May 2010

Essays

Paul Barry

Coe & Co.

David Coe gives an interview in which he promises to do all he can for the beleaguered Allco Finance Group shortly before his resignation from the company, March 2008. © Fairfax 

David Coe is one of the smartest financiers in Australia. And by most accounts he’s a lovely guy. He’s friendly and charming, fun to be with, and an all-round top bloke, or so they say. He’s also a benefactor of the arts and has given generously to charity, helping to raise millions of dollars for the Sydney Children’s Hospital.

Coe’s best mate, Gordon Fell, is just as bright and another paragon of virtue. The former Rhodes scholar, who made his millions selling property to super-fund investors, was a director of the Smith Family, chairman of Opera Australia and a trustee of Sydney Grammar School until his empire imploded in early 2008. “There’s no way he’s a shonk,” one of his advisers assured me.

So here’s the puzzle. How could these two world-class charmers be responsible for two of Australia’s biggest corporate disasters, in which almost $10 billion, belonging to shareholders and creditors, went down the gurgler? And how come they have hung on to tens of millions of dollars while the mums and dads who backed them lost everything? Come to think of it, why is that so often the story in the corporate world?

In the three years to the end of 2007, while Coe’s Allco Finance Group and Fell’s Rubicon property trusts were riding the stock-market boom, ‘Coey’ and ‘Gordo’ banked around $250 million in fees and profits, which ultimately came from investors. Coe used the money (along with millions he’d already made) to buy a brace of ferry-sized boats and an art collection, which would be the envy of many galleries and which he hung in one of his two huge waterfront mansions in Vaucluse. Meanwhile, Fell splashed out $28.7 million on a palace in Point Piper – which he moved into just as the Allco–Rubicon house of cards collapsed – and pocketed maybe $100 million in cash.

Asked in late 2008, after Rubicon’s eventual demise, whether he might consider giving some of the money back, Fell answered incredulously: “Would you do that? No one’s children were kidnapped and held up at gun point until they invested in the trusts.” No doubt that is so, but few people would have risked their hard-earned dollars in Rubicon’s highly geared property trusts or in Allco’s shares and high-rate securities had they known the dangers they faced or realised how much they were paying to their managers. And let’s be clear, $10 billion is an awful lot of money, even for a modern corporate collapse (it equates to around $500 for every person in Australia).

Like Babcock & Brown, Lehmann Brothers, Bear Stearns and others, Allco and Rubicon were brought down by a Global Financial Crisis that almost destroyed the world’s banking system. As debt markets froze up in late 2007, both companies (which had merged in December of that year) were left with huge borrowings they couldn’t refinance, plus a bunch of assets in real estate, transport and infrastructure that couldn’t be sold at any price. Deals had dried up, so profits were vanishing, and the share price was heading south. Shortly afterwards, the ship was struck with margin calls on loans worth $285 million, which Coe and his mates had taken out to buy their Allco shares; there was no longer any way to stay afloat. Coey and Gordo were washed overboard in March 2008, and the hulk went down eight months later. In the words of Allco director Michael Stefanovski, the group sailed “slap, bang into the middle of a perfect storm”.

However, as one well-respected former Allco insider observes: “To sheet it all home to that is far too kind. Coe and the other principals have themselves to blame for the group’s incredible complexity and the huge debt levels they built up.” More fundamentally, according to this insider, the Allco gang were simply too gung-ho. “They were brilliant deal-makers who had been great at fixing things and finding a way around problems for 25 years, so they reckoned there was nothing they couldn’t handle. They just thought they were too smart to fail.”

Allco began life in 1979 as a specialist in cross-border aircraft leasing for Ansett and Qantas. Coe was the brilliant lawyer who found tax breaks in Australia and the US to make the planes cheaper, while his partners “structured” the finance in tiers that had different rates of interest for different levels of risk. Over the next two decades, Allco made hundreds of millions of dollars, which was paid out to its ten partners, of whom the most important were ‘Coey’, ‘Westy’, ‘Veaky’ and ‘Nicko’, AKA David Coe, Chris West, David Veal and Nick Bain.

