Macquarie: Roads to Riches

The Australian investment bank has made billions investing in airports and highways around the world. Now, after a failed bid for the London Stock Exchange, investors are wondering whether it’s losing its way.

When Allan Moss arrived at Harvard Business School to join the class of 1977, he found himself competing against some future corporate luminaries: Rick Wagoner, now chief executive officer of General Motors Corp.; Alan Lafley, CEO of Procter & Gamble Co.; and Lukas Mühlemann, chairman of Credit Suisse Group. “Allan was very low-key and unassuming, but he stood out even in a group of intellectual heavyweights,” recalls classmate Desmond Wong, 54, now a Chicago-based partner at Ernst & Young LLP, the second-biggest U.S. accounting firm.

Moss returned to his native Australia and prospered as a banker. Until last year, however, few outside Australia had heard of him or his investment bank, Macquarie Bank Ltd. That’s when Moss, 56, decided to go on a $14 billion acquisition spree. Now, Macquarie seems to engineer a new international deal every month—most of them purchases of public utilities. Among its acquisitions over the past three years: a string of airports from Brussels to Rome, to Hainan Island, China; roads and bridges across Australia, Europe, Asia and North America; and Oslo, Norway–based explosives company Dyno Nobel ASA.

Last year, Macquarie and Madrid-based partner Cintra SA paid $1.83 billion for the Chicago Skyway, a 7.8-mile (12.6-kilometer) elevated highway that runs from downtown Chicago to the Indiana border. And in March, Macquarie and Cintra got final approval from the Indiana legislature of their $3.85 billion bid for the 157-mile Indiana Toll- way. Perhaps Macquarie’s most audacious move came in December when it made a $2.6 billion hostile bid to buy the London Stock Exchange.

Moss has made himself an international business figure by creating a most peculiar financial institution. Macquarie’s strategy is to buy up monopoly assets such as roads, bridges and water companies and then take them public, usually by bundling them into funds that are then listed on various stock markets. Macquarie manages the funds and retains a stake. The plan has helped the bank deliver 14 successive years of record profits, 12 of them on Moss’s watch, and a 10- fold increase in shareholder returns. Macquarie’s success has also lured much bigger investment banks, including Gold- man Sachs Group Inc. and JPMorgan Chase & Co., into planning their own multibillion-dollar “infrastructure” funds.

“Macquarie came from nowhere with a brilliant idea and beat the competition,” says Marc Faber, 60, who manages $200 million at Marc Faber Ltd. in Hong Kong, including shares in Macquarie MEAG Prime REIT, a Singapore-listed real estate investment trust. As of Sept. 30, Macquarie had 112 billion Australian dollars (US$83.6 billion) in assets under management, up 36 percent from a year earlier.

Now, Faber and other investors are wondering whether Macquarie has peaked. On Feb. 1, Moss and his team told a briefing for investors that investment banking income would be “significantly lower” for the six months ending on March 31, due to a fall-off in performance fees from its public works funds. On Feb. 22, one of the bank’s Sydney-listed funds, Macquarie Airports, said profit for the year ended on Dec. 31 fell 23 percent to $494 million. All of the bad news contributed to a slide in Macquarie Bank stock that began in October, when JBWere Pty., a Melbourne-based brokerage, downgraded Macquarie stock to “neutral” from “outperform,” saying Macquarie funds were underperforming their indexes amid increasing competition in the sector. Macquarie Bank stock fell 23 percent to a seven-month low on Feb. 17. It has since bounced back a bit and was down 18 percent for the six months ended on March 3. And the ubiquitous bank from Down Under took a blow to its prestige on Feb. 20, when it abandoned its bid for the LSE after attracting just 0.04 per- cent of London Stock Exchange Plc shares.

What’s gone wrong? “A good idea can soon become one of excess,” Faber says. “A lot of people are copying them.” Faber is by no means writing Macquarie off. “The verdict on Macquarie will come when there’s an economic downturn,” he says. “They only have to make one stupid acquisition that will backfire on investors.”

“Macquarie shed light on a new moneymaking opportunity,” says James Holt, 32, who manages A$6.2 billion in stocks for Zurich Financial Services Australia, a unit of Switzerland’s biggest insurer, which doesn’t hold any Macquarie shares. “But now its earnings are subject to greater competi- tive pressures.”

