Macquarie International Infrastructure Fund

[ghchua]

Well, a chapter had been closed and I hope that APTV Trust will be a better investment. I have taken APTV Trust shares instead of cash from MIIF and therefore the story lives on.

Frankly speaking, MIIF had been hit by the financial crisis but I wish to address the 3 risks highlighted by Nick and in particular with respect to MIIF.

1. Risky assets. The assets that MIIF had owned are not necessary all risky. It depends on the nature of those assets and they are acquired mostly for sustainable and predictable cash flows to fund dividend payouts. For example, ports and toll-roads are really depending on economic activities and regulated assets like pipelines and transmission towers are more stable but with little growth. MIIF also owned social assets like aged care homes which shows very resilient streams of income. The assets itself are not risky, but the price they paid was. For example, if I project economic activity to be vibrant and over-paid for those assets based on potential business growth, then I got screwed if asset prices drop after that. But that doesn't mean the assets I bought were risky. It only meant I bought over-priced assets in the first place.

2. Unstable cash flows. There is a difference between unstable cash flow and unstable dividend payouts. One must make the differentiation between these two. MIIF's assets on a whole doesn't exhibit unstable cash flows. But MIIF couldn't pay a steady cash flow because they over-geared in the initial years and have to divert cash flows from their assets to pay down debt, thereby reducing dividend payout in some years. Therefore, it is not fair to say that MIIF exhibits unstable cash flow. It is just that they have got the capital structure wrong and over-geared at fund level which resulted in unstable dividend payouts.

3. High leverage. While it is true that MIIF had high leverage at fund level in their initial years, they have reduced their leverage in subsequent years when they divest assets in Europe to focus on Asia. In fact, throughout the years, MIIF did not call for a rights issue even when their gearing were high. This shows that they had been able to de-leverage without asking shareholders for more money. We should give them credit for that. Other funds and REITs which were in trouble during the crisis had asked shareholders for rights issue to re-capitialize their balance sheet. In fact, MIFF sold assets, cuts dividends and use cash flow from their assets to pay down debt.

Of course, I also have doubts about some of MIIF's highly geared assets like Macquarie European Infrastructure Fund, Arqiva, Canadian Aged Care etc, their purchase of Miaoli Wind, Hua Nan Expressway etc and their management+success fees structure. But overall, I think they did ok, considering the challenges that they are facing.

[asphodeli]

Yup, definitely good effort by the management, assuming long-term investors who held at IPO price. At least it's not negative returns - that I would think, is an amazing feat, given that they weathered the GFC and did not do any dilutive corporate actions.

And yes, their assets weren't necessarily risky, but the price they paid for it was pretty crazy. Combined with a large amount of debt, the risk vs returns doesn't seem that good.

[pattanispirit]

quite disappointed with the divestment.
actually, wanted to dispose everything by Mar'14 where the price is around $0.11.
the NAV then was $0.148, so expecting to get somewhere around that figure.

the only consolation is overall it is still positive return, after keeping it for 2 years +.

[weijian]

IIRC, with the exception of Miaoli Wind, MIIF was never geared at fund level. All the debt was consolidated at asset level and assets were recorded as 'non current financial assets at fair value through P/L' (refer to example 3Q08 results at https://www.macquarie.com/dafiles/Intern...rt.pdf?v=1). Whether the leverage was ever reduced as they 'focused on Asia' after GFC2008, wasnt really very clear because the factsheet (of the assets) was only published once a year and the accounting wasnt easy for retail investors to comprehend.

In fact, MIIF did do a rights issue during 2005 (https://www.macquarie.com/dafiles/Intern...ed.pdf?v=1) during good times to increase their ability to do more asset churning. We can't forget that their Mgt fee is calculated based on market cap and also the level of asset churning. I would like to think that the only reason why there wasn't any rights issue at fund level, was simply because MIIF was at a yield that made any yield accretive accqusition almost impossible for a long time . Do note that during GFC2008 period, some of the assets did do cash calls (Arqiva: https://www.macquarie.com/dafiles/Intern...va.pdf?v=1) and it did not take it up.

[weijian]

quite disappointed with the divestment.
actually, wanted to dispose everything by Mar'14 where the price is around $0.11.
the NAV then was $0.148, so expecting to get somewhere around that figure.

the only consolation is overall it is still positive return, after keeping it for 2 years +.