“It was very blokey, very sporty, a real boys’ club,” says another insider, “and the in-crowd made a fortune. The ultimate sign you were in was to be invited for Friday lunch on Sydney Harbour on Coey’s big boat. He and his fellow principals treated it as an optional workday, so sometimes half the company was out of the office.” There was never any doubt that Coe’s charisma made him the leader of the pack. One ex-employee remembers a touch-footy game that demonstrated how the others deferred to him. “Coe wasn’t captain of either side, but he turned up and gathered all of us together and said, ‘OK, boys, this is what we’re going to do.’ And we did it.”

In May 2005, banner headlines on the front page of the Australian Financial Review dubbed David Coe one of Australia’s “New Masters of the Universe”, along with two other financial engineers, Nick Moore of Macquarie Bank and Phil Green of Babcock & Brown. There’s no doubt his colleagues at Allco also thought of themselves as special. “Understand, we’re the best in the world,” one banker who worked with them was told around this time.

This hubris made Allco almost impervious to criticism. In late 2006, there was uproar when it spearheaded an unsuccessful $11 billion buyout of Qantas, to be funded with a staggering $10 billion of debt. Commentators warned that the $1 billion interest bill would bankrupt Australia’s national airline – as it most certainly would have done. Yet Coe and the consortium (chaired by Allco deputy chairman and former Telstra boss Bob Mansfield, who received a near-$1 million fee) charged on regardless, until the deal was eventually voted down. A year later, Qantas shares were worth only one-third of the $5.60 offer price.

In any quest to discover the causes of the collapses of Allco and Rubicon, the words “arrogance” and “greed” keep recurring. “Frankly, I think the principals started to get greedy and stopped worrying about ethics,” says one banker, who worked alongside them for many years. “Greed was very high in a lot of these guys,” says another who was close to the inner circle. Put bluntly, Coe, Fell and their colleagues were so money hungry that even investment bankers and lawyers thought their snouts were too deep in the trough – quite an achievement.

So how did Allco get to manage billions of dollars of other people’s money? And were there doubts about its suitability for the task? In fact, there were, and as soon as Allco got its hands on investors’ funds in 2001, it was clear that the first priority of its partners was to look after themselves.

That year, Allco launched a new public company, Record Investments, to finance its deals. By then, most of the tax loopholes of cross-border leasing had been closed, so the only way to make money from leasing planes and ships was to own them. Because debt was cheap and plentiful, Allco could borrow 90% of the purchase price from banks and insurance companies, but it still needed someone to take the bottom 10% – the riskiest tier. This was where Record came in: it would be given first dibs on Allco’s deals and reap a handsome reward, if the planes or ships (and, later, office buildings) were still worth enough when the leases expired.

However, Record’s management team, who had been hired from the Commonwealth Bank, had no intention of becoming captive investors and accepting any old deal. They wanted to reject some and fiddle with others to get a better return for Record shareholders, who had contributed $190 million in a public float on the Australian Securities Exchange. So there were constant fights.

By 2004 these had turned into all-out war over who should make money from setting up managed funds to invest in Allco’s deals. Coe had promised that Record’s shareholders would get this benefit, but then announced that the Allco principals would grab it instead. Record’s highly regarded chairman, Tony Berg, a former CEO of Macquarie Bank, promptly threatened to resign and to reveal that a promise had been broken, so Coe backed off and agreed that both companies should start funds.

As part of the settlement, Allco’s principals were allotted an extra 15% of Record at a discount, and Berg agreed to depart, hoping Allco would take better care of Record’s shareholders in the future. But nothing changed. As one insider puts it: “The bullying and the stuffing continued.” And there was now no one to cry ‘foul’, because Coe had become Record’s executive chairman as well as Allco’s boss.

