WEEKEND READ: Centro in the balance

If investors or the banks are to recover a meaningful amount of money from the teetering Centro Properties group, it is imperative that it get past the April 30 deadline virtually intact.

As the April 30 deadline for the extension of the Centro Properties group’s $6.5 billion of debt looms, it is apparent that anyone expecting an imminent solution to its financing issues is almost certainly going to be disappointed. That’s probably good news for Centro investors and bad news for the opportunists that have been seeking to take advantage of Centro’s distress.

There has apparently been a lot of interest in potential buyers of Centro Properties’ interests in its two big wholesale funds, Centro Wholesale Fund and Centro America Fund – as well as their individual properties – and a number of parties that have put forward offers to inject equity into the headstock, Centro Properties.

Not surprisingly, however, the aspiring "saviours" of the group are mindful that unless the Australian banks and US bondholders extend the current moratorium on repayment of $4 billion of Centro debt until September 30, all Centro’s banks, including the US lenders who are owed $2.5 billion, will seek repayment and Centro will be plunged into administration.

The offers, apparently, reflect the perceived leverage and would involve not just equityholders in the various tiers within the group experiencing real pain, but the banks taking a 'hair cut'.

There is structural as well as financial leverage in the Centro group. Quite modest movements in value within the lower tiers of the group structure can have leveraged impacts on the value of Centro Properties and Centro Retail – it would take only a low double-digit loss of value within the structure, if that, to effectively wipe out the equity at the Centro Properties level.

That by itself would argue against Centro’s new chief executive, Glen Rufrano, being prepared to contemplate accepting a bottom-fisher’s offer, although it wouldn’t necessarily prevent the banks from effectively forcing him to take one.

As my colleague, Robert Gottliebsen has argued, however, the banks are effectively in the same boat as Centro equityholders because one of the key group assets is its services business and the value of its management rights, which would evaporate if they appointed an administrator. That undermines the banks’ ability to impose an outcome on Centro and to force it to accept an outcome that equityholders would find unpalatable.

Rufrano’s negotiating position is strengthened further if the only offers on the table involve the banks themselves losing money. They will be even more inclined to stick with the existing management, particularly as at an operational level Centro appears to be performing really well.

Debt markets are deteriorating, the US property market has been falling (although there are some signs of publicly-traded property stabilising) and the Australian listed property market has been savaged by the fallout from the sub-prime crisis. Perversely, that probably also works in Centro’s favour – this isn’t a good time for the banks to put Centro under.

At the moment the Centro priority is to obtain a further extension of the moratorium to September 30 to line the Australian lenders and the US bondholders up with the US banks.

That would not only buy time but reduce the perceived leverage of the prospective buyers of the wholesale funds or the parties offering to inject equity into the headstock. An extension might flush out more attractive bids.

It is probably also the case that the size of the Centro portfolios depresses value in conditions where debt is hard to access and very expensive. That would probably be a particular problem for the Australian fund which, while full of high-quality properties, is about three times larger than the US fund. Selling the individual properties in the two wholesale portfolios might produce better outcomes but would take a lot more time.

It is possible that the banks might be prepared to contemplate something more sophisticated than a simple extension of the moratorium until September 30. A longer extension would allow for a far more orderly realisation of assets and potentially shift the recapitalisation phase beyond the nadir of the sub-prime crisis.

As Gottliebsen suggested, it might also be possible for the banks to either help stabilise and recapitalise Centro themselves, through a partial debt-for-equity swap or by trading a longer extension for some exposure to Centro’s upside.

With their interests and those of Centro’s equityholders crudely aligned, the best chance they have of getting their money back intact is to ensure that there is something meaningful left for the equityholders. For any of that to occur, however, it is imperative that Centro get past the April 30 deadline with its portfolios intact and its funding secured for at least another five months.

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