Asked whether the new skepticism about Macquarie was justified, Moss said: “The Macquarie Bank business is in very good shape. As usual, changes in general market conditions impact on our share price.” He singled out rising interest rates as a factor that makes Macquarie assets less attractive. “The market has regarded us as a growth stock for a number of years, and growth stocks are volatile,” Moss added.

At home in Australia, Moss and his top executives have been criticized by Australian Treasurer Peter Costello and by the Australian Shareholders Association for rewarding themselves too richly. For the fiscal year ended on March 31, 2005, Moss’s pay package added up to A$18.6 million, an extraordinary sum by Australian standards. Chip Goodyear, head of BHP Billiton Ltd., the world’s biggest mining company and the largest company listed on the Australian Stock Exchange, makes only A$6.6 million. Macquarie investment banking chief Nicholas Moore earned only slightly less: A$18.2 million. Both took home twice as much as Moss’s Harvard classmates, Lafley and Wagoner. “I can’t understand how one person could be worth $18 million,” Costello said in a radio interview last year.

Stephen Matthews, 64, head of the shareholders association, couldn’t agree more. “They are extremely smart financial engineers, but the salaries they pay themselves are stratospheric,” he says. “When the results start to turn, share- holders will be less willing to accept it.”

Moss defends Macquarie’s high executive compensation by pointing out it’s based on profits. “Over 90 percent of the remuneration of the top management team is performance re- lated,” he says. “The bank’s performance has been outstanding, and remuneration is a function of that performance.”

As for the challenge from other banks, Moss says, “it’s normal and to be expected.” Speaking in his art-filled executive suite on the 10th floor of Macquarie’s 24-story headquarters, built atop the 19th-century facade of Sydney’s General Post Office, he contends there is plenty of business to go around. Before the Chicago Skyway and Indiana deals, for instance, less than 30 miles of the 5,244 miles of U.S. toll roads had been privatized, according to the Washing-ton-based International Bridge, Tunnel and Turnpike Association. “The Skyway deal has helped focus attention on the opportunities for municipalities to realize underperforming assets,” Moss says.

Moore, 47, says competition from Wall Street firms may even help his 500-strong public works team. “When Goldman and the other major players now go out to sell an infrastructure fund, it validates our story,” he says. “It makes it a lot more credible from the point of view of investors.”

Macquarie is an unusual amalgam. While it contains elements of a conventional investment bank, it also acts like a private equity operator, venture capitalist and hedge fund, mutual fund and exchange-traded fund manager. “They are like an incubator; their wheelers and dealers go look for projects, then they take them on the balance sheet,” says Jason Teh, 32, who helps manages A$5.5 billion in Australian stocks at Sydney-based Investors Mutual Ltd. “They then consolidate all those assets and try to lift them off into a vehicle in the market. What you don’t want, the worst-case scenario, is to buy an asset and it blows up on your balance sheet,” he says. Investors Mutual owns no Macquarie shares.

One secret of Macquarie’s success was Moss’s idea that he could take public works and make them profitable private companies. Macquarie’s first such venture came in 1996, when the New South Wales state government called for bids to operate a new toll road. Moss, who had been named Macquarie CEO three years earlier, and his team came up with the idea of financing the road through an initial public offering on the Australian Stock Exchange. Later that year, Macquarie set up what’s now known as Macquarie Infrastructure Group, the bank’s largest listed fund, with a market value of A$8.7 billion.

Macquarie has made one acquisition after another since then. The biggest: the 7.1 billion–euro ($8.4 billion) purchase of Europe’s third-biggest toll road operator, Société des Autoroutes Paris-Rhin-Rhône SA, in partnership with French construction company Eiffage SA, a deal that was cleared by the European Commission on Feb 16.

In addition to toll roads and airports, Macquarie owns a port in China, radio and television transmission towers in the Australian outback, Hawaii’s largest gas company, retirement homes in Canada and New Zealand and water utilities in the U.K. Over the past year, Macquarie has also purchased, for 166 million pounds ($290 million), a production arm of the British Broadcasting Corp., since renamed Red Bee Media; led a consortium that paid ¤1.83 billion for Amsterdam-based Yellow Brick Road SARL, a publisher of telephone directories in eight European countries that has been renamed European Directories SA; and paid US$634 million for Icon Parking Systems, which operates 192 parking lots in New York City.