By the early 2000s, Coe had interests outside Allco that kept him busy. He had made $200 million or more and didn’t need to work. He had his art, his charities and his friends. And he had teamed up with James Erskine of IMG to start Sports & Entertainment Ltd, which owned Cricket Australia’s merchandising rights and managed a stable of stars, including Shane Warne, Matt Giteau and Michael Parkinson. Consequently, he was travelling around the world half the time: watching the Ashes at Lord’s, playing pro–am golf at Gleneagles, entertaining friends at the Rugby World Cup or skiing in Europe and Colorado. As a result, Allco was often left to others to run.

It was Chris West, for example, who created the satellite companies Record Investments, Record Realty, Allco HIT and Allco Max. And it was Chris West who played a major role in making Allco’s structure so complicated. “Westy loved complexity and leverage,” says a former Record executive. “West was a major problem,” he adds. “We had a lot of trouble with him.”

Like Coe, West was both a principal of Allco and a director of Record, which meant he had a conflict of interests when the two groups dealt with each other (which they did all the time). But executives working solely for Record had no doubt whose interest he favoured. “West was a bully and had a temper, but what was most difficult was that he told you what he wanted to tell you,” says a former Record director. “With Westy you heard about all the good things in a deal; you had to find out about all the bad things yourself.”

With Tony Berg no longer on the scene, it was left to Record’s CEO, Mark Philips, to stand up for shareholders, but he was fighting a losing battle. “There was one of him, 250 of them,” says one close bystander. “There were fights about everything: prices, fees and whether the deals should be done at all. The tension was incredible. It just got to the point where it was impossible for him to continue.” So in early 2006, Philips decided to follow Berg out the door.

Later that year the two companies merged, allowing Coe and his colleagues to take control of the cash box. Now renamed Allco Finance Group and listed on the Australian Securities Exchange, the company attracted an array of blue-blooded directors, including ex-Telstra chairman Bob Mansfield, ex-British Airways chief executive Sir Rod Eddington and Commonwealth Bank director Barbara Ward. Yet, even though Allco was now trusted with billions of dollars of other people’s money, the culture didn’t change. Within months, the new group was exploding with huge amounts of debt and assets as it expanded into real estate, mortgage lending and infrastructure. Often it paid too much, but that was because there was no incentive to pay less. In fact, quite the opposite.

Allco made its living by charging a fee for every transaction: it charged when it bought, charged when it sold, charged when it managed and charged when it parked assets in a fund. It also charged hefty fees when it raised money from investors. Crucially, almost all these fees were based on asset values so there was an incentive to raise too much, borrow too much and pay too much. The more it jacked up the numbers, the more it earned. Size was all that mattered.

By borrowing big, Allco was able to pay double-digit returns and hook in investors, sucking in precisely the people who shouldn’t be taking risks, such as self-funded retirees who need high incomes. It was like dropping shiny cluster bomblets for kids to pick up. Few investors had any idea how easily their money could be blown away.

The key to it was leverage (or gearing). Record Realty, the group’s first fund, bought its blue-chip assets, such as Sydney’s ASX building, with 85% debt and 15% capital from investors. This turbocharged its returns, because a 15% rise in prices was enough to double shareholders’ money. But, if the market fell, it would also turbocharge losses and it wouldn’t even take a 15% fall to wipe out investors because management fees snaffled much of the gain.

Was it crazy and dangerous to run the company like this? As Alan Bond had discovered in the 1980s, yes, it was. But it didn’t seem so stupid when asset prices were rocketing and everyone was making money, which is why so many financial advisers recommended their clients invest in Allco and Rubicon, why Coe was thought of as a “Master of the Universe” and why the vast majority of stockbrokers’ analysts rated Allco a ‘buy’ until it blew up. Presumably this was also why such distinguished directors were happy to be on the board – although no doubt they were also dazzled by Coe and his connections to those in the top levels of Australian sport.

It was not only the real estate assets at Allco that were geared to the max. By early 2007, the group had also bought billions of dollars worth of aircraft, ships, trains, power stations and ports with the intention of hiving them off into new funds that would raise money from retail investors. Had this happened, Allco would have collected more fees and profits, and established itself as a fund manager, just as Babcock and Macquarie had. It would also have passed the risk on to others. Meanwhile, all these expensive assets sat on the balance sheet, financed by borrowings. “There really wasn’t any equity at all,” says another Allco insider. “Tim Dodd (the chief financial officer) and David Trafford (who ran Allco’s treasury) could see what was going to happen and tried to warn about it. But either they weren’t heard or no one listened.”

