Description

Investment Thesis:

Centro Retail Group ("CER") represents a similar situation to that experienced in the recent General Growth Properties bankruptcy/restructuring:

• - Limited negative and improving operational performance
• - Asset value (retail shopping malls) well in excess of liabilities
• - Limited to no recourse among real estate properties
• - Decline in share price due to technical factors
• - Clear and evident path forward
• - Publicly identified strategic interest in the asset portfolio
• - Ongoing and potential material litigation that has depressed the current share price

Centro currently trades at 60% of its stated NAV based on the Company's conservative valuation metrics..  While the company faces some near term debt maturity issues, its announced strategic alternatives process offers an opportunity to unlock its intrinsic value in the near term.  If valued in line with comparable asset comps, the stock would trade at multiples of the current valuation.    

Description:

CER is an Australian retail property and investment trust owning high quality retail assets in Australia and lesser strip mall shopping center assets in the United States.  CER is part of the Centro Properties Group (CNP AU).  CER and CNP own stakes in a number of the same assets and CNP beneficially owns approximately 45% of CER.  The difference between CER and CNP is that CER only owns the stakes in the various assets and not indirect stakes through a variety of funds/affiliates.  Essentially, CER offers a more direct and simple means of ownership to the underlying real estate asset portfolio.

Basic company financials are laid out below:

Shares Outstanding:            2,286.4mm

Share Price:                           $0.24

Equity Value:                        $548.7mm

Net Debt:                               $3,258.4mm

Enterprise Value:                  $3,807.1mm

How Did We Get Here:

Between 2005 and 2007, Centro, through its various funds/affiliates, attempted to leverage its significant Australian shopping center and undertook a number of significant acquisitions  in the US (Heritage, New Plan and Kramont portfolios) leading to an over-leveraged capital structure in the face of the ensuing global economic meltdown.  Despite the fact that its properties were less dramatically affected by the economic conditions than other businesses, debt refinancings have created a near-term liquidity situation for the Company.  

Market Failure to Recognize Value:

Admittedly, the Centro situation is complicated given the inter-relationships and intra-ownership between the various affiliates, which has led to market confusion.  Investors appear to believe that asset-specific refinancing issues could impact the entire portfolio, rather than, for the most part, being ring-fenced.  This perspective, along with concerns about an on-going shareholder lawsuit, caused the stock to trade at less than 50% of the Company's reported NAV.  This situation has been exacerbated by the fact that Australian retail investors simply have no interest in investing in a distressed situation that lacks a dividend payout.

Portfolio Performance and Underlying Value:

CER's assets can be separated into two categories: US and Australia portfolios. 

• - The Australia portfolio consists of 29 properties of which 35% are located in Victoria. At June 30, 2009, the portfolio was 99.6% leased. The lease expiration schedule is typical for shopping centers of this type and the company has been able to push through rent increases of 3.7% on renewal leases and 6% on new leases, leading to 4.3%NOI increase. In short, it is an excellent collection of assets generating over AU$114mm of NOI annually.

• - The US portfolio consists of 382 properties dispersed across the US, 89.6% of the portfolio was leased at June 30, 2010. 67% of CER's gross leasable area is grocery-anchored. These grocery stores have sales per square foot of approximately $574. 68% of the portfolio consisted of community shopping center with the remainder being small, neighborhood shopping centers. Since 2001, 40% of the gross leasable area has been redeveloped and the average portfolio age was 12 years. The assets generated combined NOI of A$353.4mm. Of this amount, approximately A$155.6 mm is situated outside of the Super LLC structure.

• - The Super LLC is a joint venture between CER and CNP to facilitate a number of their historical acquisitions. The structure faces the most near term refinancing issues. However, the company has assured us that the structure is largely ring-fenced, exclusive, exclusive of a small credit facility. The company is in the process of removing this single piece of cross collateralization through the provision of incremental security. which the company is in the process of resolving. Nevertheless, it is generally assumed that the assets in the Super LLC structure are likely out of the money.

• - Set out below are some summary valuation criteria for the entire portfolio:

• - Set out below are some summary valuation criteria for the portfolio, excluding the SuperLLC assets, which, theoretically, could be returned to the lenders if a near-term refinancing could not be completed.
• -

Australian comparables, such CFS Retail Property Trust and GPT Group trade at implied cap. rates of approximately 7.5%.  US Comparables (EQY, REG and WRI) trade at implied cap. rate of approximately 7.0% of lower.

Risks:

1. Shareholder Class Action:                                The company is subject to 2 class action lawsuits.  The lawsuits allege that the Company failed to disclose the full extent of its debt obligation under prior management.  The Company is seeking to settle the lawsuits, so that they do not become an impediment to any of its strategic alternatives.  No dollar figure has been placed on the litigation; though, press reports have indicated that the plaintiffs were seeking hundreds of millions.

1. Convoluted Centro Structure:          Many of the assets owned by CER are at least partially owned by other Centro entities.  Two other entities have significant ownership stakes in CER as well.  This structure may make it difficult to resolve some of the asset sales.

Catalyst

• Sale of underlying assets
• Recapitalization
• Debt restructuring