Centro's tale: how the mighty are fallen

Not everyone was surprised when Centro's level of debt threatened to become too much to bear.

At Centro Roselands, in western Sydney, the franchisee who runs Amore Gourmet Burger and Grill got a tip-off from his business partner about a month ago.
"He plays on the sharemarket a lot," Sam, who did not want his surname used, told the Herald this week. "He picked this a month ago. He sent us all a note saying: 'Watch out, they're going to go bad."'
And how. This week a stock that traded with a market capitalisation of $4.8 billion plunged to as low as 42c. At current prices it wiped out $3.7 billion in investors' funds.
Caught out by $2 billion in short-term loans that banks are threatening to drop like a hot potato, the trust and its chief executive, Andrew Scott, were in the middle of a financial crisis partly of their own making.
It was a spectacular firestorm surrounding a company that had built the value of its business to a portfolio of funds under management worth $26 billion, including 128 shopping centres in Australia and 682 in the US.
The advance warnings were not confined to tip-offs from savvy partners. In February the Credit Suisse analyst Andrew Rosivach warned the underlying debt level of the $6.7 billion acquisition of the US shopping centre owner New Plan Excel stood at a staggering 96 per cent. Among several complaints levelled at Scott and the company he built, there is strong condemnation of the level of disclosure displayed before its trading halt on Thursday last week and the devastating announcement on Monday.
Mark Wist, the head of research at the specialist real estate group PIR, this week criticised the "sub-optimal level of disclosure from a group whose complex structure has lost favour with the market".
He said: "From dizzying heights of $10.02 in early May … how the mighty have fallen."
A fund manager said: "In one swoop Centro and Andrew Scott have undone 17 years of hard work by the listed property trust industry in building up market confidence in the form of good disclosure, transparency and competence."
Here is one small example that is likely to play on investors' minds: a statement released late yesterday suggests Centro was in talks with its banks in early December about asset sales or an equity injection, despite no disclosure on refinancing initiatives since its August 9 financial statement.
Scott, who is variously described as driven, arrogant and ambitious, is attempting to play down the gravity of the market confidence issues internally. He gave a speech to staff at the Melbourne head office on Wednesday, claiming to be undeterred and emphasising Centro would survive its current troubles.

Large in stature, he is said not to tolerate fools gladly. But in his fall, he has dragged some big names with him. These include substantial investors such as UBS and Macquarie Bank. Then there are big names behind the organisations, like the executive chairman of JP Morgan in Australia, Andrew Pridham, who has served as mentor to Scott's ambitious program of expansion. It signals challenging times for what has been a lucrative partnership: in one transaction alone, underwriting a capital raising of $1 billion for Centro Retail Group in March, JP Morgan banked $25 million.
The pressing question for many market watchers is what happens to the two large unlisted funds the Centro Group manages that have suspended withdrawals amid the chaos. Credit Suisse's Rosivach had warned of precedents in open-ended real estate funds that have previously suffered a "run".
"Germany historically had a robust offering of open-end real estate funds that came under a crisis of confidence in 2005," he wrote. "In this time period a number of open-end funds became closed when investors attempted to cash out their position."
The fund manager warned: "The real fear is what is going to happen to the syndicate business when the freeze on applications and withdrawals is lifted. Do they sell shares and/or assets, and to whom? What will existing investors do? Perhaps they will just want their money back."
The fund manager Winston Sammut, whose Maxim Asset Management, specialises in property, is in the happy position of having sold out of Centro midyear.
One of the reasons he decided to sell was the mind-boggling complexity of the group. He recalls attending an investor presentation shortly after the New Plan acquisition.
"One of the slides at the presentation showed a cascading list of names and funds with about 18 arrows," Sammut says. "I couldn't understand the structure."
The business model involved swapping assets between two listed companies, Centro Properties Group and Centro Retail Group, unlisted property funds and joint ventures.
The chart only showed the links between the assets and their owners. "We didn't see the debt side," says Sammut. The companies disclosed their own borrowings, but not the combined exposure of the group.
In the industry they call it providing information on a "look-through basis" and there is anger in the market that Centro did not offer this transparency.

"It seems to me that maybe Andrew is the only one who knows the full structure," Sammut says.
Scott's intimate knowledge of how the pieces fit together makes him a vital person to have around as Centro battles to stay afloat.
But, in the coming weeks, the power he has enjoyed as the unquestioned leader of the company will meet some strong counter-forces.
The important decisions will be made by those most exposed: the directors and the banks. The Corporations Act makes directors personally liable if a company continues to trade while unable to pay its debts. All directors will be considering their personal positions very closely and putting a lot of pressure on management. The power of the banks increases the closer Centro veers towards insolvency.
And in this case, there is a bewildering array of lenders. They are not linked via a joint banking agreement, so each will be looking out for itself. St George Bank said this week its exposure to Centro was $400 million. This was in the form of "20 or 30" loans to trusts managed by Centro, said the bank's chairman, John Thame.
This structure is replicated many times over across the group.
As the February deadline nears, the jostling for control will intensify. Scott will be trying to keep the company he built afloat. The directors will be anxious about their personal liability. The banks will be trying to beat each other to the proceeds of asset sales.
In the meantime angry investors will be looking for recompense. A share price drop of 76 per cent on a single day is the kind of event to attract the attention of plaintiff law firms. In the wave of shareholder class actions working their way through courts it is commonly claimed that a company breached the continuous disclosure rules. The loss to investors is measured by the fall in market capitalisation when disclosure is made late.
The class actions depend on the plaintiff investors being able to prove that management knew of bad news for some time before it was disclosed.
In Centro's carefully worded bombshell on Monday, the chairman, Brian Healey, said: "In August, the Centro board and management took the view that the long-term refinancing of our debt obligations would be available with attractive funding terms through the US CMBS markets.
"We never expected, nor could reasonably anticipate, that the sources of funding that have historically been available to us and many other companies would shut for business."

