half-year result to December 31 2008 with a massive headline...

half-year result to December 31 2008 with a massive headline loss under AIFRS, no distribution payable and no guidance provided by management for the balance of the year. In particular, the deteriorating global outlook will adversely affect VPG’s significant exposures to the UK and Europe and to industrial property. Our recommendation is maintained as AVOID with no valuation or price triggers provided accordingly. VPG is unsuitable for risk-averse investors and should only be considered by investors willing to accept very high risk and speculate on a positive medium-term outlook.

VPG claim underlying earnings of $14.0m or 87cpu for the half year. Reflecting the absence of transparency in their financial statements we suspect an operating loss of around $3.5m. After a downward revaluation of only 4.8% in the owned property portfolio, but with around 60% writedowns in various intangibles, VPG reported a half-year loss under AIFRS of $0.82bn.

Management claims to have implemented a cost reduction program of $30m or 20% of total costs by FY2010. With the entrepreneurial nature of the board and management, extremely well rewarded with a heavily incentivised remuneration structure during the AREIT boom, leading to a high cost base it is a positive that senior management have accepted voluntary pay cuts but disappointing they have not gone a step further and voluntarily linked their remuneration to unitholder returns in the current downturn. No distribution will be payable and management declined to provide earnings or distribution guidance for the balance of the year.

The Asia Pacific property portfolio continues to have a strong lease expiry profile of 4.7 years and high occupancy of 94.6% with 96% tenant retention, but the European portfolio is deteriorating with 84.7% occupancy and only 68% tenant retention. With 58% of assets under management in mainland Europe and 22% in the UK, where the adverse impacts of the recession are more advanced, and 50% in industrial, which is particularly vulnerable to economic downturn, the outlook for security of earnings looks bleak and even bleaker for earnings growth with very thin operating margins.

Facing the risk of covenant breach, VPG’s bankers have agreed to revise lending terms extending the facility by 12 months to September 2011 but replacing group covenants with direct asset security. While the support of their bankers is a positive, realistically the banks had no more attractive alternatives and the debt problem is deferred rather than resolved. Still, VPG has bought time to undertake asset disposals which its lenders will reward with lower lending rates.

In June 2007, VPG paid $667.2m to acquire the Scarborough business in the UK and Europe. This was funded through a rights issue at $1.92pu, compared to the current trading price of around 3cpu, with the vendors reinvesting around $140m of the proceeds back into VPG. VPG has now written the value of the business down to $143.4m and is apparently in ongoing negotiations with the Scarborough vendors as to swapping debt for equity. The benefit of such negotiations to other VPG unitholders is unclear.

Surprisingly, with 97% of the portfolio externally valued over the last year a property valuation fall of only 9% was recorded for the year, reflecting a 74bps weakening in the weighted average capitalisation rate to 8.0%. Given the high proportion of UK and European properties and industrial assets in the portfolio, a greater fall was expected and may still occur. Debt covenants were renegotiated to 55% with falling property values taking gearing to 47% on a balance sheet basis, or 53% on a look-through basis. NTA fell to $0.51pu.

VPG continues to have a boom time board and management who are not ideally suited to a long property market downturn. While management referred to focusing on the core business of value adding, greater comfort would derive from a focus on short- to medium-term survival and the appointment of new, independent directors with strong financial .........