The cult of green
If there’s one word that sums up the shocking story of Babcock & Brown (bbl), the investment bank that lost billions of dollars for investors in 2009, it’s ingenuity. Not arrogance, avarice, greed or hubris, though all played a major part, but ingenuity. Because never before has anyone designed such a marvellous machine to strip money from the public.
In the four years BBL was listed on the Australian Securities Exchange (ASX), Phil Green and his team of tyros harvested more than $2 billion in fees from the bank’s satellite funds and other operations, and paid themselves almost $1.2 billion in bonuses. Green, the chief executive, raked in $56 million for himself, while the other head honchos, Peter Hofbauer, Robert Topfer and Eric Lucas, received around $125 million between them.
Then BBL went spectacularly bust and flushed what had been $12 billion of shareholder value down the drain. Those who invested in its many satellite funds collectively lost several billion dollars more. By comparison with this, Alan Bond’s efforts in the 1980s, when he filled his pockets to the brim at the expense of shareholders, look distinctly amateur.
One of Green’s oldest friends assures me that Phil was devastated by the crash. “He was extremely depressed. We’d have lunch together and he’d say ‘Hello’, I’d say ‘Goodbye’ and pay the bill, and there would be nothing in between. He lived for business. He loved doing deals. It’s what brought him his standing in the community. But what really hurt him is that he lost money for so many people.”
Even worse for Green is that so many of his victims shared his faith. “Babcock & Brown did to the Jews in New South Wales and Victoria what Bernie Madoff did to the Jewish population in New York,” says one big investor who financed Green in several deals in the 1990s. “You look at who backed him and it was all Jewish money. It’s horrendous.”
There’s one big difference, of course, between Green and Madoff, namely that BBL’s billion-dollar fleece was all perfectly legal. “Phil didn’t set out to steal money or to cheat people, and he didn’t hit charities,” his old friend protests. “And I only know of a handful who have lost everything and had to sell their houses.”
One such casualty would arguably be enough but in fact there are thousands of people whose finances have been ravaged by BBL. A friend of mine rashly invested $500,000 of his super in Babcock & Brown Power (BBP), “on the firmest of recommendations”, and lost everything. “Actually, I think I got a cheque for $76,” he says ruefully. He may now have to sell his home so he can afford to retire.
Many others took a similar risk, on the recommendation of the best brokers’ analysts who almost unanimously supported BBL’s shares. I have to confess I was one of them, as was my investment adviser, who told me BBL was so safe he was putting his mother into it.
Why we were all naive enough to believe the BBL story is not clear. And why Australia’s highly paid fund managers put millions of dollars of our savings into the shares is even harder to fathom. Reading the report written by the bank’s administrator, Deloitte, it is now blindingly obvious that the business was rapacious, risky and badly run. Another analysis from RiskMetrics Group in April 2008 – months before the crash – also laid this bare. BBL consumed cash in alarming fashion, borrowed money to pay dividends and generated most of its profit by revaluing assets – all classic ’80s rorts. On top of which there were those billion-dollar bonuses. Yet, with one or two honourable exceptions, scarcely a whisper of warning disturbed the chorus of approval.
One of hundreds who got caught was 66-year-old William Deathridge, who emailed Business Spectator in late 2008 to say, “I’m an old-age pensioner. I had 1000 Babcock & Brown shares, which I paid $27 each for … these crooks have to be jailed! How can the ASX allow this sort of thing to go on?” Two years on, he’s just as angry. “I don’t know how they’re allowed to get away with it,” he told me. “It’s shocking.”
A number of other shareholders contacted me with similar stories, but many more don’t even know they lost. “We all owned it through our super funds,” says RiskMetrics’ Dean Paatsch. “It sucked up the compulsory savings of the average Australian.”
Two months ago, in the Federal Court in Sydney, BBL’s (now) liquidator Deloitte took the first tentative steps towards recovering some of the money for creditors. But it’s unlikely to be more than a few drops in the ocean of losses. And shareholders will get nothing. In the meantime, our corporate cops at the Australian Securities and Investments Commission (ASIC) remain silent.
Of course, some investors did make money out of BBL, at least for a time. The Liberman and Heine families in Melbourne and the Lowy and Packer families in Sydney put serious money into several of Green’s deals before BBL went public in October 2004, as did Rodney Adler of FAI and Peter Ivany of Hoyts. And they may well have ended up ahead. James Packer even made a huge bet against BBL by shorting its shares in 2007, although he apparently lost courage and pulled out before payday.
