Babcock & Brown sank in a sea of debt during the Global Financial Crisis, soon leaving $70 billion of assets around the world up for grabs. Its rail business in WA went to the then little known Canadian financier, Brookfield. And Brookfield has made a killing, closing down 2,100k of narrow gauge track, funnelling profits offshore and forging a 280 per cent return, even tapping the government for grants. Michael West reports on the Brookfield’s buying spree.
After getting a serious toehold in Australia by acquiring construction giant Multiplex, Brookfield has been on an acquisition binge over the past ten years, snapping up infrastructure, rolling it into fancy trusts and funds, stripping out cash, injecting extreme levels of debt and siphoning billions in profits out to Caribbean tax havens.
These are the new masters of financial engineering and corporate welfare, most recently clinching 43 Australian hospitals via the successful $5 billion takeover bid for Healthscope. Now they have lobbed a bid for aged care and retirement village play, Aveo. Versus other buyers, Brookfield has a distinct advantage. It pays almost no tax so can afford to stump up more money.
The question is, will it last? Or will it unravel like Babcock & Brown in a morass of leverage? Debt, that is; both debt you can see and debt you can only guess at.
Like Babcock & Brown, Brookfield has a bamboozling financial structure, although one far less visible because it is not exposed to the scrutiny of the sharemarket and the gaze of investment analysts.
Like Babcock & Brown, this financial engineering juggernaut controls a massive suite of infrastructure assets, often essential public utilities, monopolies which have been privatised.
Out-Babcocking Babcock
Now Brookfield operates the very rail assets in Western Australia which Babcock used to run before it imploded in 2008. And they have well and truly out-Babcocked Babcock: plastering the assets with more debt, ramping up the related party deals, paying nary a skerrick in income tax, asset stripping, playing the government for grants, hiding stuff, letting service levels slide and ripping out billions to tax havens.
It is now called Arc Infrastructure, and if you go to the Arc accounts, you will find the very barest disclosures; not even a related party note from Brookfield and its auditors from Deloitte.
You can see the $2.7 billion in assets, the $1.66 billion in debt, the $74 million in interest payments raked out to who knows where, probably Bermuda or the Cayman Islands, and a $73 million dividend too, despite the tax and profit nothingness.
Yet, in a submission to the Surface Transportation Board (STB) in the US, there is some interesting analysis. The STB is one of the regulators who can approve or reject the takeover by Brookfield for the large US rail company, Genesee & Wyoming Inc (GWI). GWI also has assets here, also subject to offers.
The submission by boutique investor and research group, Dalrymple Finance, which is run by Victoria and Keith Dalrymple, is quite revelatory about Brookfield and Arc Infrastructure. The case put by the Dalrymples, which argues against US regulators approving the GWI bid, concerns the sheer financial risk which Brookfield poses given the group’s opacity, its financial engineering and heavy debt levels.
“Brookfield aggressively monetised its Australian rail asset through high debt levels, management fees, related party loans and distributions. Over $A1 billion were “upstreamed” from the rail asset from 2012 to 2016 after an initial investment of $A380 million in the business in 2010/11 (280% return on capital),” says the submission.
“The company has been in non-compliance with its reporting requirements since 2016 and has not filed statements with ASIC as required.”
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Typical of the arrogance of the multinational, and the oversight of the Australian regulators, this sort of compliance failure is all too common.
Victoria Dalrymple goes on to say in the submission that, due to the capital intensity of the business, “significant cash distributions are only possible through elevated debt levels”.
In other words, Brookfield is putting Western Australian taxpayers at risk in order to line the pockets of its executives and shareholders.
“Arc’s debt balances (current plus long-term debt, FX hedging) have increased from $A550 million in 2011 to $A1.67 billion in 2016 at the asset level. Revenues less than doubled before declining on significant customer mine closures that were well in the planning.
“Brookfield’s accounting choices under IFRS have allowed Arc to raise extraordinary levels of interest-only debt at pricing lower than that of some Class I operators with significantly higher credit ratings.”
To put this in perspective, Babcock & Brown bit the dust in 2008 with its excessive leverage but since Brookfield took over its rail assets, Arc’s debt has doubled.
Who guarantees Arc in the event of failure? Its accounts say there is a cross guarantee from other Brookfield entities. But how would this stand up in court? Would it even be challenged? Is anybody in government even watching?
The issue is bigger than Arc. It goes to the risk of the Brookfield model globally. The Dalrymple submission:
“The debt levels are higher than stated on the asset balance sheet due to the unique structure of Brookfield entities that creates additional leverage at multiple levels.
“We estimate total debt including proportional amounts at holding companies and up to Brookfield Infrastructure Partners, but not above, to exceed $A2.2 billion. Due to declining revenues from mine closures, the free cashflow (EBITDA – Maintenance) to Debt is estimated at 2% to 4% or 40x (compared to 4.8x or 20-25% current GWI level), essentially a non-viable financial structure.
“In sum, should the asset level debt default (mostly US 144A), there are limited cross-guarantees with other holding company assets but it is likely that the asset lease should be allowed to return to the government after the extraction of substantial benefits.”
According to SEC filings, Brookfield is acquiring GWI though an infrastructure fund that is commonly controlled and co-invested with its publicly-traded Bermuda-based partnership Brookfield Infrastructure Partners (BIP). BIP, in turn, has controlled 100% of Arc since 2010.
The risk therefore to Australia is not confined to individual entities but to the entire Brookfield group, such is the opacity and aggressive leverage.
“As Brookfield raises larger and larger infrastructure funds (latest Brookfield Infrastructure Fund IV raised $20B USD and is the investor behind the GWI acquisition) with undisclosed investor concentrations and terms, the influence of foreign investors on key US infrastructure is, in essence, unknown and subject to significant changes.”
The Foreign Investment Review Board has already waved through the Healthscope acquisition and is presently deliberating on the Aveo deal. Yet the question must be asked; as Brookfield pays so little tax in Australia, what is the national interest in allowing this tax haven operator to buy billions of dollars buying key infrastructure when it merely siphons the profits offshore?
Postscript:
The story quotes the STB submission saying that Arc has been in non-compliance since 2016 and has not filed statements with ASIC as required. This was true when the filing was made. However, Brookfield made the 2017 and 2018 filings on the same day 27/08/19, a week after the STB submission was filed.
These late filings are another example of Brookfield’s failure to comply with the laws of Australia. It is an offence to file late financial statements. It seems it took a complaint to the US regulator with authority over the Genesee transaction to have an impact.
Brookfield and Arc were approached for comment. They declined.
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Michael West established Michael West Media in 2016 to focus on journalism of high public interest, particularly the rising power of corporations over democracy. West was formerly a journalist and editor with Fairfax newspapers, a columnist for News Corp and even, once, a stockbroker.