Going Kaput – The Lessons We Can Learn From Babcock & Brown 

26th of June, 2019

Alceon may not be a name that rings a bell with a lot of people unless you are in the investment banking scene, however Phil Green one of the key consultants of Alceon is someone many investors may have heard of.

You see, Alceon is an offshoot of the tragically well-known Babcock and Brown (B&B) – now this IS a name I know will ring a bell with you!

In 2006-07, before the Global Financial Crisis, Babcock & Brown would have been on your list of ten-baggers. You know, those stocks you buy at $5 and sell for $50 a year or two later?

For those who are less familiar with B&B, here is a chart of one of the most exciting companies to leverage vast amounts of other people’s money only to then get it drastically wrong.

Who would have ever thought that leverage could go wrong hey?

Wikipedia sums it up quite nicely. ‘Babcock & Brown was a global investment and advisory firm based in Sydney, Australia that went into liquidation in 2009. It was best known in financial markets for structured finance deals. The company had at its peak 28 offices and over 1,500 employees worldwide.’

Phil Green, the former CEO of B&B, was the much-loved face of B&B – that was until they collapsed and everyone lost their money.

It is of interest to note that the chart B&B made lower tops, signifying weakness before the November 09 high of the All Ordinaries Index and well before the onset of the GFC. This was just one of those tipoffs that despite being a former darling of the market it was heading for some serious trouble

For me, whenever I see an interview with a former tycoon I can’t help but take a look and this is exactly what happened recently when I saw an interview with Green.

Ignoring B&B’s final fall from grace, one has to marvel at the balls Green showed to build a company that was often referred to as the “Little Macquarie”. A company with revenues of approximately $1.3B. You can’t just build something as big as he did and not have an enormous self-belief in yourself (even if some of it might be a little misplaced!) Once again showing just how important psychology is…

So when I saw Green quoted as saying ‘I was wrong’ about the collapse of B&B he certainly had my attention.
Had the infamous Phil Green, the man responsible for the $9.1B blow up of B&B, finally figured out the debt and real-estate cycle?
HA! Of course, not…

Phil would also go on to explain that they shouldn’t have leveraged as much as they did. That the mistake was not out of carelessness, but they just did not model the possibility of a GFC (read Credit induced Land Bust here).

See in this article what kept my interest was his explanation of his model of the economic cycle and more importantly the pieces of the puzzle he left out.

His model was based upon a post 1987-stock market crash era. He noted some short-term ‘blips’ such as the Russian crisis, the Asian debt crisis, Iraqi wars and the tech bubble bursting in 2000. But that was just it – he had a model that conveniently commenced at the start of a new cycle. He had naively developed a market theory based upon the actions and happenings of the “FIRST HALF OF THE CYCLE”

This is a BIG problem because he was not comparing apples with apples.

The actions and process of the first half of the cycle IS DIFFERENT to the second half of the cycle. They are like apples and oranges.

Its no wonder Green turned B&B into nothing more than a mixed fruit smoothie!

The “blips” he was referring to occurred in the first half of the cycle and are very different to what occurs at the end of the cycle. See in the first half of the cycle the system hasn’t yet been injected with copious amounts of credit to be used for speculative purposes, so any financial calamity (ie Russian crisis, the Asian debt crisis, Iraqi wars or a busting of a tech bubble) that comes along can be more easily dealt with because the banks are not precariously overleveraged.

Babcock and Brown, despite laying claim to some very smart investment bankers and having billions of dollars at their disposal, did NOT recognise that the economic cycle has two parts. Consequently, their entire business model was flawed – because it was based upon the premise that the first half of the cycle will repeat like the second half,

SORRY, THAT’S WRONG B&B as they found out at the end of 2007.

When you study the history of the property and stock markets, and I mean long-term history, you can see the cycles more clearly. You can invest with confidence and know when to time your investments using leverage and when to pull back and invest more conservatively. This is because you can see the FULL cycles over and over again. Those of you who have attended many of our events will have seen the cycles as far back as 1900 for the Australian Stock market and these long term cycles have been factored into our Economic Cycle Action Plan and general market approach.

In B&B’s case, they did not look back far enough to realise that the cycle has two distinct halves (apples and oranges), or in Greens words, the blips in the first half of the cycle are very different to what occurs at the end of the cycle. Know your economic history as it will not repeat but it will rhyme.

Warren Buffett, arguably the most successful investor in the world, has his economic models. One thing you can be guaranteed, is his investment fund, Berkshire Hathaway, is not highly leveraged at the top of the economic cycles. Never has been and never will be.

And despite Buffett having made billions of dollars of mistakes over the years, his foundation and the models he applies means each mistake is a mere drop in the ocean relatively speaking.

Buffett has mentioned a few of the big mistakes he has made over the years including his spiteful move in the early days of Berkshire Hathaway that cost him $200bn. Then there was the $444 million mistake on Tesco however, in Buffett’s words, Dexter Shoe Co was his worst investment decision, suggesting it cost his investors $3.5bn.

Buffett makes ultra-ballsy moves when companies are in the most pain, like when he invested $5 billion in Goldman Sachs at the bottom of the cycle when everybody else was running for cover.

By 2011, Berkshire Hathaway had earned $3.7 billion from that initial investment and still owns 13.2 million shares of Goldman Sachs. Not a bad return!

Alceon and Green, on the other hand, do not appear to have learned the real lesson from their past. Green was mistaken with his model. It’s a different paradigm because the long-term cycle is punctuated with a Mid-Cycle slowdown which is different to the cycle termination associated with a Credit Induced Land Bust.

Green still hasn’t factored in that there’s a cycle and its land and credit related.

It would not surprise me to see him getting it all wrong again, being overexposed towards the end of the cycle, right when you’ve got a contraction of credit and a fall of asset prices, especially land. He may again make the same underlying mistakes that sent B&B to the wall.

Same, same, but different.

Because we are not at the end of the credit cycle, in the short term, Alceon and Green are likely to flourish.

But mark my words, the economic model we follow and have seen play out for over 200 years is alive and well. We’ll continue to use the Calnan Flack Economic Cycle Action Plan and our market knowledge, to steer our ship and yours towards the opportunities ahead.

The unlearned lessons of Babcock and Brown are sure to be repeated and at Calnan Flack, we will be on the lookout for them.