But most who rode the gravy train got caught in the crash. The so-called Friends of Babcock – who are perhaps not so friendly now – put big money into BBL’s ventures over the years. One of this group of doctors, dentists and friends of friends was known to BBL insiders as the Five Million Dollar Man, because he put $5 million into every new fund Babcock opened.
Fortunately for Phil Green, it seems he is rarely troubled at public functions. “Phil doesn’t get attacked,” says his friend. “He’s a nice guy; he’s lost as much as anybody and he has not done what David did (David Coe left for London when Allco crashed in 2008). Sure we’re not happy with some of the things that happened, but no one dislikes Phil as a person even now.”
The same cannot be said for Phil’s late brother Max, who was bludgeoned to death in a hotel room in Phnom Penh in 1998 after stealing $42 million from some of Melbourne’s richest families and investing in dangerous gem deals in Cambodia. Max was a Toorak lawyer who had sold a complex tax scheme to the (mainly Jewish) clients of several big accounting firms and, instead of investing their money, had simply run off with it. Max, too, was a likeable bloke, and no one could believe he would do such a thing.
It’s a sad irony that the two brothers should both end up inflicting financial pain on others, although in Phil’s case it was clearly never intended.
Now in his mid-fifties, Phil Green has an unlikely pedigree for an A-list financier. He grew up in Maroubra, a rough working-class suburb in Sydney’s south, and had a tough childhood. But he was smart enough to win a place at Sydney Boys High School and excel at law at the University of New South Wales. From there he joined Arthur Andersen as a tax specialist.
Green was still at AA in 1983 when Babcock & Brown’s American co-founder, Jim Babcock, flew in from California to stitch up an aircraft leasing deal. Back then, BBL was a boutique bank in San Francisco with three partners and a dozen employees. Green structured the lease and so impressed the Americans that they hired him and opened a new office in Sydney. “I enjoyed working with Phil,” says one former colleague. “He was incredibly smart and just had a different way of thinking. He was the first guy to see you could get tax breaks in both countries when leasing aircraft. His paper on it formed the basis of an industry.”
Phil’s genius was his passport to the big end of town: to status, friendship and the A-list. It’s no wonder he’s devastated by the loss. Now when ex-colleagues boast of his brilliance, they quickly qualify their praise. “He’s extremely gifted but I’ve never met a man with poorer social skills,” says one ex-Babcock executive who has known him for many years. Another senior ex-BBL executive says: “I like Phil, he’s very smart and numerate and he’s got a good mind,” before adding: “He’s not someone I’d want to go out for a meal with.” Green was also, as it turned out, no good at managing people or businesses. In the deep, distant past he apparently owned a hardware store, which was not a success. Ideas were his forte; compliance and execution were not.
By the early 1990s, BBL was expanding offshore, to Milan, Rome, London and Tokyo, and moving into areas such as real estate and private–public partnerships. In 1997 it took over an investment bank called Industrial Development Corporation of Australia (AIDC) and got its hands on some capital. Four years later, it bought its first big infrastructure asset, the coal-loading terminal at Dalrymple Bay in north Queensland. Soon afterwards it was selling these assets into satellite funds and collecting huge fees, which remained its core business until the end.
Back then, governments everywhere were privatising railways, roads, airports and power stations as fast as they could, and Australian firms such as Macquarie and BBL (the latter dubbed ‘mini-Mac’ or ‘mini-me’) were dressing them up and applying lipstick to make them more seductive. Most were already good investments, because they were monopolies or oligopolies with a reliable, growing cash flow. They were also dull, because returns were low. The makeover gave them yields of 12% or more and made them irresistible to pension funds and retirees who needed income to live off. As so often in the world of investment, the most vulnerable were the ones who were sucked in.
The genius lay in the maths of it all, which worked something like this. The company would buy an asset for $1 billion and borrow $900 million from the banks to fund it. That might cost $36 million per year in interest (because rates were only 4%) while the asset would earn $50 million per year in cash after expenses (a return of 5%). This left $14 million per year to pay unit holders, or a 14% return on the $100 million they had invested. All thanks to the magic of leverage.
Remarkably, there was no shortage of lenders wanting to do the deal. In fact they were falling over each other to get the business. For a small fee it was possible to lock in these low rates for 15 years, so the only thing that could go wrong was cash flow failing to meet the forecast. At least in theory.
It was brilliant stuff, and it spawned a multi-billion-dollar industry, in which Macquarie and BBL (and later Allco) led the world, much as Alan Bond and his fellow Aussie entrepreneurs had done in the ’80s. And while debt stayed cheap everything was fine, just as it had been with Bond.
