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Shares in the company collapsed by 28 per cent yesterday, slicing its stock market value to $2.3billion in the kind of selling frenzy that in the past year has crippled companies such as ABC Learning Centres and the Allco Finance Group.
The plunge forced Babcock into talks with the bankers behind a $2.8billion loan. If the company cannot restore its market value to above $2.5billion within four months, the syndicate of 25 banks, led by the Bank of Scotland and including Australia's big four retail banks, have the right to demand early repayment of their loans to the company.
The heavily geared Babcock, which has about $46billion in debt across 20 separate listed and unlisted funds, is Macquarie Bank's biggest imitator. Like Macquarie Bank, it buys businesses, such as infrastructure assets, packages them together in one fund and charges a fee for managing them.
Babcock yesterday insisted it remained "robust" and that it had not breached loan convenants, classifying its issue with the banks as a "review event".
However, the bank admitted that if the banks ordered a review of its debt position it would have to seek their permission to pay dividends to its shareholders and interest on its subordinated notes.
Babcock, which is already in the process of selling significant assets in its wind farm and power funds, has also been forced to consider a review of its business, particularly its debt levels.
Ratings agency Standard and Poor's Ratings Services said yesterday it had placed Babcock on credit watch with "negative implications", meaning its debt rating is more likely to fall than rise.
"We have just got to show by our actions over the next couple of days and weeks that our business model remains completely intact, that we are developing and growing our business," the company's head of capital markets, Trevor Lowensohn, told The Australian.
Babcock shares, which were trading above $34 each last year, valuing the company at almost $12billion, yesterday crashed $2.62 to $6.90 on concerns the company had been targeted by hedge funds and short-sellers, who last year drove ABC and Allco to the brink of collapse.
The selling accelerated after Babcock admitted the fall had triggered the debt review. "There were rumours around Friday that it has fallen over, and rumours on Monday it had fallen over," Mr Lowensohn said.
The stock has collapsed by 75per cent this year - more than any Wall Street banking firm - even though it has managed to avoid the sub-prime losses that have crippled several other banks.
Shares in its biggest listed spin-off, Babcock & Brown Power, Western Australia's biggest gas retailer, returned to trading yesterday only to be cut almost in half, losing more than $400million for investors.
The problems at Babcock, coupled with a fall on Wall Street, weighed heavily on the Australian market, with investors concerned the global credit squeeze might claim more victims. The S&P/ASX 200 index fell 138.1 points to 5329.2, its lowest close for almost two months.
The accelerating fall in Babcock shares, which listed on the stock market in late 2004, has unnerved investors.
"They're obviously very nervous as many bought at higher levels," ABN AMRO Morgans adviser Lisa Jarvis said yesterday. "Certainly people have ridden the stock up from $7 (to $34) and not sold it and it's all the way back there now."
But Ms Jarvis said her clients still had hope for the stock. "After (yesterday's) fall, they're shocked but most are holding Babcock, hoping it will come good and hoping it was overdone," Ms Jarvis said. "Of course we don't know because when hedge funds get hold of things, they can be pretty vicious."
Southern Cross Equities executive director Angus Aitken said Babcock's problem was its business was based around the recycling of capital.
"That is, the buying of assets and selling them at a profit and moving onto the next deal but it's hard to see who are buyers of assets in many sectors they operate in right now," Mr Aitken said. "The cost of borrowing is going up and the asset valuations are coming down and that's what worries people."
Last night, as Babcock moved into damage control, the group stood by its forecast of a full-year profit of $750 million and insisted that it could put its share price woes behind it.
There is widespread belief that Babcock must move to rein in its high debt levels and re-focus its business model if it is to survive.
Mr Lowensohn admitted yesterday that across the group, leverage - the level of debt to the level of equity in the business - would be about 60 per cent. "We will be looking directionally to lower gearing," he said.
Three weeks of heavy selling, including shortselling by hedge funds, has halved the company's share price and exposed the covenant on the loan. The trigger was Babcock's market capitalisation falling below $2.5 billion.
"Reaching the market capitalisation level does not in itself trigger any requirement to repay our debt or accelerate payment of debt," Babcock chief executive Phil Green said.
But despite this assurance from the company, many were questioning the earnings credibility of the company, particularly its satellites, while talk of hedge fund activity added to the momentum.
"All in all, you've got an issue with the market fearing that some of the continued short sellers could trigger some of these debt covenants," an analyst said.
"There's a lot of concern in terms of their debt financing - that's the key where all this is stemming from. They reiterated to the market two weeks ago that they have earnings growth but if the market keeps selling your stock and your satellites, how are you going to achieve that?"
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