This was Allco’s precarious position in late 2007 when the American subprime mortgage crisis first hit Australia, and when the directors agreed to gear up even more by buying Rubicon Holdings from its two main shareholders, Fell and Coe, who respectively owned 45% and 20% of the company. Anyone could see that buying Rubicon, which managed commercial real estate worth $5 billion in Japan, Europe and the US, was a terrible idea. At the time, house prices were in free fall right across the US. Huge bank auctions in California were knocking down repossessed homes for 40% less than their owners had paid a year or two earlier; thousands of other homes had been abandoned. Hundreds of lenders and several hedge funds had already gone bust. Commercial real estate was clearly next in line, and Rubicon already had a whole bunch of toxic commercial loans that were almost worthless.

The carnage was sufficiently obvious for Rubicon’s three funds to be making writedowns by mid-December 2007 and for its auditors to be expressing doubts about whether the American, European and Japanese trusts could continue as going concerns. It was also far-reaching: Australia’s Centro Properties Group, which owned 700 American shopping centres, was on the verge of collapse (its shares fell 76% in a day on 16 December 2007). Yet Allco was agreeing to buy Rubicon for roughly 25 times its earnings.

“Is Rubicon a piece of shit?” Bob Mansfield asked his fellow directors before an Allco board meeting in November, as they chatted within earshot of Fell, its founder. Sadly, history doesn’t relate the answer he was given, but there is no doubt it should have been “Yes.” By this stage Allco was committed to buying Rubicon for $328 million, despite extreme hostility from investors. It was also committed to paying $52 million of this sum in cash to Coe and Fell (who used the money to pay for his new Point Piper pad, Routala). The same two men stood to get another $20 million or so in dividends and profits as part of the deal. “It was absolutely the last straw,” says a distinguished company director who knew Allco well. “I was horrified, I couldn’t believe they were doing it. And I don’t understand why they went ahead. David can’t have needed the money; he had so much already.”

This appalling transaction was one of the main reasons the key players were hauled into the Federal Court in Sydney in late March to be examined by Allco’s receiver, Peter Gothard of Ferrier Hodgson, who is planning legal action to recover money for creditors. On the evidence so far – and a proper examination will come in a second court session – it appears that the only person to raise their voice against the Rubicon deal was Allco’s deputy managing director, Michael Stefanovski. In an angry email sent in early December 2007 to his CEO, David Clarke, and the lead independent director, Bob Mansfield, Stefanovski warned that market hostility to the Rubicon transaction was so extreme that Allco could run slap bang into that “perfect storm”. Clarke simply told him it was too late to turn back; they could not stop now. It is not clear why.

Stefanovski then sent a similar email to David Coe and received this reply: “We will not dump the Rubicon transaction.” Stefanovski warned there was a second element in this “perfect storm” that could engulf the company: Allco was going to miss its earnings targets and might need to issue a profit warning to the Australian Securities Exchange. This would put further downward pressure on the share price, which was rapidly heading south. Allco did take some action on this. As the company’s shares wobbled and sank, the directors set about buoying the accounts in the hope that banks and investors would not abandon ship.

Back in May, the board had authorised Project FINAO (Failure Is Not An Option) to ensure its 2007 earnings did not disappoint the market and, six months later, Project FINAO 2 swung into action. This operation essentially manufactured profits for Allco by parking assets in a subsidiary, the Allco Principals Trust (APT), which was already on the skids and running out of cash. According to John Sheahan SC, counsel for the receiver, 78% of Allco’s earnings for the first half of the 2008 financial year were created in this way, with the happy result that a profit warning was avoided.