But the makeover meant these airports, toll roads and port facilities were no longer safe investments. First, they were incredibly highly geared – with up to $9 of borrowed money for every $1 of equity – so a small fall in asset prices could wipe out the fund’s entire value. Second, they didn’t actually make a profit, so their managers had to create one. Every time BBL revalued the funds’ assets, the group could declare a profit and borrow more from the banks – just as Bond had done. It could then pay fat fees to its managers and fat dividends to unit-holders, even if the cash wasn’t there.
In 2006, for example, Babcock & Brown Wind Partners (BBW) had operating cash flow of only $14 million but paid out $48 million to shareholders. These dividends were much larger than any profit the fund was generating (in fact BBW made a loss). But Green and his fellow geniuses at BBL managed to get round the law (requiring such payments to be made out of profits) by slotting a Bermuda company into BBW’s ownership structure. Other BBL funds, which faced the same problem, used a trust to achieve the same result.
Naturally, Green and his chums weren’t just putting lip-stick on the pig to please aged pensioners. They were doing it so they could rip out a fortune in fees for BBL. In 2007 alone, these fees amounted to $1 billion, of which half was paid in bonuses to Green and his employees, to top up their $300 million salaries. But BBL wasn’t generating cash either, because many of its profits were also paper, so it had to borrow too. Between 2006 and 2008, BBL’s operating cash flow was minus $1.3 billion, during which time it borrowed an extra $13 billion to pay bonuses and dividends and buy more assets.
While the lads at BBL (and the managers of the satellite funds) pocketed fabulous rewards, shareholders in the funds paid through the nose. First was an annual management fee of around 1.5% of market value. Next came huge advisory fees for raising money, issuing shares and buying or selling assets for the fund. These were typically three to four times what other banks charged and were levied on enterprise value including debt. Finally there was an outperformance fee – charged at 20% of any rise in the fund’s share price beyond 7–8% per year.
In 2006, BBW recorded a loss, but still paid an outperformance fee of $38 million and total fees of $102 million to BBL, or almost eight times as much as it generated from its businesses. These fees amounted to almost 12% of BBW’s market capitalisation, so investors gave away almost an eighth of the value of their investment in that one year, half of which ended up in the pockets of Green and his team. Needless to say, no one offered to repay the money when BBW’s value collapsed.
Presumably, BBW’s shareholders (who were receiving an artificially high yield on their shares) didn’t care about this heist or didn’t see it happening. But shareholders in BBL were thrilled and clapped their directors at the annual general meeting. By mid 2007 their share price had rocketed to an all-time high of $34, almost seven times BBL’s launch price less than three years earlier.
What the happy clappers failed to appreciate was that if the deals stopped happening or share prices ceased rising, the flow of fees and dividends would slow to a trickle. And if share prices fell and the empire started to shrink, those fees and dividends could dry up altogether. BBL therefore had a powerful incentive at the corporate level to grow and grow and borrow and borrow – regardless of whether this was prudent. And everyone who worked for BBL had an incentive to make sure it happened, because they wanted to keep earning their bonuses. So grow it did.
By the end of 2007, BBL boasted $72 billion worth of funds under management – roughly 50 times what it had had in October 2004 at the time of the float. To support these assets the group had amassed around $50 billion in debt, which was also 50 times as much as it had started with. These huge liabilities did not have to be declared in BBL’s annual accounts (which recorded debts of around $13 billion) because they could be kept off the balance sheet, and their full extent was only revealed when Green came clean at a press conference in February 2008. Even then, he insisted the figure was of little or no significance because the debts were mainly non-recourse to BBL, meaning they couldn’t come back to bite the parent.
By this time, everyone and everything at BBL was hocked to the hilt: the directors were hocked to buy shares on margin, BBL was hocked to buy stakes in its satellite funds (among other things), and the funds were hocked to buy the power stations, ports and wind farms that generated the cash for everyone else down the food chain. This might have been OK had it not been for the global financial crisis. It might also have been OK had BBL bought all these fund assets at the right price and managed them well. Unfortunately, it had frequently failed to do either.
“They were trying to run a whole lot of businesses all over the world,” says the Australian CEO of a big foreign bank, “and they didn’t have the management to do it. They stretched themselves awfully thin. It was like pulling a piece of chewing gum. Sooner or later, if you stretch it far enough it’s going to break.” BBL had also bought recklessly. So great was the incentive to earn fees and bonuses and so intense was the competition that BBL often bought the wrong things or paid too much. As one ex-BBL fund manager puts it: “The assumptions that went into the financial models were always pitched at the aggressive end of what’s reasonable.” After BBL went public in 2004 these assumptions and valuations got even more aggressive: “They lost all discipline.”
