SPECIAL REPORT: Tackling Centro

Private real estate’s finest are scrutinising Centro Properties Group, one of the credit crunch’s largest casualties. But are its complex ownership structures too off-putting? PERE Magazine, February 2011 issue.

If you’re looking for a poster boy of the credit crunch for real estate, there have been few larger than Centro Properties Group, the Melbourne-based shopping centre business. Currently buckling under a debt load of A$18.4 billion – effectively the same value as its Australia and US property empire – the business is hanging on by a thread.

Cue private equity real estate’s finest. Finally succumbing to stakeholder and lender pressure at the end of last year, Centro opened its doors to a formal competitive market process to assess interest in its multiple investment platforms and, most importantly, its portfolio of more than 700 shopping centres, many of which are performing well and some less so. In doing so, it has instigated what could be one of the most complex unravelings of a real estate company in a generation.

Something near 20 indicative bids reportedly have been received for either the US or Australian businesses or both, and these have come from both home and abroad in the form of joint and individual efforts. Bidding parties reportedly include The Blackstone Group, Apollo Global Management, NRDC Equity Partners, Brookfield Asset Management, Lend Lease and Colonial First Global Asset Management.

Centro insists the competitive process is part of a wider review into a potential restructure and/or recapitalisation effort, but it has been more than three years since it alerted the market it was unable to repay nearly A$4 billion of immediate debt, an admission resulting in a 90 percent freefall in its share price. Subsequent stabilisation efforts ultimately have failed and, three group chief executives later, the firm’s capital and finance providers have seemingly had enough – some of the latter have already sold their positions – and are now looking for as high a yielding exit as possible.

As Centro ponders over potential suitors – “evaluation of the proposals received will take time due to this being a complex process,” Centro warned in its last market address – PERE gauged market reaction to the Centro opportunity and looked back at what went wrong for Australia’s second largest retail real estate owner behind Westfield and one of the largest in the US.

Spaghetti junction
ASX-listed Centro previously was a standard Australian REIT specialising in acquiring and managing shopping centres typically focused on non-discretionary retail spending, such as food and other everyday needs. Under the leadership of former chief executive officer Andrew Scott, the company tried to expand by growing a fund management business, bringing in various streams of third-party capital from both large institutional and retail sources to help facilitate its ambitions.

What ensued was a myriad of ownership structures including wholesale funds and syndicates, each with their own debt facilities. As one Sydney-based real estate investment advisor put it: “A bowl of spaghetti would be the best way to describe it now”. Indeed, the company’s balance sheet had become so convoluted with cross-collateralised debt and syndications of ownership interests that, although Centro looks like an ideal distressed situation play for private equity real estate firms, some have been put off from bidding.

One CEO of such a firm said: “It seems like a can of worms to me.” Others noted that certain assets must be sold at a serious discount for all the unraveling to be worth it. “Unless all the issues Centro has make these assets cheap, I don’t think folks will be willing to get too involved,” another CEO added.

One source familiar with the bidding process said some parties had identified certain portfolios they wanted but were deterred by Centro’s complex ownership structures. These parties, he noted, had decided to either explore bidding for one of Centro’s entire regional businesses or both, reflecting their value of the less attractive assets in their bid, or had walked away entirely.

Indeed, ownership structures are a major issue for Centro and, by default, any suitors. After Scott fell on his sword in January 2008, his replacement, Glenn Rufrano, struck a deal to hand over 90 percent of Centro’s shares to its 23 lenders, including JPMorgan, BNP Paribas, Royal Bank of Scotland and Australia and New Zealand Banking Group in exchange for significant debt extensions. Some of these, including ANZ, have since taken haircuts on their exposures – reports abound of sales at less than 50 cents on the dollar – selling their loans to parties that include hedge funds. Subsequently, new lenders to surface in the media over the past months include Centerbridge Partners, Davidson Kempner, Paulson & Co and Appaloosa Management.

One PERE source suggested the varying agendas of Centro’s lending community have, consequently, shifted somewhat. “Those guys have come in to make a profit,” the source said. “They aren’t going to sit back and let the assets be sold at a serious discount; they’ll want a hedge fund-style return.” 