In 2005, a Macquarie-led consortium and Macquarie’s client, Melbourne-based Orica Ltd., the world’s largest explosives maker, paid US$1.7 billion to buy Dyno Nobel, a 141-year-old company that traces its origins to Alfred Nobel, inventor of dynamite and founder of the Nobel prizes. Macquarie and Orica then split the company up between them, with Orica taking Dyno Nobel’s European, Latin American, Asian and African businesses, while the consortium got the Australian and North American units. On March 1, Macquarie announced it would raise as much as A$1.03 billion by selling shares in its part of the company, which retains the name Dyno Nobel. The listing is scheduled for April 7 in Australia.

In property, Macquarie has partnered with Aussie golfer Greg Norman to build housing communities centered on golf courses in Mexico and the U.S. A Macquarie real estate in- vestment trust, Macquarie Office Trust, also owns the Wachovia Financial Center, the largest office building in Miami. In January, Moss agreed to pay US$270 million to acquire St. Paul, Minnesota–based Smarte Carte Corp., the world’s biggest renter of airport luggage carts, with operations at 175 airports, giving Macquarie another income stream from travellers. The deal closed on Feb. 28.

Macquarie and the 27 funds it has listed on the Australia, New York, Singapore, Seoul and Toronto stock exchanges are popular among institutional investors because they offer steady, predictable, long-term income. Half of the investors in Macquarie funds are from outside Australia. One fund company, Los Angeles–based Capital Group Cos., which operates the American Funds, owns 13 percent of Macquarie Bank, accord- ing to Macquarie, and 8 percent of Macquarie Infrastructure Group, according to data compiled by Bloomberg. Boston- based Putnam Investments, another mutual fund company, owns 2 percent of Macquarie Bank. “Macquarie is usually able to bid more aggressively for assets because they have more- sophisticated financing capability,” says Hendrik van Brevoort, a London-based senior vice president at Putnam, who helps manage $10 billion and tracks toll roads and utilities. “They finance with debt. I don’t know how they do it, but they’re able to finance at lower cost of capital than other people.”

For its own bottom line, Macquarie doesn’t just depend on profits from the landing charges, taxes and tolls paid by the 110 million passengers who use its airports and the 620 million vehicles that pass along its toll roads annually. It also collects fees for underwriting the IPOs and managing the funds. Then it creams off a performance fee of up to 20 percent for beating agreed benchmarks. In the first half of the year ended on Sept. 30, Macquarie made A$168 million, pretax, from performance fees alone—a third of its six-month net profit.

In Australia, where it still makes 60 percent of its income, Macquarie runs a full investment banking service, including the underwriting of stocks and bonds and the sale of corporate advice. It does the same in Asia, where, in 2004, it bought the securities business of Amsterdam-based ING Groep NV. Globally, however, Macquarie ranked only 30th in mergers and acquisitions deals and 19th in equity sales last year, according to data compiled by Bloomberg. Even in its home market, it ranks second to UBS AG. Its market value of A$14.3 billion is one-seventh that of Merrill Lynch & Co., the biggest U.S. investment bank. “In 10 years’ time, will we have a broking license in London and the U.S. like Merrill Lynch?” Moore asks. “Unlikely, but possible.”

Wherever Macquarie is headed, investors have been en- joying the ride. At Macquarie Bank’s listing on the Australian Stock Exchange in 1996, the stock sold for A$6.50. By Sept. 29, 2005, it had soared 12-fold to A$77.45 compared with a 133 percent rise in the benchmark Standard & Poor’s/ASX 200 Index.

In the year ended on March 31, 2005, Macquarie Bank earned A$823 million on total income of A$3.65 billion— a 67 percent profit increase from 2004 and quadruple the figure for four years earlier. In the six months to Sept. 30, 2005, it made A$482 million—up 88 percent from a year earlier. Investors in Macquarie’s listed and unlisted public utility and property funds have earned an average of 19 percent a year, according to Macquarie Bank documents.

With that level of return, it’s no surprise competition has sprung up. In October, Goldman Sachs, which advised Chicago and Indiana on their tollway sales to Macquarie, told investors it’s planning its own $3 billion public utility fund, according to John Schmidt, who was Chicago’s legal counsel on the Skyway deal. Michael Duvally, a New York–based spokesman for Gold- man, declined to comment. In February, JPMorgan Chase’s money management arm, which oversees $50 billion, announced it was forming an Infrastructure Investments Group. Mark Weisdorf, 48, the group’s chief investment officer, declined to comment directly on its competition with Macquarie, saying only, "There will be room for many participants in the market."

