In-Valadated

This story features GOODMAN GROUP. For more info SHARE ANALYSIS: GMG

The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

December 14, 2007, was the day of infamy in the Australian listed property trust (LPT), or to use the correct international expression, real estate investment trust (REIT) sector, when Centro Property ((CNP)) hit the wall. Not one analyst saw it coming, although strategists had earlier mostly suggested REITs were a bit of a risk in the credit crunch. Merrill Lynch did downgrade to Sell just before the proverbial hit the fan, but only because Centro called a trading halt. There was no chance to sell anyway.

Centro took the whole REIT sector down with it that day, and a few infra trusts to boot, on a “guilt by association” basis. Analysts were quick to point out however, that Centro’s high level of gearing and low-quality asset portfolio were stand-outs (with 20-20 hindsight that is) and that other REITs need not necessarily be tarred with the same brush. Among those granted an “oversold” call at the time was Valad Property Group ((VPG)).

Merrills, for one, pointed out Valad’s gearing was only 35%, it had a quality long-dated wealth management business, and a fee-earning division, Valad Capital Services (VCS). Merrills upgraded to Buy. The analysts stuck with Buy, although later suggesting the call was not without some risk.

Valad’s share price did bounce momentarily following the Centro rout, before drifting lower once more on general credit crisis concerns. But then Valad surprised the market by making good on a $340m capital raising for its UK Opportunity Fund. This had been flagged, but in the current credit climate it wasn’t necessarily a given. Valad’s shares bounced again, and the six brokers covering the stock in the FNArena database settled on a 4/2/0 B/H/S ratio with a $1.85 average target – not terribly much lower than the average pre-Centro.

It seemed like Valad would ride out the crisis without incident.

Until yesterday. Yesterday Valad announced it had formed a “strategic alliance” with large US REIT Kimco. Nothing wrong with strategic alliances, except that this one involved the issue of $200m of freshly printed five-year convertible notes to Kimco at a 9.5% coupon, with an “any time” convertibility at $1.33. Valad had closed at $1.46 the day before.

As JP Morgan suggests, there are two ways to look at the note issue. It’s either cheap dilutive equity or very expensive debt. Valad has debt to repay at 8.5%, and it’s raising the money to cover that at 9.5%. Danger Will Robinson!

There is a ring of the US bank experience here, where Citigroup and others have shored up their immediate capital problems by selling convertibles to the Arabs at very high coupons. While there is relief in the fact Valad actually has raised some capital, the price suggests all is not well at the office. Nor did it help that a very sombre Valad CEO accompanied the announcement with “particularly pessimistic assessment” of the “changed world” for REIT investors, as JP Morgan’s roving reporter explained. The JPM analysts thus declared “Our LPT outlook for 2008 just took another notch down from an already bearish position”.

(Mind you, such a pessimistic presentation is probably, on a contrarian basis, a good thing. Too numerous are the times a CEO announces all is swell – nothing to worry about – just before the receivers move in and that CEO cashes out.)

JP Morgan had been one of the two brokers on Hold prior to yesterday, the other being GSJB Were. Macquarie, Citi and Merrill Lynch all downgraded this morning from Buy to Hold.

Macquarie pointed out that the cost of capital for Valad just showed how tough market conditions have become, particularly for fund managers with a strategy of recycling assets (ie, buy a property, extract cashflow, sell at a profit, find another one). Citi suggested the capital raising augured poorly for the company’s risk going forward, and Merrills pointed out that a capital raising only three weeks before the first-half result casts a shadow over just what that result might be.

Further evidence on the last point is derived from the fact Valad reconfirmed its intended 12.5cps full-year distribution, but with a caveat that only 35% would be paid as the interim with the rest coming after the second half. Is Valad hoping like hell this “strategic alliance” will help to pull the company out of the mire for the second half?

Only UBS has been game enough to hang on to its Buy rating, and the fact the share price fell 18% yesterday probably helped. But UBS is banking on those second half earnings, while dropping its price target. The current share price implies a “corporation value” of zero, Merrills suggests (and most brokers point out the value in VCS), and that is unsustainable.

The average target has now fallen to $1.45, with the stock trading at $0.97 late morning.

What is the lesson to be learnt here? That an investor really has to wait for that last aria from the size-challenged prima donna in any vulnerable sector? Even Goodman Group ((GMG)), the REIT that nearly every broker suggested should never have been sold down on the Centro debacle, has been slipping rather precariously since yesterday.

You can run, but you can’t hide.

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