robert gottliebsen two articles

Save Centro or lose billions


Later today Centro is expected to make an important announcement. The daily press anticipates the group will go under but I would be surprised. Centro shows us the best and worst of the current investment scene in Australia.

Let's start with the worst. A majority of the big four banks, led by the Commonwealth, are owed about $3.5 billion by Centro Properties – and it is unsecured. Centro Properties is a holding company for an incredibly complex set of joint ventures. If the weight of that complexity (and the nervous bankers in other parts of the group who are fighting over security) actually sends Centro to the wall, then the big Australian banks will lose most of their $3.5 billion. It will be one of the biggest bank losses we have ever seen.

If key parts of the Centro group go into administration, the shopping centre management contracts which are a key Centro Properties asset will unravel. The management contracts are valued at $5 billion on the books, but will be close to worthless if the group collapses. Very little value will trickle down to Centro Properties' unsecured creditors once administrators start charging and/or properties are flogged at low prices.

What on earth were the big banks thinking when they loaned such huge sums, unsecured, to Centro Properties? We saw an equally silly lending game when the big four banks loaned big sums to the ailing US Countrywide group. Both these loans show that over confidence has crept into the lending departments of our big banks. The market fears that more mistakes have been made, which has contributed to the bank share price fall.

While that $3.5 billion unsecured loan represents some of the worst features of our market, the best feature is that there is a huge pile of equity money looking for bargains in troubled situations. We saw the latent capital available in the Citibank equity issue.

In Australia the word from the big banks is that they have been pleasantly surprised at the number of groups that have expressed interest in investing equity in all or part of Centro.

Centro is, after all, the fifth largest retail property owner/manager in the US and the second largest retail property owner/manager in Australia. In Australia it is the largest provider of retail space to Coles Group and Woolworths. These are world class assets that are virtually recession proof. They have attracted global and local interest. The equity money on the sidelines was reflected in the recovery in the Australian market yesterday.

Normally with Centro-style problems, the big banks go into a frenzy of shooting themselves in the foot, but this time they have acted more maturely. The big banks need the management contracts to hold and for there to be a massive equity investment into Centro. You will see in Business Spectator's Conversation pages that many believe that most value is to be found in the Centro Retail company. One of the contributors to our Conversation, Xan Phung, has put forward a remarkably detailed plan to rescue the company. That’s the sort of thing that is being worked on now.

What makes Centro so different is that its assets are well managed and produce cash flow. This is a financing problem.

New hope for Centro


Like so many chief executives facing a crisis, Andrew Scott could not handle the breakdown of the Centro group he had built, and manage the crisis in a matter of fact way. It is now vital for the group that the new CEO, the former chief of Centro US, Glenn Rufrano, be able to maintain the confidence of the banks.

Nevertheless, along with a terrible mess, Scott hands Rufrano two advantages – a shopping centre network that is performing well and a set of four pillar Australian banks who are owed around $3.5 billion and are desperate for Centro to hold together because they don’t have any security. Huge billion-dollar-plus write-offs would not be popular with big Australian bank shareholders.

I set out the detail of this motivation in my comment earlier this morning (see Save Centro or lose billions)and the directors have confirmed those comments in their statement. It is also important to again warn bank shareholders that their lending departments have been taking excessive risks and have been over confident.
The Centro directors also confirm what the banks have been privately saying – that there is enormous interest in the Centro group from the mountain of equity money in Australia and around the world looking for opportunities that come out of the hard times.

Reflecting this interest, the proposal to sell the Australian and US wholesale funds is a relatively small exercise, covering about 15 per cent of the Centro group’s shopping centres.

The big prize is to re-capitalize the whole group. The Centro American wholesale fund has about $A1.2 billion in assets and debt of about $A500 million while the Australian wholesale fund has around $A2.6 billion in assets and debt of just under $1billion.

The group has $26 billion of shopping centre assets and the sell-off appears to be equal to about $3.8 billion. If book values were received, then in theory around $2.3 billion would be raised after loan repayments.

Unfortunately for Centro Properties the money flows to them via the diversified funds, so about half would go to the outside investors in the funds. As I explained this morning, the key to Centro Properties' future is the shopping centre management contracts which last year were valued by KPMG at $5 billion.

If the two funds are sold and Centro Properties retains management, or management rights are sold for a good price, then that’s great news for the four pillar banks. If the management rights are transferred without consideration, that would be bad news for the big Australian banks and of course Centro Properties shareholders.

Nevertheless it would create group cash and set a current value for the other centres which might make it easier to raise the money to re-capitalise the rest of the operation. It would also be very good news for Centro Retail shareholders who own centres in their own right.

In most collapses, banks panic and demand to be repaid. It is clear that $US450 million of American private placement noteholders thought about pulling the plug, but were convinced to back off. If they had forced an administration it would have triggered a transfer of all the management contracts and caused carnage.

There are two points of great importance to Australian trading bank shareholders and hopefully for Centro Properties shareholders. First, the reports in the daily press saying that the end was near at Centro were simply wrong. There is a good chance the banks will get their money back and at least a chance for Centro Property shareholders to get something.

But secondly there are absolutely no certainties. The group is far too highly leveraged and the US capital market is a mess. Nevertheless, if I wanted to invest in American property, food stores like those held by Centro are about the safest way to go and they appear to be performing well. That’s why they are attracting so much interest. Having an experienced US executive spearheading the rescue improves that chance.

But the rising Australian dollar is a blow to Centro because it can no longer obtain hedge cover and there is always the possibility that global conditions will worsen.

We will keep you posted.