I havent track MIIF much since i divested everything in 2013 when they managed to list APTV (finally, they found a new sucker to hold the baby). To incentivise the Manager to divest asap and as much, there was a success fee involved. I am not sure whether the NAV of 0.148 you quoted includes the success fee or not. But if it does, it should simply mean that the market is discounting the success fee and most probably also applying a ~0.8x NAV of the remaining Huanan Expressway (historically, Mr Market applies a 0.6-0.8x discount to the valuation of what the MIIF directors like to believe)

[ghchua]

Hi weijian,

Just to clarify a few points. The equity fund raising they have done in 2005 was not a rights issue. It was a placement plus ATM FCFS (First come First served) to fund proposed asset acquisitions. It was very much during their initial years after IPO. They have not asked shareholders for any rights issue throughout the life of the fund.

MIIF sold Macquarie Airports in 2008 to reduce fund level debt from $178.2 million to $20 million. The debt was reduced at fund level, while I agree with you that at asset level, it was still not very clear. But debt at asset level is non-recourse to MIIF. I was more concerned about debt at fund level.

With respect to Arqiva, MIIF is like any other shareholder. They can choose not to take up any cash call done by the company. Yes, Arqiva was highly geared which is why MIIF disposed all those European assets eventually to focus on Asia.

[Nick]

I don't think it was advisable to be leveraged at Fund level in the first place - there is no reason why a Fund interested in paying sustainable dividends should be carrying substantial debt in its books. The very fact it had debt at corporate level in the initial years shows how 'risk-inclined' it was. This is not like a REIT or a Business Trust borrowing at corporate level to finance the acquisition of assets directly. This is a mutual fund that was investing in other highly leveraged funds or assets. To put it in perspective, it is akin to an individual investor using high level of margin to acquire a portfolio of already highly leveraged unlisted assets. This will jack up returns in good times but when brick hits the fan, this strategy may lead to substantial destruction in shareholders' value. It was commendable that they quickly repaid their debt at Fund level and focused on deleveraging the underlying assets.

Personally, I believe the idea of non-recourse debt is over-hyped. Technically, the underlying debts are ring-fenced within the asset so a default wouldn't affect the sustainability of the other operations or the parent company. However, realistically, if there was a default, the fund investment would have experienced a significant impairment and the distribution stream would be halted. This occurred with Arqiva and Miaoli Wind. Granted, it will be less disastrous than having recourse debt (i.e. packing debt as shareholders loan) but it doesn't mean you won't suffer if the assets under performed.

With that being said, the Management did try their best to reverse the situation. They bought back shares instead of diluting existing shareholders and liquidated assets at a decent price. As such, shareholders who stayed on managed to recoup their investment losses - kudos to the Management.

The MLPs listed in USA has done well over the years so it might take some years before investors appreciate this asset class.

[ghchua]

Hi Nick,

Before GFC, credit was available freely and asset securitisation was the name of the game. It allows companies to borrow money against expected future cash flows, and it suits infrastructure assets perfectly during that period due to the predictable cash flow of these assets. Then, as we know, credit crisis came and leverage became a double-edged sword.

As for gearing at fund level as compared to REITs and Business Trusts, we must understand that MIIF don't own 100% of these assets directly. Therefore, they have no control over how much distributions those underlying assets will distribute up to MIIF at fund level, which might affect MIIF distribution to shareholders as well. Therefore, MIIF did gear up at fund level in the initial years to maintain high dividend so that they can invest in more assets. A case in point is Arqiva, which choose to withheld distribution to MIIF for a capital structure review. MIIF has no control on what Arqiva is doing. This is different as REITs and Business Trusts own most assets directly and they certainly have control on them.

MIIF was doing well using that strategy since 2005 before crisis strike. If we were to look back, MIIF distributes 7.05cts per share in 2006, 8.15cts per share in 2007 and 8.5cts per share in 2008. Nobody was complaining about the high leverage then. MIIF continues to distribute dividends every year even when crisis strike when a lot of funds had stop distribution and asked shareholders for rights issues. MIIF did not and as you mentioned, they even did share buyback.

Arqiva was a much better asset than Miaoli Wind as it generates decent distributions for MIIF in its initial years. However, because it is a much bigger allocation in MIIF's portfolio, its impact was much larger. Miaoli Wind was a lemon. Fortunately, MIIF acquired Miaoli for $27.9 million in 2008 and almost all of it was written off. Compared to $434.8 million invested for Arqiva. Clearly, the impact of Arqiva was larger.