One of Macquarie’s biggest investors, the Toronto-based Ontario Teachers’ Pension Plan, which manages 88 billion Canadian dollars (US$77.5 billion), now prefers to invest directly in roads and airports rather than pay Macquarie to invest through its funds. Jim Leech, 58, who manages C$12 billion for the teachers’ plan, says that in the past year, he has cut his four-year-old investment in Macquarie funds by C$100 million to C$650 million. “It’s like the whole world woke up to the fact that infrastructure is a long- term asset that can match pension funds’ liabilities,” Leech says. “There is now a whole lot of money that is focused there that is driving prices up dramatically.”

That doesn’t mean Macquarie won’t continue to win deals, says Nick Vidale, 28, who helps manage US$22 billion for Deutsche Asset Management, which owns shares in Macquarie Bank and some of its funds. “They bring operational expertise and a track record rather than just financing,” he says.

Despite Macquarie’s recent problems, on March 2, Standard & Poor’s reaffirmed Macquarie Bank’s longtime A rating. Melbourne-based S&P analyst Craig Bennett cited Macquarie’s resilient earnings, well-diversified businesses and strong asset quality as reasons for maintaining the rating. “The bank is involved in market segments that are highly complex, inherently volatile and subject to intense competition,” he wrote.

The bankers who do business with Macquarie say it seldom makes risky bets. “There’s a sort of Australian who can be quite brash, but the people who run Macquarie are anything but that,” says Simon Murray, former Asia-Pacific chairman of Deutsche Bank AG, who signed on in December as chairman of Macquarie’s corporate finance business in Asia. Murray, 65, also runs his own $650 million, Hong Kong– based private equity company, General Enterprise Management Services. Macquarie and GEMS are discussing mutual investments, Murray says.

When Moss first joined what is now Macquarie Bank in 1977, it was the Sydney branch of London investment bank Hill Samuel Ltd. and had a staff of 50. In 1971, David Clarke and Mark Johnson, two Australians with Harvard MBAs, joined as joint managing directors, heading a team of 14. They recruited Moss, a financier’s son from Sydney’s affluent eastern suburbs who had finished in the top 5 percent of that 1977 Harvard Business School class. “There were just two rooms in the Sydney office,” says Moss of the Hill Samuel operation. “In one room, people worked in corporate advice. The other room was where people worked in a very basic money market operation. Back then, the phrase 'Australia multinational' was a contra- diction in terms.”

In the mid-1980s, Clarke, now Macquarie executive chairman, and his team decided to transform the Hill Samuel branch into a full-fledged Australian bank. They formed a new company that bought 70 percent of the shares from Hill Samuel, which is now defunct, kept 10 percent for staff and placed the rest with Australian institutional investors. “Because Allan’s so bright, we got him to run our application for a banking license,” Clarke says.

Moss also helped choose the bank’s new name. It honors Lachlan Macquarie, a British colonial governor who, in 1813, solved a currency crisis in the penal colony of New South Wales by importing Spanish silver dollars and punching out the middle to double the number in circulation. The so- called holey dollar is now Macquarie’s halolike logo. The bank has contributed to the maintenance of Lachlan Macquarie’s grave on the Scottish island of Mull.

‘Most of the deal ideas end up in the shredder,’ CEO Moss says. His LSE bid was too low to attract investors

In 1993, the chief executive’s job fell vacant. Moss was such an obvious candidate that the directors agreed to appoint him by phone without calling a meeting, Clarke says. But it wasn’t be- cause the lanky, balding banker looked the part of a dashing CEO. “Allan Moss looks more like the headmaster of a school than an investment banker,” Murray says. “He’s very professorial.”

Three years later, Moss took Macquarie Bank public. The same year, Moss did the New South Wales toll road deal. “When we all saw how very successful that was, we thought we should try to do more,” he says. “And that was effectively the origin of the infrastructure business.” Where does he find such inspiration? He says he does some of his best creative thinking when kayaking alone on Sydney Harbour and strolling on Australian beaches inhabited by wallabies.

Moss attributes the bank’s success to being able to meld an entrepreneurial culture with strong risk management. “The phrase that we use is ‘freedom within boundaries,’” he says. “We seek to control centrally just a small number of really key risks, and we leave as much freedom as we can to the people in the businesses.” Neither Moss nor Moore takes the micro- phone when Macquarie embarks on one of its highly publicized international deals. The spokesman for Macquarie’s bid for the London Stock Exchange was the bank’s London-based head of European business, Jim Craig. In the high-profile U.S. toll road deals, it was the CEO of Macquarie Infrastructure Group, Steve Allen.

