Escaping Centro's tangled web Stephen BartholomeuszPublished...

Escaping Centro's tangled web Stephen Bartholomeusz

Published 5:28 PM, 1 Mar 2011

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The $US9.4 billion sale of the Centro group?s US property assets to Blackstone that was confirmed today has opened a path through the maze that could end in the recapitalisation and consolidation of the over-leveraged and extraordinarily complex structure of the distressed group.

In a stroke the group, if the transaction is completed, will more than halve its overall debt burden, wiping out $800 million of debt associated with the US assets and enabling about $1.4 billion to be repatriated, about $1.1 billion of it flowing into the key entities, Centro Properties (CNP) and Centro retail (CER) to reduce their debt burdens.

In CER?s case, the $500 million it will receive will reduce its gearing from an unsustainable 75 per cent to about 43 per cent.

What it doesn?t do is disentangle it from the wider Centro group, which owns about 51 per cent of its securities and has co-ownership stakes in most of its underlying properties.

Given that CNP, the headstock within the group, will still have about $3.5 billion of debt after it receives its $600 million share of the US proceeds and a $1.6 billion hole where its security holders? funds used to be, while the US sale will downsize the group, reduce its complexity and stabilise CER, it doesn?t resolve the structural issues within the incestuous group.

The group, however, announced more than an asset sale today. CNP has agreed with 73 per cent of its senior debt holders to cancel all of its debt in exchange for most of its Australian assets, including its direct property interests, its interests in its wholesale funds and its interest in CER.

To appease security holders, junior creditors and the class action litigants the lenders are going to create a $100 million pool which will be distributed among them in order to give them an incentive to support the scheme. While they might be disappointed at the size of the funds being made available, $100 million is better than nothing, which is what they would share if CNP were liquidated.

To fill in a $1.6 billion hole and provide the $100 million the lenders have clearly being prepared to take a very significant haircut on the face value of their loans to CNP, which after the US sale amount to roughly $4 billion, which implies a discount of perhaps 40 cents in the dollar.

Most of CNP?s original bank lenders, however, sold out at steep discounts of their own ? the average was probably around or a bit more than the 40 per cent level ? to a collection of hedge funds, private equity funds and distressed debt funds, so the new holders of the debt can afford to write-off value that doesn?t exist.

In fact, with a very attractive running yield, the currency appreciation and, for most of them, some profit on conversion because of the extent of the discounts to face value they extracted from the banks, the funds are probably well in front already.

The next proposed steps in the transaction are very clever. The major obstacle to any reconstruction of the Centro group was the deficiency within CNP, which made it impossible to bring in CER, which has positive security holder funds of about $943 million.

Wiping out the deficiency through a debt for assets swap (and leaving the class actions and CNP security holders behind in the process) makes it feasible and for the debt investors, who were fundamentally taking an equity risk anyway, is a very pragmatic approach.

If they can get everyone to agree, all the Centro entities, including its wholesale funds, would pool their common assets, at net asset values, within a single new entity and obtain equity in exchange. The funds holding the CNP debt would probably own more than 50 per cent.

All the current complexity and financial engineering within the Centro group would disappear and the "new" Centro would look like any conventional and conservatively geared real estate investment trust and it would have 100 per cent ownership of a high-quality and purely Australasian portfolio of regional and sub-regional retail centres.

By itself, the removal of the complexity and leverage and threat of a messy insolvency would, one would expect, lead to uplift in value for the continuing stakeholders, including CER security holders. Australian property values have stabilised and, indeed, may have turned.

Solving the Centro puzzle would also remove the over-hang from the retail property segment of the market ? the threat that Centro?s portfolio might have to be sold off in distressed circumstances ? which might also have a positive impact on capitalisation rates.

All the parties involved also know that the Centro properties have been starved of capital and the boards and managements of all the entities have been grossly distracted since the group plunged into crisis more than three years ago. Access to capital and a clearer focus ought to bring with it opportunities to add considerable value to the portfolio ? and upside for all those contributing assets to the new entity.

The complexity of the group and its intra-group relationships means that while the end game is simple in concept the process is going to be inordinately complicated and will take time. There will also be some parties whose consents will probably be needed, who may seek to use their leverage to extract better deals.

For all concerned, however, the consequences of not getting the planned amalgamation of assets that would create the new $4 billion listed REIT through the obstacles would be far less appealing than what the Centro entities, and the very sophisticated parties that now control most of the CNP debt, envisage.