In mid 2007, as the first waves of the GFC pushed out from America, BBL did a deal that loaded the group with another $5 billion of debt, winning a bidding war for Alinta, the Western Australian gas distributor and energy retailer. “Phil got it into his head they had to beat Macquarie Bank at something and this was going to be the one,” says one ex-BBL veteran. “He broke all barriers to get it and he broke the company in the process.” According to another senior ex-BBL fund manager: “It was a battle for bragging rights. I think the weight of hubris finally overcame them.”
As the clouds gathered – two American hedge funds went down in May 2007 and world stock markets dropped sharply in August – the BBL mothership and its satellites set off into the storm loaded to the gunwales. By the end of the year, Centro Properties was below the waterline, Allco was sinking fast and BBL was listing badly. Yet Phil remained supremely confident, like the captain of the Titanic, assuring his passengers that all would be fine.
In February 2008, Green announced a record $643 million group profit for 2007, promised an even better $750 million result for 2008 and claimed the group had $2.6 billion in cash and unused bank facilities. It was hard to argue with such brash confidence. One of BBL’s biggest critics, the Fairfax journalist Michael West, was so impressed that he pronounced “the boys done well” and judged BBL to be out of danger. Plenty of investors also bought the line and hung on to their shares.
But within weeks ship BBL was taking on water. An enterprising hedge fund discovered a clause in the bank coven-ants that gave BBL’s bankers the right to call in their loans if the company’s market value dipped below $3 billion. BBL’s shares immediately came under attack from short sellers, the price halved and, in June 2008, the clause was triggered.
Green bought off the banks by agreeing to pay higher interest rates and cut borrowings, and then launched a PR offensive against the group’s critics. But all this did was buy time. Six weeks later, a deal to sell BBL’s wind farms fell through and BBL was forced to admit that profits would fall well short of its promises (which had been repeated as late as 31 May). In mid August, Green was forced to hand over the helm and, a month later, he walked the plank and resigned from the board.
The ship was now struggling to stay afloat. The satellite funds were trying to cut loose from their expensive management contracts – which bound them to BBL for 25 years – so they could stop paying fees to BBL, while huge falls in their share prices were wiping out BBL’s equity. Worse still, BBP was sinking because it had been forced to carry a big share of Alinta. Needing to refinance at least $3.1 billion in bank loans, it could only raise $2.7 billion and had no way of finding the extra funds, except by going begging to BBL, which was also in trouble. Debts in other funds were also falling due (back in 2006, it had stopped being possible to lock in low rates for the long term), so the satellites faced either higher interest rates that would wipe out their surplus cash flow or failing to renew their loans at all, which would sink them and drag BBL down too.
And that is eventually what happened. BBL’s shares were suspended in January 2009 at 32 cents, or less than one-hundredth of what they had been at their peak. Two months later, the company’s directors deep-sixed the flagship. BBL been forced to write down its assets by $4.9 billion in the 2008 accounts and record a $5.6 billion loss. There was no way it could survive after that.
Many people close to Green had trusted him to steer through the storm. “I lost money in B&B, too,” says one former executive. “I thought he wouldn’t let something like this slip away. Now we discover he thought he could rescue Allco as well. These guys were in dreamland, absolute dreamland.” According to another senior ex-BBL executive, “I always believed Phil knew what he was doing, but he had no idea, he had no plan, he had to go home for a week because he got sick. This was a guy who paid himself $22 million a year but he couldn’t handle it.”
So where was BBL’s board while all this was happening? Applauding Phil is the answer. BBL’s chair, Elizabeth Nosworthy, sent the chief executive on his way in August 2008 with a ringing valedictory: “Everyone at Babcock & Brown thanks Phil for his enormous contribution to the development and success of Babcock & Brown over so many years. We recognise in particular his leadership and vision in building the business since the float in 2004. Phil is greatly admired by his board colleagues, by employees across the Babcock & Brown world and by many shareholders and co-investors.”
Nor did Nosworthy do better when the ship went to Davy Jones’s locker. Telling the press it was “devastating” to see so much shareholder wealth destroyed, she sheeted it all home to “by far the worst liquidity crisis that I have seen in my corporate career. It’s as bad, if not worse, than 1929. It’s right across the world. All the major banks are struggling.” She made no mention of BBL’s greed, arrogance, risk-taking, complexity, conflicts of interest or unjustified optimism. Nor did she give any acknowledgement that mistakes had been made. Here was a management team that had enriched itself at investors’ expense while torpedoing billions of dollars of shareholder value. Yet Nosworthy was giving them all an honourable discharge.
“Elizabeth Nosworthy is a sweet person, honest, industrious and hard working but ultimately very naive,” says one ex-BBL fund manager. “It’s sad to see her reputation being trashed, but she visited it upon herself.”
