The Jig Is Up For Cross-collateralised Allco Principals As Nab Makes Its Move

The Age

Friday March 7, 2008

Michael West

The big guns did not want to stump up their own money, giving the bank little choice.

IT'S ADMINISTRATORS at dawn. The first bank has moved on the Allco group, pushing the structured financier to the brink of oblivion and triggering a chain reaction that should have lawyers in work into the second decade of this millennium.

NAB had little choice. David Coe and the Allco principals wanted time. NAB wanted security over its loan to the Allco Principals Trust (APT). NAB gave them time, they opted not to deliver the collateral to back their own creation. This is the guts of it. Talks between APT and the bank had been dragging on for weeks. The Allco principals had the chance to put their own money in as collateral for NAB on the APT stake. That they didn't means the jig is up.

According to the NAB release, the bank had been trying to complete a stand-still agreement, to give the principals more time. The heads of agreement was signed but the principals did not want to stump up their own money and nobody else would tip in theirs.

APT issued a release shortly after NAB moved, appointing its own administrator in a legal move to protect itself and to try to control a fluid situation.

Notwithstanding the immense debt across the Allco myriad entities, perhaps surpassing $8 billion, the thing that is sinking Allco is the "cross-collateralisation" of its companies, the complex and interlocking arrangements. The same phenomenon threatens to sink Centro. It's Enron-esque. It's the "smartest guys in the room" syndrome.

Ironically, some close observers reckon the writing was on the wall early last year, hence the Qantas deal.

Had Allco and its Airline Partners Australia bid got up - and it was within a whisker of grasping control of the national carrier - billions would have been raised in equity. Again the accounts would have been muddied. Allco would have got a lot bigger and lasted longer.

Financial engineers who rely on "deal velocity" or doing a lot of deals to keep the game alive - and keep the capital and the fees rolling in - can keep outsiders guessing about the real state of their accounts. In this way they avoid scrutiny. Analysts can't compare like with like. There is no like, only deals.

When the stock started trading after its suspension a fortnight ago and Allco 'fessed up to a lazy $900 million looming debt commitment - hitherto unnoticed - the market began to look more closely and stopped believing. It was just a matter of time.

Topping it off was the ridiculous Rubicon deal last November when, in a scurrilously overpriced related-party transaction, Allco paid $320 million for an asset whose very survival is now in doubt.

If yesterday marked the first move by a bank on Allco, the day before was the first swoop by a vulture when Credit Suisse snapped up Allco's stakes in the Rubicon trusts.

If whoever that was is making a play for Allco's management rights over the Rubicon property trusts, that someone has a poison pill to contend with.

In the case of Rubicon America Trust, there is a 15-year management contract with a US entity called Rubicon Advisory LLC.

It is an unusual structure (though one that has been adopted by other financial engineers), presumably designed to entrench the Australian manager Rubicon Asset Management's control over the management rights, which may turn out to be the only thing of value once the property assets are matched against the heavy debt burden.

We should know soon who is behind the Rubicon play. It could be two or three players. Goldman Sachs has been buying Rubicon Japan; UBS has a "buy" on Rubicon Europe.

One of Rubicon's bankers, Credit Suisse, has forced the margin sale of Allco's stake in the three Rubicon trusts, which means Allco may have dusted another $150 million following its disastrous $320 million takeover of Rubicon Asset Management.

As the portfolio of mezzanine loans in the Rubicon trusts is thought to be worth very little, the bulk of the value is in the management rights

But back to the complex drama around APT.

APT has 6.5% of Allco Finance Group and David Coe owns 28% of APT. APT also has shares in Allco HIT, which in turn has to repay $770 million by June 30. The parent Allco is up for $250 million to be paid or refinanced by May and total debt across the entire group is in the vicinity of $8 billion.

That there is some $43 million owed by the Allco mothership to APT and another $45 million due to APT from Allco HIT which not only clouds the picture but brings forward the prospect of a deadly chain reaction.

From the tone and detail of its statement, NAB clearly got fed up negotiating with the Allco principals.

As the assorted Allco share prices are wallowing at next to nothing with virtually no prospect of raising equity - added to the news on the Rubicon trusts and now this move from NAB - it would be a bold call to buy shares in Allco today . . . if they are still listed.

EDDY Groves was looking good. He had nipped over to the US on a mission to sell some assets and recapitalise his child-care empire.

In no time at all, he had struck a deal with Morgan Stanley private equity. It might have been a fire sale but the $502 million price tag for the bulk of his US centres didn't look too shabby.

Eddy was back. Smaller. But back.

With the $811 million proceeds from a convertible notes issue ABC could now make a large dent in the $1.2 billion senior bank facilities - the covenants of which ABC had come so perilously close to breaching.

The stock price rallied. Then mysteriously, at 3pm yesterday, ABC shares took a 25% pounding. What happened?

One theory is the hedge funds are back having their evil way with Eddy's stock price again. It could be true. Perhaps they have seen the terms of the recent convertible note issue.

It is a bit speculative at this point but, according to a Goldman Sachs JBWere note to clients, these convertible notes may be known as "exploding convertible notes", that is, "if the ordinary shares drop in value, the number on issue explodes".

If so, ABC shareholders are in for a torrid time and whoever owns these convertible notes has got the company by the proverbials.

"The last big company to issue such notes was HIH Insurance in 1999. In the case of ABC, there appears to be no limit on how many shares could be issued on conversion, whereas with HIH there was."

If Goldman is correct, this security is one of the silliest ever issued to raise money. It would even go down in the annals of corporate history as the "iconic" security of the great market downturn of 2008.

ABC issued the notes last June, according to reports, about the time of the US credit market meltdown.

"It did the issue on a dollar basis rather than the conventional 'fixed proportion' system," says Goldman, which means they are an absolute bargain. Why would you ever buy ordinary shares again?

The story goes that the hedge funds may have driven down the ABC ordinary shares while buying up as many of these notes as they could.

Naturally Eddy Groves and his advisers from Austock did not contemplate the stock being so low but that is no excuse for issuing these notes, if indeed the story is right.

According to reports, CommSec holds some $360 million of the $600 million tranche and may turn out to be a very large holder of ABC.

In Eddy's defence, unlike the Allco executives, Eddy declined to draw a large salary last year, preferring to take stock instead. He is indeed a true believer, though perhaps poorly advised.

Despite the aggressive accounting, extreme expansion tendencies and poor corporate governance of ABC that has led to its recent troubles, Eddy Groves certainly deserves to own a few of those convertible notes.