expect 33% divs in 12 months time, page-28

Hu guys,

I've done some digging in past reports and put some numbers together that may be of interest to you. Beware this is long!!

1) DEBT

AEU, in 2007 changed its debt structure, opting for long term Senior Notes that have terms of 7 and 10 years. These were provided in USD, CAD, and AUD. In total AUD $78 mill have 7 year terms whilst AUD $70 mill have a 10 year term.

These notes are monitored and rated by NAIC and dependent upon the rating, 'penalty' interest is added if the rating falls. In the last annual report 100bp were added to these notes due to a rating slip (added $325,000 to the interest bill).

These Notes appear to be hedged against negative forex movements. In the last HY report the increase in LT debt appears to be from forex movements and not an increase in borrowings.

A further AUD $100 mill is with the NAB, who have rolled over the term until July 2010. A further $15 mill emergency fund is also held with the NAB.

IMO, this debt structure appears to be good. The terms are very long for the Notes and there doesn't appear to be any 'roll over risk' for AEU with the Notes.

The shorter term facility with the NAB is with an Aussie bank that would come under the Rudd Govt influence in this politically sensitive area - ie recall the loan and Ozzy and NZ kids have no where to go each day. In addition, they appear to be working well with AEU and I am sure that they don't want to deal with 400 odd child care centres on their books if they pulled the pin on AEU.

I assume that the asset sales (below) will go toward reducing this NAB facility (by over half).

2) ASSET SALES

In these conditions I think they are going very well. Effectively AEU is selling its crappiest assets that were either unprofitable operating child care centres or blocks of dirt.

To date AEU has received $15.3 mill AUD from asset sales of closed centres (13 for $10.7 mill) and development sites (3 for $4.6 mill).

If AEU's projections are accurate and all 33 closed centres are sold for 88% of bv and the development sites are sold for 75% of bv, then this will result in sales proceeds of $ 45.37 mill AUD.

In addition to this there have been 2 ABC2 centres sold where sales figures were not provided. They had a bv of $1.5 mill, and assuming they were sold for 88% bv, then sales proceeds of $1.32 mill.

This leaves 9 ABC2 centres untennanted and up for either lease or sale. Assuming that they are all sold for the same discount as is projected for the closed centres (88%) then this would realise $7.39 mill.

In total, this would equate to $54.08 mill from asset sales.

3) DEBT REPAYMENT AND RATIOS

In total, assets with a bv of $65.5 mill will have been sold by the end of this process for a projected total of $54.08 mill. This represents a discounted bv of 82.5%.

4) REPAYMENT OF DEBT

Assuming that these funds of $54 mill are used to repay the NAB debt then the following will occur:

Total Assets will reduce by $65.5 mill from the asset sales and now be $395.3 mill

Financial Liabilities will reduce by $54 mill through the repayment of debt and reduce from $279.3 mill to $225.3 mill.

The LVR ratio will reduce from 60.6% to 56.9% ---> a good outcome and further improves the headroom between it and the covenant of 65%.

(Note: very simple calcs and doesn't take into account further asset valuations, retained cash used to repay debt, or that AEU may not achieve its expected results).

4) LEASING

The problematic part of the ABC failure (ABC2 centres) appears to be largely resolved with outcomes for 80 of the 89 centres.

It would also appear that these leases are for 15 year terms !! I haven't seen too many other AREITs with lease terms that long!

ABC1 and ABC NZ will be much more easily resolved (although taking longer) as they are both profitable operations. The time delays revolve around the fact that buyers in Oz want to see some financial track record before paying top dollar, and in NZ I have read in the media that some late bidders have appeared on the scene. Again - both good signs and in the interim rent is being paid to AEU.

5) OUTLOOK

When the process is completed AEU will have disposed of its worst, underperforming assets and reduced its debt significantly. In addition its LVR will have improved also.

With only leased ABC2, ABC1 and ABC NZ centres now on its books, all paying rent and with a wider, profitable tennant base AEU will be in a good position.

Operating costs will be reduced and profit will increase. This will increase the ICR and bring it back within the covenant requirements.

It would then be likely that NAIC will improve the Senior Notes rating and the interest rate will be reduced.

6) FINALLY

IMO AEU represents an excellent opportunity at present due to the uncertainty surrounding leasing outcomes and asset sales.

It has disappointed the ST traders who wanted a distribution. And fair enough - when BJT announced an effective 25% divi yeild yesterday I can see why ST money is itching to go elsewhere.

Also, it is still too risky for those conservative REIT investors when Trusts such as GPT, DXS, SGP etc have sorted out their debt issues with capital raisings and don't have the same operational issues as AEU.

However, by not appealing to the short termers and not yet being safe enough for conservative investors, IMO makes AEU a very attractive LT investment.

Whilst maintaining diversity I will continue to buy as many AEU shares as is offered around these prices being comfortable that the heavy discount between the SP and NTA will limit any downside...

Good luck
John