“And the others?”
“Jim Babcock, Mr Chesty Bond, he went missing in action.”
It was not just at the end that BBL’s board failed to shine. It had failed to set up adequate risk-management systems, despite repeated warnings from the group’s internal auditors and external consultants, which began in 2004 and continued right up to 2008. In Deloitte’s blunt assessment, “the group’s risk management was not adequate … for such a large, complex and high-risk business. Shortcomings … were either justified, inadequately addressed or addressed over too long a time frame.”
BBL’s board also allowed Green and his executives to lose all sense of what was a reasonable reward. “Some of the directors were prudent, reasonable, ethical people,” says another ex-BBL senior executive. “I just can’t fathom how they let Phil and his managers get away with it all. But I guess Phil pushed them aside. It was the power of his personality and his intellect. He always had the next big idea. I don’t think they could stand up to him.”
Most observers believe things started to go wrong after the float in 2004. Until then there had been some discipline, if only because outside investors such as the Liberman family and Rodney Adler were putting up funds. But once BBL had its own pot of money, Green could do what he liked. From 2005 to 2007 the share price was doubling every nine months. The world thought Green brilliant and he agreed. “Phil liked showing off his ego,” says one ex-BBL executive, “and the young guys there hung off his every word. It was the worst sort of boys’ club.”
But Green’s wasn’t the only big ego on display. There were other alpha males at BBL – Hofbauer, Topfer and Lucas – who each had his own fiefdom. The most powerful of these was Hofbauer, global head of infrastructure, who was in charge of buying assets for the funds and ‘stuffing’ them in at the price and on the conditions that BBL required. “Hofbauer ruled by fear and tyranny,” says one BBL satellite fund manager who tried to argue with him, “he was ruthless, aggressive and took no prisoners.”
“That’s uncharitable,” says another fund manager who tried to take him on, “but I don’t think it’s unfair. Hofbauer worked harder than anyone and he was financially brilliant, but I had enormous problems with his personality.” According to this executive, there was a “cult of personality” at BBL that allowed these head honchos to wield so much power. “You need to lead and manage people like that and Green didn’t do it. There was no teamwork, no camaraderie and too many egos.”
“People complained to Phil that he wasn’t managing these egos,” says another top BBL executive, “but he did nothing. That’s what ultimately shocked me most, that Phil had no balls. He couldn’t handle these strong personalities.”
Watching Green at the liquidator’s examination in July 2010, I was struck, like everyone else, by how smart he is. Unlike most executives put through such interrogations, he never had to ask for a question to be repeated and hardly ever paused before answering. It seemed he was always one step ahead. Friends say Green was surprised and relieved by how easy it was. As one friend comments: “It wasn’t half as tough as he expected. It didn’t even get close on the issues he was worried about.”
But it may be too early for Green to relax. Deloitte’s official 160-page report to ASIC, written in September 2009, outlines a number of actions that might be pursued, either to recover money or to punish alleged breaches of director’s duties.
Several of these relate to the fact that investors who lent $600 million to BBL in two note issues were surprised to discover their money had been passed to another company, Babcock & Brown International Pty Ltd (BIPL), which owned all the assets. These investors were even more surprised to be told they had no right to sue BIPL to recover these funds unless BIPL’s bankers agreed. Deloitte raised the possibility that the note-holders had been misled by Green and his fellow BBL directors in a number of ways on a number of occasions.
Deloitte also raised the question – without making any conclusions on potential breaches of the law – of whether Green and his fellow directors had used company money illegally in 2008 to buy BBL shares from employees and again where company money was used to rescue other BBL shares (owned by Green in particular) that would have been swallowed up if the big margin-lending broker, Tricom, had collapsed at that time.
In addition, there is already a class action against BBP, and another may be in the offing against BBL itself. In other words, Green may still get his day in court.
Much will depend on ASIC, and even a successful legal action would not repair the damage done to shareholders and creditors. Nor would it prevent another Babcock happening in the future. And that brings me back to ingenuity. Every decade, the geniuses in the financial community find a new way to fleece the investing public. It could be nickel, real estate, dotcoms, subprime or financial engineering of infrastructure, yet the results are always the same: a small band of people get away with billions of dollars, while the ever-credulous public lose their shirts.
One reason this happens is that we all trust too much and expect professional advisers to look after us. Another is that good men and women don’t tell the world what they know. One BBL executive blames himself for this. “Why didn’t we say anything? We’re so weak in the CBD. We think we have a moral platform and sense of values in our home lives but we get into work and we’re just bullied out of it.”
This executive passionately believes he should have done more, but even now is not prepared to go public with his confession.