Even Rufrano’s replacement, Robert Tsenin, admitted as much in an interview with the Wall Street Journal. “The new investors have come in with a new cost basis. That, in their minds, opens up opportunities that were less likely as serious options previously,” he said. Whether that means further extensions are made on parts of the business – for instance, in Australia, where the economy is improving – remains to be seen. Given the backgrounds of most of the bidders on the Australian business, coupled with the relative health of its assets, it looks like more of a core play than an opportunistic one. The US economy, however, remains more unclear, so discounted sales there could be inevitable.

Perhaps not coincidently, Centro’s US assets, the majority of which are managed by Centro’s REIT affiliate Centro Retail Trust (CER), are in a more perilous state than those in Australia. The 600 US assets, of which 380 are managed by CER, were generating net operating income of negative 4.9 percent, rental income growth of  negative 2.4 percent and were only 89.4 percent occupied, according to Centro figures.

Furthermore, the assets are turning in a lackluster performance at a time when the forecast for US consumer spending is looking uncertain. As one source put it: “Those assets are riskier because the industry expects consolidation among malls in the US.”
Perhaps it is no surprise then that PERE understands that Blackstone and Apollo, at least, are mainly concerned with Centro’s assets stateside. Commenting on the US assets, another source said: “Buyers will either need to buy very cheap or have real estate asset management skills of a high calibre to add any value.” That is just what the private equity real estate businesses of Blackstone and Apollo pride themselves on.

If navigating through Centro’s ownership structures wasn’t enough, there also is the looming threat of two class-action lawsuits against the group by shareholders. The actions relate to alleged misleading and deceptive conduct by Centro, as well as failures to disclose company information between April 2007 and the end of February 2008 – the time leading up to and immediately after it admitted it was unable to repay almost A$4 billion of expiring debt. Centro said it would “vigorously” defend itself although, at the time of writing, no court date had been set.

For another headache, a further class action has been filed against PricewaterhouseCoopers, Centro’s auditor in 2007. Centro has made a counterclaim against the firm in case it is found liable for incorrectly stating its accounts. Such litigation threats could well become a bargaining chip for potential buyers to drive asking prices down.

A bridge too far
Most Centro followers believe the firm’s aggressive US expansion is to blame for its current turmoil. Central to that expansion was its $5 billion outlay for US REIT New Plan Excel Realty Trust in February 2007, just months before the advent of the credit crunch when financing was relatively cheap and readily available to facilitate such a move. In one fell swoop, Centro inherited 467 shopping centres, making it the largest owner of retail real estate in the country.

However, the move was made against a backdrop of frothy asset valuations. When the global credit markets began drying up, valuations plummeted and Centro became unable to service its debt obligations. Between June 2008 and June 2009, for example, its assets fell in value by A$2.74 billion. Refrano’s debt extension exercise of 2008 aside, the obvious course of action was to start selling, and Centro has since attempted a number of portfolio sales.

Some of the larger efforts failed to materialise. In January 2008, Australian business news service The Age reported that Colonial First State Global Asset Management head of listed property funds and property management Darren Steinberg was running the numbers ahead of a sizable investment. While that event led nowhere, Colonial reportedly are still interested in Centro’s Australian assets as it seeks to expand its retail footprint in the country. Last month, PERE revealed the firm’s plans for a new retail fund – a further effort to do just that.

Others have worked. In December, Centro sold majority positions in a portfolio of 25 US shopping centres to Inland American CP Investment, a subsidiary of Inland American Real Estate Trust, in a deal valued at $471 million. The deal was financed with $310 million of new debt funding from Goldman Sachs and JPMorgan.

Centro also is on course to offload its unlisted Centro MCS Syndicates fund management business after agreeing to an exclusive due diligence period with Brisbane-based property trust Cromwell Group. But as with other Centro businesses, MCS shares positions in Centro assets and any sale would need consents and approvals from other stakeholders. It also would likely have a knock-on effect for bidders on Centro’s US, Australian or entire business. The total value of MCS’ positions is A$2.8 billion in Australia and $2.3 billion in the US, according to Centro figures.

There is a plethora of possible outcomes for the assets of Centro Properties Group, and sources said some of these might take the best part of a year to unravel. What is certain today is that Centro has close to A$10 billion in debt across its businesses that needs to be refinanced in that time and the current lenders are unlikely to grant more extensions. There still remains the possibility of bankruptcy, which under Australian law means the mandatory liquidation of assets, but that would invite more parties into an already overcrowded situation. There are almost certainly more groups interested in seeing as orderly a workout of the assets as possible. If that happens, then one poster boy of the credit crunch can finally come down.