• Keith Dalrymple

The Importance of Sound Governance Practices in Cases of Critical Infrastructure Acquisitions

John Dizard AUGUST 30 2019

Brookfield Infrastructure Partners, like other components of the Brookfield Asset Management group, seems to have achieved a state of quantum superposition in dealing with its regulators, or potential regulators, along with its investors and the general public. I think this description sounds much better than “regulatory arbitrageur”.

While private equity and infrastructure funds are collecting investor money by the barge-load, there is far more political risk to their business models than in the recent past.

Consider, for example, US senator Elizabeth Warren’s proposed Stop Wall Street Looting Act of 2019, which is mostly directed at imposing very strict regulations on buyouts. It is particularly hard on cash and asset stripping by leveraged financial buyers.

It is not going to become law in 2019, or 2020. But Ms Warren is now outpolling President Donald Trump as a 2020 candidate.

Despite the rumblings from the Jacobins and populists, some private equity people appear to believe that they can wave off the political threats with more slide-deck bromides.

They seem to assume that various sets of regulators, customers and outside investors will never find out what the others have been promised. Giant returns can be earned with little risk. Investment managers can be credible “operators” of a vast array of companies.

For example, when Sam Pollock, BIP’s chief executive, announced the company’s prospective $8.4bn takeover of Genesee & Wyoming, a major operator of US short-line rail companies, he spoke of how “G & W will be a significant addition to our global rail platform, and will expand our presence in this sector to four continents”.

He boasted of “our significant experience owning and operating rail, ports and other large-scale transportation infrastructure businesses”.

Yet Brookfield Asset Management — which controls and staffs BIP and DJP, Brookfield’s acquisition vehicle — subsequently filed a verified notice of exemption with the US Surface Transportation Board to avoid going through the regulator’s review and approval requirements.

In the filing, the phrase “global rail platform” does not appear. All that “significant experience owning and operating rail, ports . . . ”? Nada!

According to the filing, “DJP and Brookfield are not rail carriers”. Brookfield is described as “an alternative asset manager with over $365bn of assets under management”.

The experience of the regulators and customers of Brookfield-controlled rail operations in Australia and Brazil? How much cash was transferred from rail operating companies to the Brookfield parent companies?

Did those cash transfers reduce the money available to maintain reliable service? Not, apparently, relevant to whether the G & W deal should be waved through without review.

It is true that up to now Brookfield and its strategic partners (which include GIC, the Singapore sovereign fund) have not operated rail assets in the US. That makes them “non-carriers” in the language of the US rail regulation.

According to the STB’s 2017 annual report, while “non-carriers may acquire rail lines under a class exemption”, “required notification, along with the Board’s ability to revoke class exemption for particular transactions, prevent exemption abuse”.

There has already been a filing with the STB in opposition to the G & W merger. Victoria Dalrymple, an analyst who works with hedge funds, says as a shareholder in G & W, she opposes the exemption requested by Brookfield.

“Any potential benefits that the applicants might claim (eg access to capital) are directly contradicted by documented evidence of decapitalising rail assets thus creating anti-competitive pressures and significant safety and efficiency costs and damages,” she writes.

Brookfield spokespeople tend to dismiss such talk as the chatter of researchers for short sellers. However, there is a considerable body of complaints and concerns about Brookfield-controlled rail services that has been registered by Australian rail users and legislators.

For example, CBH Group, which uses Brookfield’s Arc Infrastructure-managed rail network to ship grain, wrote to the Western Australian government that despite investing A$175m ($118m) in rolling stock, it had been unable to achieve operating efficiencies due to “the railway owner’s attempts to extract higher prices”.

It added: “Access payments to [Arc Infrastructure] make up over 50 per cent of CBH’s rail supply chain costs. Comparatively, CBH estimates that Western Australia grain growers are paying approximately 2.6 to 5 times what growers in eastern Australia pay for track access . . . Due to a lack of transparency around issues such as access pricing and performance standards, there is also considerable uncertainty over how these access fees are being expended.”

Also, there was discontent with Brookfield-Arc’s operating management. “Track performance standards have been steadily decreasing. The present performance of the grain rail network has caused grave concerns as to how it is being managed and as to its sustainability.”

This all reads a lot like the anti-railroad populist literature of the late 19th and early 20th centuries. The commodities producers of Western Australia are not dissimilar to many of G & W’s rail customers in the western US. Eventually, they may compare notes on how much track has been shut down, how maintenance practices have changed and the direction of rail access prices.

The Surface Transportation Board may well approve the Brookfield-G & W takeover as an exempt transaction. Or it may take its time and consider whether it should accept bland assurances of “world class safety and outstanding service”, at the same time the investors are being promised exceptional returns.

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