The final decisions are made at the bank’s headquarters at No. 1 Martin Place in Sydney’s Central Business District. “Most of the deal ideas end up in the shredder,” Moss says. “Even where we decide to seriously pursue ideas, a huge percentage don’t succeed for one reason or another.”

Has Moss’s confection of roads, bridges and tunnels begun to crumble? The question first arose in September, when the bank’s leading funds went into reverse. In December, Macqua- rie International Real Estate Fund Ltd., a global real estate investor, canceled a planned IPO in Singapore of 676 million Singaporean dollars (US$402 million), blaming a softening market for property trusts.

The same month, Macquarie made its bid for the London Stock Exchange. The LSE resisted the 580 pence–a-share bid, with CEO Clara Furse calling it “derisory.” On Feb. 20, Macquarie said it would not raise its offer and effectively abandoned its bid. That day, the bank’s share price surged as much as 4.5 percent. The LSE is now considering a higher bid from Nasdaq Stock Market Inc.

Moss was hardly cowed by this failure. Within 48 hours of pulling out of the deal, Macquarie announced that its Macquarie Korea Infrastructure Fund would seek to raise as much as US$1.17 billion on the London and Seoul stock exchanges. (It actually raised $963 million.) The fund, which owns roads, bridges and tunnels, began trading in London on March 14. Then, on Feb. 24, Macquarie announced it was spending £491 million to buy Kelda Group Plc’s U.S. unit, Aquarion Co. Kelda is the U.K.’s third-largest publicly traded water company.

What mystifies investors and transportation analysts is Macquarie’s ability to outbid its rivals for major utilities and still turn a profit. Its bid of $1.83 billion for the Chicago Sky- way was more than double the $700 million offer from its nearest rival. Although Indiana hasn’t released details of the competing bids, Charles Schalliol, Governor Mitch Daniels’s budget director, says the Macquarie-Cintra bid of $3.85 billion means the state will reap almost 25 percent more than it expected. “I think very few people here thought we would get much north of $3 billion,” says Schalliol, 58, a former Eli Lilly & Co. executive.

It was a similar story back in 2002 when Macquarie paid A$5.6 billion for state-owned Sydney Airport, A$600 million more than the Australian government’s best expectations, as Finance Minister Nick Minchin said at the time. Not long after the sale, the share price of both the bank and Macquarie Airports, into which the Sydney facility was fold- ed, fell by 40 percent. But Macquarie Airports has turned the Sydney facility into a money spinner, increasing revenue 13 percent a year and profit 16 percent, by attracting more airlines, enlarging shopping areas and increasing fees for covered parking and baggage carts. Taxis leaving the airport now pay A$2 to Macquarie. “I used to get a two-dollar tip from passengers I dropped off from the airport,” Sydney cabbie Fiona Fu says. “Now, it’s Macquarie that gets the tip. I think they’re greedy.”

Moss accepts the criticism with equanimity. “We try to do the best job that we can, but we understand that when you are a custodian of public assets, it’s inevitable that you will be part of community debate from time to time, and we think that’s fair enough,” he says.

Moss’s 13 years as CEO make him one of the longest- surviving chief executive officers in Australia, where the average tenure is five years. Ernst & Young’s Wong attributes Moss’s long tenure to a quality he shares with his Harvard classmates, Lafley and Wagoner. “All three are genuinely people oriented,” says Wong, who has remained in contact with them. “People who work for them actually like them and will do their best not to disappoint them. That’s a very powerful motivational force.”

Moss’s wife, Irene, a lawyer, is almost as well known in Australia as her husband. Until recently, she was head of the New South Wales Independent Commission Against Corruption, a high-profile state graft-fighting authority. They have no children. She retired in 2004.

How long will Moss stay in his job? “I don’t know,” he says. “The important thing is to have an open mind. I try to be objective in thinking of how I am going both in terms of broader business performance and contributing value to the team.” Macquarie’s full-year results, to be announced on May 16, may give some clue about Moss’s future. If Macquarie regains its footing and continues with its global deal making, the quiet man from Australia could eventually upstage his better- known Harvard peers.