to
higher funding costs, particularly as B&B is viewed by the
markets as being opaque about its operations and exposure to
higher funding costs.


4. (U) Like many financial institutions, B&B had felt
downward pressure on its share price since October 2007,
thanks to global financial conditions. But the pressure on
B&B grew extreme during the short Australian trading week
last week. Amid concerns that B&B's debts, including a new
A$2.8 billion loan closed in April, were growing too great to
manage, B&B share prices fell from A$11.16 to A$5.25 last
week. The rout picked up later in the week after analysts
pointed out that a drop below A$7.50 would reduce B&B's
market capitalization below A$2.5 billion, which would allow
creditors to call for a review of the April A$2.8 billion
loan. To date, no such call for a review has been made.


5. (U) Business reporting and media analysis also indicates a
lack of confidence in B&B management. This week, B&B has
announced plans to appoint independent chairman to the boards
of its four Australian-listed satellite funds that don't
already have such positions. So far this week, B&B has
recovered some lost ground; as of mid-afternoon Wednesday
June 18, its share price was up to A$6.86.


6. (SBU) The question of market manipulation has been
mentioned in at least one media report about the B&B rout and
has been suggested by some of our contacts. The Australian
Qhas been suggested by some of our contacts. The Australian
Securities Exchange has said it is closely monitoring trading
in B&B, but noted it saw no indication of any manipulation.
The Australian Securities and Investment Commission has made
no public comment. One experienced economic journalist told
us he was convinced this was a case of manipulation. A
longtime contact who is a trader at a major investment bank
expressed similar sentiments, though stressing that he had no
proof. He speculated that hedge funds had targeted B&B
because of its size (big enough to make a raid worthwhile but
small enough to minimize the chances of getting burned) and
very legitimate questions about its funding model.


7. (SBU) A trader with a bank in Melbourne told Embassy that
the questions in financial circles were centered on where all
the sold B&B stock came from. He said there was talk that
the B&B slump was driven by speculative short-selling by
hedge funds, and that the improvement in B&B's share price
this week could be short-sellers buying stocks in order to
meet their contracts rather than a fundamental judgment in
B&B's viability as a good place to invest. He also noted
that Fidelity's recent decision to drop its holdings in B&B

CANBERRA 00000623 002 OF 002


from 7.5% to 5% would also have increased downward pressure
on B&B's share value. Another financial journalist expressed
doubt about reports of manipulation, saying that some of the
complaints sound like sour grapes from people who were burned
by the rapid fall in the share price. However, this contact
commented that he has been surprised by the extent and the
persistence of rumors that B&B's share price collapse
reflected some kind of manipulation.

MCCALLUM