CENTRO Retail Trust was subordinate to its 50 per cent shareholder, Centro Properties Group, when Centro hit the wall at the end of 2007 after failing to renegotiate short term debts in the face of an escalating global financial crisis.
But now it isn't, and that is crucial as Centro Properties attempts to secure a debt-for assets-and-equity swap with hedge funds that now own its debt, followed by a merger with Centro Retail to create a low-geared, unified, Australian shopping centre trust.
When the group was a boom-time darling the two Centros were peas in a single governance pod, with identical boards. But their interests diverged as Centro's existential crisis developed, and in 2009 Centro Retail appointed an independent chairman, Peter Day. Last year he completed a board restructuring that put a majority of non-Centro directors in place.
Advertisement: Story continues below The independents have had a key role in preliminary negotiations about the deals foreshadowed yesterday, and their agreement to discuss them in detail means that they have decided that they can create more value for Centro Retail's security holders than the alternative - continued independence.
The key there is that while Centro Retail is now the financially stronger company, with shareholders' equity of close to $1 billion when Centro Properties has negative equity of about $1.6 billion, it is still joined to the hip of its parent, which not only owns 50 per cent of its shares but is also the property manager, the source of about $100 million in loan funds, and a separate investor in its own right in key Centro Australian shopping centres.
Those connections would become even more complicated and potentially dangerous if the deal were rejected, and Centro Properties fell over. The inter-company debt would be called in, and stakes in shopping centres would come onto the market: Centro Retail could bid for them to try and consolidate its ownership, but it would need its shareholders to back that, and help fund it.
Two interdependent steps are being negotiated with the aim of finally getting the Centro group on to a stable footing.
Centro Properties is to extinguish its senior debt by handing up all of its Australian assets to its senior lenders - hedge funds who have bought the debt at a discount. Junior creditors would be excluded from the deal: a $100 million fund would be set aside to separately pay them out.
Assets effectively handed to the lenders to extinguish the debt include Centro's 50 per cent stake in Centro retail, additional equity in the Australian shopping centre portfolio held through separate wholesale trusts including Centro Australia Wholesale Fund, and management rights on the properties. But the deal will be structured around a new issue of Centro Properties shares.
Centro Properties and Centro Retail will then merge to create a trust that owns and manages the group's Australian shopping centres, and the hedge funds will emerge with more than 50 per cent of the merged business.
Peter Day spoke positively about the plan today, and so did Centro Properties' chairman, Paul Cooper, who stood down in 2009 as chairman of Centro Retail when Day came on board.
Robert Tsenin, the chief executive of both groups, also said no general share raising would be required. Centro Properties would be merged debt-free and, after US private equity group Blackstone's $US9.4 billion purchase of Centro's US shopping centres (which clears $US1.4 billion after debts on the properties are paid out), gearing of the merged group should be in line with the post-financial crisis property trust average of around 35 per cent.
Day and his fellow independent directors must tread carefully, however, because there is already value in Centro Retail - even though it is value that is half owned by Centro Properties.
Even before it uses its $500 million share of the US sale to retire its own debt and pull its debt to equity ratio down from a too-high 75 per cent to 43 per cent, Centro Retail has shareholders' funds of more than $800 million, and net tangible assets of 41? per security.
Centro Properties, on the other hand, had negative equity of $1.6 billion at December 31 last year, and slightly more now, because while Tsenin extracted a better than expected sale price for the US assets, it was still at a 1.3 per cent discount to book value. Centro Properties will use its $600 million share of the US property sale proceeds to retire debt, but will still be well underwater.
The prize in view then, is the consolidation of ownership of the Australian shopping centres, in a vehicle that is capable of embarking on overdue reinvestment in the centres, and even expansion.
But Day and his fellow independent directors should only agree to it if it creates more value than no merger at all. Centro Retail's existing net asset backing of 41? a share is the crucial benchmark.
CER Price at posting:
35.5¢ Sentiment: Hold Disclosure: Held