This is similar to what Bond Corporation did after the October 1987 stock-market crash, when it flicked a few properties to Alan’s mates to pump up profits by $400 million and keep the banks happy. And the similarities with Bond don’t stop there. Like Bond, Allco was also awash with debt and needed asset prices to keep rising, was rife with related-party transactions and was dominated by a charismatic chairman. It also exhibited contempt for shareholders, published false information in its accounts and ended up spending other people’s money in the hope of saving the fortunes of its bosses.

The third element of the perfect storm was massive margin loans on 52 million Allco shares that were owned by Coey, Veaky, Westy and Nicko. Back in 2005, an Allco satellite had raised $250 million from mum and dad investors and used the proceeds to buy shares in Allco that were being issued to Allco’s partners. Sometime later, it had used these shares as security to load up more debt, worth $285 million, and it was now running out of cash to pay the interest.

No one seems to be sure when these margin loans were taken out, but Coe maintained in court (somewhat implausibly) that he and the other directors knew nothing about them until August 2007. By this time, Allco’s share price was diving (it fell from $10.54 in early August to $5.45 on 18 December) and it was increasingly likely that the margin loans would be called. This would cause the Allco Principals Trust to dump millions of shares onto the market and oblige Allco to inform the Australian Securities Exchange that Coe and his mates were selling. In turn, this would send the share prices down further and lead, in Stefanovski’s view, to “an uncontrollable meltdown scenario”. The only way out of this, Allco’s directors were told, was to approve a $50 million loan to APT in the hope it would be enough to keep the margin lenders at bay.

There is no doubt the Allco board was angry about being put in this position, but the directors who gave evidence in the Federal Court claimed they had little choice. It was, as Fell put it, “a necessary evil”. On the other hand, the easy terms, which Chris West negotiated for APT, were entirely unnecessary and an absolute disgrace. There was essentially no security and no payback plan for a loan to a company that had negative net assets and was almost certainly insolvent.

Stefanovski and Mansfield both told the Federal Court they thought the loan was secured against assets worth $100 million but how they came to this conclusion is a mystery. APT was already hocked to the hilt and Allco would have been right at the end of the queue, even if it had been given security, which it hadn’t. Mansfield told the court he believed APT had given a negative pledge (a promise not to issue new charges to other lenders) but a clause in the loan agreement that Mansfield signed specifically excluded APT’s only valuable properties.

Mansfield, who chaired the board meeting on 18 December and the related party committee that approved this loan, emerges with very little credit from the entire Allco saga. He was “weak”, “a pushover” and “too easily persuaded”, according to several bystanders. Sir Rod Eddington, who has yet to be questioned in court, appears to have been little better. But then, no one comes out of Allco looking good. Investment advisers at Grant Samuel should be ashamed of themselves for recommending the Rubicon deal as fair and reasonable to Allco shareholders. The auditors at KPMG Peat Marwick should be ashamed of themselves for approving two sets of accounts containing false information: first, that $1.9 billion of Allco’s liabilities were non-current; and second, that its $50 million loan to APT was properly secured. Australia’s top investment analysts should also be ashamed of themselves. As of December 2007, five out of seven brokers and banks covering Allco were advising investors to buy; none was saying “Sell”. Three months later the shares were practically worthless.

And then there are the top blokes who built this house of cards, who should feel even more ashamed of themselves for taking a fortune from investors and leading them to disaster. Of course, the dynamic duo, Coey and Gordo, are not entirely unscathed. Their shares are worth nothing, they’ve slipped down the rich list and their reputations are in tatters. Coe has even had to sell one of his Vaucluse mansions, for an Australian record of $45 million. But as far as we know, he’s still got the one next door and his fabulous art collection is still intact. There are unconfirmed (and un-denied) reports that he has taken delivery of a new luxury yacht. Meanwhile, Fell is sitting pretty in his $28.7 million Point Piper pad, which he bought in his wife’s name just as the empire began to collapse.

Paul Barry
Paul Barry is a journalist and investigative reporter. He is the author of Who Wants to be a Billionaire? The James Packer Story and The Rise and Rise of Kerry Packer.

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