The mighty Macquarie is only human

In the dog days of summer, you can always count on the odd controversial deal to keep those still stuck at their desks entertained. This year has proved no different. The German utility giant RWE is looking to offload Thames Water, the leaking water company that has incurred the wrath of homeowners in the South with its drought orders, high charges and even higher executive remuneration packages. Domes-tic unrest aside, the price tag remains watertight, with a value of around £7bn attached.

Then there are the bidders - and one in particular: the Australian investment bank Macquarie. Dubbed the "Millionaires' Factory" for the vast sums of money it has made its senior staff over the years, the publicity-shy bank has built up a solid reputation despite rarely speaking to the press.

With a relatively modest market capitalisation of A$15bn (£6bn), it has bumped up against bigger investment banks and major private equity groups to secure a succession of high-profile deals not just in Australia but across Europe, the US and Asia, both in a bidding and advisory capacity. It is now the world's largest non-governmental owner of infrastructure assets. In Britain, it owns the M6 toll road and a stake in Bristol airport, among other assets.

One source close to the bank suggests that high on its European shopping list are telecommunications, energy, property, airport and water assets. The source adds that it is pursuing more acquisitions in Britain. It recently snapped up Stagecoach's London bus operations for £263.6m and worked with the Spanish services group Ferrovial on its £10.1bn bid for the airports group BAA. It supported Citigroup, the lead adviser on the deal, and as Citigroup is likely to walk away with more than £75m in fees, it was evidently a lucrative assignment for Macquarie.

But when it comes to Thames Water, it is looking increasingly unlikely that it will bag the prize. First-round offers went in last week and although insiders remain confident, Macquarie's bid has been hindered by its inability so far to offload South East Water. Under competition rules, it is extremely unlikely that the bank would get away with owning both.

Nor is this the first deal that Macquarie has been unable to land in recent months. Last December it hit the headlines following an audacious £1.5bn approach for the London Stock Exchange, but this came to nothing. It failed to win Associated British Ports in a tightly fought auction earlier this year, and lost out in the battle for the media and telecom assets of Hong Kong conglomerate PCCW.

Concerns are starting to grow that the company's stellar performance could be faltering. "For the first time in several years, some cracks are appearing in the market's perception of management," Citigroup commented in a recent research note.

"It is fair to say that the type of global weakness and collective jitters in equity markets that Macquarie Bank would fear have actually materialised in the past two months."

Even the bank itself has admitted conditions are getting tougher. At its annual general meeting in Sydney last month, it warned that market sentiment had deteriorated.

Unlike many of its peers, Macquarie mostly turns to equity markets, both to source funding and by bundling up assets into listed investment funds. But the threat of more rises in interest rates and market volatility due to concerns over economic growth has cast a shadow over this strategy.

In May, Macquarie raised A$700m without explaining exactly where the money would be going, leaving some analysts to ponder whether the bank thought this was as good as the market would get this year.

Macquarie is both a traditional investment bank and unconventional infrastructure specialist. Once it buys an asset, this is restructured and usually spun off into one of nearly 30 satellite funds, removing the financial risk from Macquarie's balance sheet. It is particularly attracted by opportunities to buy privatised monopolies that promise golden cashflow streams - hence its interest in Thames Water. Macquarie has continued to roll out investment funds to house these assets, including last year's $425m (£224m) float of a global infrastructure fund on the New York Stock Exchange and several other funds in Europe. The group acts as a one-stop shop with its own corporate advisory, financing, trading and funds management teams taking care of every step of the process. This all-round expertise has proved a money-spinner; underlying annual profits are up by one-third this year alone.

Macquarie rewards itself with generous fees for snaring and managing assets. Its shares have skyrocketed over the past decade, jumping above A$70 earlier this year. Since then, the share price has fallen, mainly due to market jitters and lower-than-expected advisory fees. The stock is trading at around A$60, although that is still more than 10 times its 1996 listing price.

Shares in Macquarie's listed funds, however, have failed to match such increases, and questions remain about their outlook. The funds are untested in a rising interest rate environment, where it now costs more to service the debt of their highly geared assets. Recent market volatility has already led the bank to shy away from creating further listed funds. The bank's model is reliant on a steady cashflow, so its bankers are constantly looking for more assets to keep the Macquarie engine running.

