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 The IPO that died of shame - Eureka Report article 

August 1, 2008
The IPO that died of shame
By Scott Francis

PORTFOLIO POINT: The BrisConnections tollway float destroyed about $250 million of investor wealth - a similar amount to the Fincorp and Westpoint collapses.


The stunning failure of the BrisConnections float - issued at $1 and closing today at 38.5 - leaves the financial services industry with a lot of questions to answer.

Retail investors who were persuaded to take a position in the float have seen two-thirds of the value of their application cheque sliced off their investment. The poor performance of the float can hardly be a surprise: two weeks ago we commented on the lack of cash flow from the opportunity, the manufactured yield that comes from issuing more units for distributions; and the poor performance of the recent RiverCity float.

As we said on July 21: "The BrisConnections float should be a 'safe option'; in fact it's speculative and the big underwriting fees reveal the risk." (See Tollway float not hazard-free.)

The media this morning carried quotes from BrisConnections' well-regarded chairman, Trevor Rowe (chairman of both BrisConnections and BrisConnections shareholder Queensland Investment Corporation) suggesting that the float is now carrying a "day-one yield of 28%". Unfortunately for those involved in the BrisConnections float, it seems that investors have looked past this "manufactured yield" to see that there is no real cash flow for some years.

Indeed, there seems to be a touch of denial in even talking about this pretend yield. The reality is simple: there is no true cash flow from the toll road operation for some time. Any other suggestion is spin, and that's a shame because when investors are considering putting money into the market in these volatile conditions, they deserve better.

Even more than this, the fact that distributions are to be paid out of money raised by issuing more units may be a drag on investments. The lower the unit price at any time, the more units will need to be issued to make a payment.

For example, with the units trading at $1, an investor entitled to a $1000 distribution would receive 1000 additional units in the dividend re-investment program. At the moment, with units trading below 40, 2500 units have to be issued to make the same payment. This will significantly dilute the holdings of any unit holder who chooses to receive their "distribution" as cash.

This level of wealth destruction is not to be sneezed at. At a micro-level, consider an investor who was tempted by the high "income" and invested $10,000. At the time of writing, their holding is now valued at less than $4000, and their holding will be diluted further if they decide to take their much-promoted distributions as cash rather than extra units. At a macro level, the pure float of $400 million has fallen in value to about $160 million: wealth destruction of $240 million. This is of a similar order to the amount of wealth destroyed by Fincorp or Westpoint.



This flop will frustrate and embarrass many: QIC, which manages the Queensland State Government's QSuper (which has a strong performance history), is a major shareholder in BrisConnections, owning 25 million units. At a unit price of 38.5, this is currently a big mistake for QIC and possibly QSuper investors.

Macquarie received a fee as a co-underwriter of the BrisConnections float, and has ended up holding a significant portion of the company. Macquarie Financial Services holds 5.27% of the company, Macquarie Investment Holdings 7.25%, the Macquarie Alpha Opportunities fund 1.4% and the Macquarie Australian Long Short Equities fund holds 1.2%.

Investors in Macquarie funds that ended up holding slices of the BrisConnections float might wonder if they are part owners of BrisConnections because their fund managers thought it was a great buy, or because it helped Macquarie fulfil its underwriting duties?

Of course, this is no different to retail investors who were encouraged by advisers from any of the underwriters of the float, including Macquarie, Credit Suisse, Deutsche Bank and JP Morgan. Almost any underwriting process has a significant potential conflict of interest built into it. On the one hand, the company takes a fee to guarantee that all stock in a float is taken. On the other hand, it is making recommendations to clients about whether the investment is in their best interests.

Suddenly the strategy of Transurban chief executive Chris Lynch to only fund distributions out of cash flow is looking like a far more acceptable model to investors. He describes the plan as a "cleaner and easier to understand investment proposition". The evidence from the BrisConnections float seems to show people voting with their feet - manufactured yield through distribution reinvestment plans does not seem to attract the attention of a market that must be increasingly careful about the use of debt and the cash flow generated by investments.

Conclusion

The concerns about the BrisConnections float were significant and easily identifiable for most investors, but the float went ahead anyway, with the support of four big underwriters. With about $250 million in wealth destroyed by the float, questions can reasonably be asked, particularly by investors who either directly or indirectly (ie, through a managed investment) ended up with their money in the float.

We must ask: Did the underwriting process serve investors well here? Did relationships between Macquarie as underwriter and Macquarie as a fund manager cloud investment decisions? Did inherent support for Brisbane cloud the decision of QIC? And were retail investors who purchased units in the float well advised
Scott Francis' articles in the Eureka Report 

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