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 Tollway float not hazard-free - Eureka Report article 

July 21, 2008
Tollway float not hazard-free
By Scott Francis
PORTFOLIO POINT: Despite the high yield, BrisConnections' lack of a track record makes it difficult to evaluate. Brisbane's other tollway, RiverCity, is trading well below its issue price.

BrisConnections, the $1.2 billion float of the Brisbane airport tollway project is set to be one of the biggest IPOs this year. With perhaps only the float of the Qantas frequent flyer program to rival it, BrisConnections would normally be attractive. But times have changed and there are some hard questions to be answered.

Many investors will examine this IPO because of the sheer amount of money BrisConnections is seeking ($1.226 billion across three instalments) in a volatile equity market.

The environment for new floats is difficult. For infrastructure funds in particular, there has been a change in sentiment that means the market no longer applauds distributions that are "manufactured", that is coming from anything other than operating profits.

The BrisConnections float comes after Chris Lynch, chief executive of the ASX-listed Transurban, announced that in future distributions would only be funded out of cashflow, a "cleaner and easier to understand investment proposition". Although Transurban was sharply marked down in the market after Lynch's announcement, many investors believe he did the right thing. Some, particularly investment bankers, reportedly believe Lynch "went too far" and that it is reasonable to allow some early payments to investors from debt to get a project under way.

Certainly, the BrisConnections management does not agree with Lynch moving ahead with a plan to pay distributions primarily from issuing new equity in the early years. No wonder, BrisConnections' chairman, the well-respected Trevor Rowe, describes the float conditions as a "very challenging market".

How the offer works

The offer is for 409 million stapled securities, with each security having three $1 payments, the first payable immediately, the next in nine months' time and the last in 18 months. The money will be used to construct a tollway link to the Brisbane airport, to open in June 2012. (As a Brisbane local, I can attest to the fact that better access to the airport would be well received).

Investors will immediately receive distributions equal to 14% of their initial contribution, and 8% of the fully paid up value of the investment (once the full $3 per security is paid). Shares are expected to start trading on July 31.

There are, however, a number of issues that investors should think about beyond just the difficult environment for infrastructure, including the weight they put on the distributions paid during the construction phase, the fees paid for underwriting and the performance of a similar infrastructure traffic infrastructure project in Brisbane - the RiverCity Motorway.

Distributions not related to earnings

Many investors might think that the income payments - the distributions or dividends paid by a company - are a function of the cash flow of an investment and so are a signal of the project's corporate health. That is not always the case.

There have been investments that have failed, which have in part used distributions to misrepresent the heath of the investment to investors. Most recently the MFS Premium Income Fund, which purported to pay investments a reliable income stream, failed spectacularly with investors recently told that their $1 investment would be worth less than 20 if liquidated. Investors had been receiving regular income payments up until the end of 2007, and probably thought they meant the investment was progressing nicely.

Investors might also remember back to the early part of this decade, when Australian Magnesium Corporation listed offering an 8% yield, even thought it was a company with no cash flow. These distributions were supported by the government of the time, with media commentary describing the distributions as the strategy to attract "mum and dad" investors looking for strong yield. Of course, the underlying project itself was not creating real earnings, so distributions were not paid out of project earnings as investors might have thought.

The distributions during the "fixed distribution phase" of the BrisConnections IPO, that is the period identified by the product disclosure statement as being up until of June 30, 2014, are actually paid in the form of additional units. Unless investors specifically request a cash distribution they will be "paid" extra units in place of distributions. Where an investor makes life awkward for the company and wants their distributions paid in cash, this will be done by issuing more units (which will be underwritten).

This, in itself, might be of concern for investors in a volatile market, because a falling unit price might lead to large numbers of units having to be issued to fund distributions, diluting the original interest of all investors.

Underwriting fees

The underwriting fees on this float are high. In an initial public offering, it is sometimes possible for the marketing material to distract you from the fact that there are fees associated. Underwriting is an important part of a float process; for a fee the underwriter guarantees the price for a certain number of securities in the float. The fee for the underwriting of the float is $63.57 million, with a further $20.58 million expected for the underwriting of the dividend re-investment plan. The fees for underwriting, totalling just over $84 million, represent 6.9% of the $1.226 billion raised.

Performance of RiverCity Motorway

Brisbane's other tollway, the RiverCity Motorway, listed in 2006 with securities costing $1 each, paid in two instalments. It is currently trading below 30. The 6 a year distributions that it is paying - which would mean a reasonably attractive yield of 6% on a $1 unit price - has not been attractive enough to support the share price.

An opportunity in a distressed market?

Before completely writing off such an opportunity, it is worth reflecting on the Macquarie Airports float. There was a lot of negative publicity around the time of the float (who can forget the 'What a Bunch of Bankers' add from Virgin), which may well have depressed the value of the offering. However, it has been a solid performer, returning 16.3% annual average return for the five years to last Friday, July 18. Given current difficult market conditions for infrastructure, perhaps this provides an opportunity for investors. Certainly some of the information around the float has implied that it has been priced to provide a higher than usual return for investors.

Conclusion

There are a lot of reasons for investors to generally keep an eye on this offer - not least that it will be an interesting barometer of corporate activity, particularly in a market sector under pressure.

However, this remains a difficult IPO for investors to assess. There is no real income for some period of time, although anyone who has sat in a Brisbane traffic jam knows the need for such infrastructure and, it would not be unreasonable to assume that, more than other road users, people heading to or from the airport might be more inclined to pay a toll. The lack of earnings history makes the offer very different to evaluate.

BrisConnections is unlike an IPO in which the company has a history of earnings and sales growth, and a track record over a variety of market conditions. Trying to evaluate a yet to be completed infrastructure project must be significantly more speculative.
Scott Francis' articles in the Eureka Report 

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