It adheres to a disciplined approach to buying assets and will walk away if an opportunity does not meet its profits criteria. However, it plays down the risk that it might run out of assets to acquire and says its expertise and structure allow it to buy during volatile times. But those close to Macquarie believe that it cannot afford to devote such significant resources to mergers and acquisitions without success.

Another danger is damage to its reputation if one of its ambitious projects courts controversy - as another Australian company, Multiplex, the embattled developer of London's Wembley Stadium, can attest. Macquarie has already had a taste of this: it was forced to weather the backlash in 2002 over the perceived premium paid for Sydney airport.

Macquarie's ability to attract top talent with premium-rate salaries has fostered loyalty during tough times and provided an edge. Its managing director, Allan Moss, is the highest-paid executive in Australia, on A$21m a year. His hiring of ex-politicians to help win public tenders has proved controversial but ultimately successful.

"Macquarie is effectively betting on its intellectual capital," says one Melbourne-based analyst, speaking on condition of anonymity. But as he warns, high-profile staff and lofty strategies are not, in themselves, enough. "They now have to come up with the next big idea."

Yet for all the creeping concerns, for the time being at least, investors appear to be backing the bank. At the same AGM at which Macquarie warned about tough conditions, Brian Johnson, a leading Australian analyst at JPMorgan and a Macquarie shareholder, defended the bank's remuneration policy. Some investors had complained that rewards for executives were growing faster than profits. Yet, as Mr Johnson pointed out: "The reason those [remuneration] numbers are so big is because we have actually done very well."

Macquarie has the sort of track record larger rivals would be pleased to boast. The bank is on its way to producing its 15th consecutive year of profits growth. Offshore markets now produce around half its operating income: it has been in the UK since 1999 and employs 600 staff at its European headquarters in London. The problem is that as the big guys such as Goldman Sachs start to follow the Macquarie approach, so conditions get tougher as the bank has to fight off more suitors.

"The risk is that the super-normal returns from this bank will moderate as competition increases," argues one Australian stockbroker, who declined to be named. "Cashed-up private equity firms are fighting for their share of the action with these infrastructure assets."

Morgan Stanley, in a recent research note, was equally cautious. "The bears may conclude that the listed specialist fund business looks as though it has had its day for now, citing the clogging of the balance sheet with seed assets [and] no demand for further listed funds as reasons why Macquarie Bank needs to change the game. The bears could also conclude that trading and equities markets peaked in the first quarter. It can only get worse."

Yet for all the potential, the millionaires at the factory remain remarkably calm. The Macquarie source says: "Recently, some notable bids have been gaining publicity. [But] deals have always been highly contested. There has been a lot of liquidity in private equity but we don't get spooked by that." He points out that while Macquarie is adamant it will never overpay for assets, its rivals are not always so emphatic. "People will make mistakes," he notes.

But in the months to come, investors who have become accustomed to the profits and deals churned out by Australia's Millionaires' Factory will be hoping that human frailty is a problem only for its rivals.

Rich Pickings: It's just one damned deal after another at the Millionaires' Factory

July 2006

Snaps up six shopping centres in the US for $122.7m (£64.8m). Also acquires Canadian mortgage provider Cervus Financial Corp for C$12.5m (£5.9m).

June 2006

Buys Stagecoach's London bus operations for £263.6m. In the US, Macquarie Infrastructure leads a consortium to buy an Indiana toll road for $3.8bn.

April 2006

Macquarie-led consortium buys Select Service Partner from catering giant Compass for £1.82bn.

March 2006

Secures public-private partnership deal to deliver 12 new or refurbished schools in the Birmingham area. Contract is valued at £90.5m.

December 2005

Macquarie Goodman acquires Arlington Securities, a British property services and investment manager, for A$507m (£204m).

November 2005

Macquarie International Infrastructure Fund acquires a German oil and chemical tank storage business from Lehnkering for €147m (£100m). Macquarie Capital Alliance buys a 49 per cent stake in Zig Inge Retirement Villages in Australia for A$155m.

October 2005

Buys Isle of Man Steam Packet Group for £225m. Novera Macquarie Renewable Energy acquires three landfill gas sites in Norfolk for £11m. Macquarie-led consortium buys Icon Parking Systems in the US for $869m.

September 2005

Macquarie Infrastructure Group buys an 86.7 per cent interest in the Dulles Greenway toll road in Washington DC. Also acquires the partnership that operates the road. Deal valued at $533m.