When investigating the quality of Macquarie Bank’s (ASX:MBL) infrastructure assets, you want to discuss them in two senses. First, whether they are going to grow earnings without requiring additional capital investment and second, whether or not the assets themselves going to grow in value.
Toll roads, for example, would seem like exactly the sort of asset that requires a lot of additional capital investment. It’s possible Macquarie Bank has structured the deal so that someone else pays for the upkeep on the assets, while the Bank collects the income. If so, well, that would be a clever deal.
And as to the assets themselves…will they grow in value? That too, is possible. But a key question is the purchase price of the asset to begin with. We know what his upside is if the asset grows in value. But what’s his downside if the asset falls in value?
We dusted off our copy of Graham’s “The Intelligent Investor,” to see what the dynamic duo of value investing had to say on just this dilemma. You’ll find this in chapter eight. “The holder of marketable shares actually has a double status, and with it the privilege of taking advantage of either as his choice. On the one hand, his position is analogous to that of a minority stockholder or silent partner in a private business. Here is results are entirely dependent on the profits of the enterprise or on a change in the underlying value of its assets.”
MacBank seems to have skirted this risk a bit as it’s been able to create two streams of revenue from the asset, the earnings from the operation of the infrastructure itself and the selling of those earnings through a fund. Still, ultimate profitability comes down to the underlying value of the assets, and not paying too much for them to start with.
Graham and Dodd continue, “He would usually determine the value of such a private business interest by calculating his share of net worth as shown on the most recent balance sheet. On the other hand, the common stock investor holds a piece of paper, an engraved stock certificate, which can be sold in a matter of minutes at a price which varies from moment to moment-when the market is open, that is-and often is far removed from balance sheet value.”
Ah yes. Claims on earnings can trade at large premiums to underlying book value. That’s why being an investment bank is such a good business, whereas being a real business owner ties you more directly to the balance sheet, and keeping it healthy.
“The development of the stock market in recent decades has made the typical investor more dependent on the course of price quotations and less free than formerly to consider himself merely a business owner. The reason is that the successful enterprises in which he is likely to concentrate his holdings sell almost constantly at prices well above their net asset value (or book value, or ‘balance sheet value’). In paying these market premiums, the investor gives precious hostages to fortune, for he must depend on the stock market itself to validate his commitments.”
So has MacBank given precious hostages to fortune? That is, has it paid too much for costly infrastructure assets whose value is utterly dependent on stock market confidence? Time will tell. There’s no doubt the bank has tangible assets on the balance sheet. But it’s got a lot of other things on the balance sheet too. And what we don’t really know yet is how those assets are going to hold up over time, how much capital they require, and how sustainable the earnings they create will be.
That’s a lot not to know.
The Daily Reckoning Australia