Scott put it more colourfully in a newspaper interview on Wednesday. "Did we put in large red letters on the prospectus that the subprime crisis would cause the close-down of an $80 billion-a-month debt market in the United States? No we did not."
Centro had "an appropriate process within the organisation to ensure appropriate compliance with what is required" in terms of disclosure, he said.
These statements from Healey and Scott will be tested if the matter ends up in court.
The law firm Maurice Blackburn has been approached by disgruntled investors, says its principal, Ben Slade .
"It does look at first blush that the company is likely to have been in possession of material information for a few months in relation to its financial figures that possibly should have been disclosed earlier," he says.
The firm is unlikely to decide whether a class action is justified until February.
On paper Scott looks like the ideal person to run a large commercial property group focused on the retail sector. His early career was anchored in finance. In 1982 he became corporate treasurer of Coles Myer, a position he held for a decade.
During that time he was chairman of the Australian Society of Corporate Treasurers.
In one of the many executive reshuffles at Coles Myer, Scott became the director of planning and development and, in 1993, the director of property and strategy.
From the springboard of running the property portfolio of Australia's largest retail group, he moved to Centro.
The non-executive directors Peter Wilkinson and Graham Goldie are also formerly of Coles, and the presence of Healey (also a veteran of the Fosters and Incitec Pivot boards) and the former National Mutual funds management boss Sam Kavourakis underline the close-knit Melbourne focus of the board.
FOR years listed property trusts were a market darling, providing steady distributions to investors in a business model that was based on putting a host of buildings into a trust, taking the rent, meeting the interest repayments on loans to banks, paying a management fee and returning the remainder to investors. Over the past five years the sector has averaged about 18 per cent returns to shareholders every year.
Pretty simple, really. But in recent times the business model has been pushed so far that it has been bent and sometimes broken. Or, as Macquarie Bank put it in a note that singled out Centro for adverse attention in June, there were "highly leveraged, weaker or, in some cases, even compromised business models".

The changes to the business model have occurred in steady increments but the net result has been property trusts with little resemblance to those that have gone before them.
For one, property trusts started an aggressive phase of consolidation, changing the face of the industry. For example, mergers of trusts with developers immediately changed the risk profile of "trusts" - an evolution that investors in the Multiplex "trust" learned to their considerable cost as problems plagued the construction of Wembley.
For another, trusts started aggressively expanding their property portfolios overseas, to the point that 60 per cent of listed Australian investments are held offshore.
Finally, the structuring and complexity surrounding trusts became so dense that investors had trouble discerning whether they were involved in a bricks-and-mortar investment or some weird foreign currency play.
(Unfortunately this complaint about complexity is no exaggeration. Interest rate "carry" on a property trusts' offshore foreign exchange income has now been extended to the entire value of the offshore assets - raising concerns among critics about the exposure to interest rate and currency movements.)
On top of all this, the levels of debt grew higher and higher. The problems of the entire sector in this regard were highlighted by Macquarie Bank in June, when it noted that an estimated free-to-invest cashflow of $4 billion in 2006-07 was based on $4.1 billion of equity raisings.
Consider this for a moment. Without raising cash, the combined sector would have experienced negative free-to-invest cashflow of $100 million. Put another way, the sector was involved in a shell game in which equity-raising was helping to underwrite payments to investors while growth relied on the willingness of banks and investors.
Macquarie Bank was not alone in its cautions. The UBS equity strategist David Cassidy warned in June: "Price-earnings ratios for the sector are in uncharted territory and are difficult to justify … Already we are seeing the [ratios] come under pressure, and the sector has been the worst performing major sector this year."
Centro embraced all four of the problems listed above in spades. It was an aggressive purchaser, it was aggressive in its push into the US, it was complex to a fault and the levels of debt were opaque and alarming.
Questions are now being asked about whether it was fooling the market, fooling itself or both when it issued upbeat statements to the market including Centro's annual results released in August headlined: "Centro's resilience for growth."
Wist from PIR says: "As late as last week, announcements remained bullish about the prospects for the Group's operations."
Now the vultures are circling. Macquarie Bank, Orchard Funds Management and even Mirvac, Lend Lease or GPT would be interested parties in any of the fund's platforms.
In Australia attention on asset sales will focus will be on the top four centres considered the trophies: Centro Roselands, The Glen, Victoria, Galleria in WA and Colonnades in South Australia.
But whatever happens in the shifting spheres of the major shopping centre owners, Sam at Amore is pragmatic.
"I'm not nervous at all," he says. "Worst case scenario: the sharks will come around and they will be bought out. We've all got leases, we'll pay the same rent whoever owns us."