ASPEN GROUP — Call Transcript 2013

Aug 25, 2013

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Welcome to the 2013 Financial Year results presentation. This is Clem Salwin, chief executive of Aspen.

Also on the call, I am joined by Brett Fullarton our CFO, Adam Marrs Ekamper, our group financial controller and other members of the management team.

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Today, I would like to cover off 4 topics.

I would like to share my analysis of our business since commencing last month, and outline our strategy to restore value.

I will then review the financial results over 2013 and provide an update on our business lines.

I will conclude with a summary of our priority action points for the coming year. Let me start with some of the key points of the 2013 financial year performance. With that, I will ask if there are any questions.

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The last financial year has been one of major change for the business. Importantly, the business is clearly on a path of simplification, focus and de‐leveraging.

There have been substantial areas of progress on the strategic initiatives announced at the 2012 AGM. The business has stabilised. New management is now in place with my appointment last month. Gearing has been reduced from over 46% to 40% over the year and covenanted debt paydowns have been met. Debt facilities have been extended, with the core corporate facility extended to August 2015 . Non ‐ core asset sales across Aspen Group and the managed funds of over $200 million have been successfully achieved.

And importantly, the business has delivered on its guidance provided at the time of the 2012 equity raising. Core operating profit after tax was 2.0 cents per share, exceeding guidance of 1.8 cents per share. And distributions were also in line with forecast, at 1.5 cents per share.

Nevertheless, overall financial results remain disappointing. The statutory loss for the year, reflecting particularly non‐cash valuation changes, was $34.3 million or 2.9 cents per share. Net assets per share over the year fell from 41 to 24 cents per share and assessed NTA per share was 22 cents as at 30 June.

We are also acutely aware that returns to the shareowners are unacceptable; and that the share price is persistently and significantly below NTA.

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Turning now to our analysis of the business and the strategy of restoring value. An apt descriptor of the Aspen business historically has been “complexity”; especially for a business of this size . It has been complex in the breadth of its property segments: office , industrial , residential development, accommodation and much more besides.

It has been complex in its breadth of geographic operations: across 5 states and multiple markets, including regional locations. It has been complex in its structures, with multiple funds, joint ventures as well as balance sheet assets. And it has been complex in its financial arrangements: with high leverage, multiple debt facilities, guarantees and put options.

This complexity has driven multiple business and financial issues:

th e diff us on o i f us ness resources cap b i ( it a an l d managemen t) ma k es very it diffi cu lt o u t b ild mar k e t leading positions in all of our business areas;

• the diffusion of business resources (capital and management) makes it very difficult to build market leading positions in all of our business areas;

• the complexity is a risk when the market cycle turns down – most clearly seen with the GFC;

• the complexity is inherently challenging to manage; and

• the complexity is expensive to manage , requiring significant overhead .

One of the key drivers over FY13 has been business simplification, to reduce this complexity. Simplification will continue to be a key objective over FY14, and we will look to accelerate this process.

The very large value gap between the current share price and the NTA of the business is the immediate strategic issue to be addressed. It is unsustainable.

It is unstainable in terms of return on the capital of the shareowners.

I t s a so unsusta na i l i bl e rom a us ness perspect ve. n my v ew, t s mposs f b i i I i i i i ibl e to ave a strong, h well performing real estate business without access to capital and at an appropriate cost. Aspen does not currently have either.

Addressing the consequences of complexity, by simplifying and focussing the business, is our key strategy to addressing the discount in the current share price.

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Aspen has 3 business areas:

• accommodation;

• commercial property; and

• non‐core assets.

These first two were together what was designated at the time of the 2012 equity raising as “core”.

To summarise our strategy to restore value with these business areas:

• for our accommodation business: capitalise on our strong industry position

• for our commercial property portfolio: look to dispose of the entire portfolio

• for non‐core assets: our strategy for non‐core assets remains the same, to realise value in an orderly manner, at the same time as minimising both costs and cash requirements.

Turning to the first two business lines.

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Our accommodation business comprises two activities:

• the ownership of the Aspen Karratha Village, a transient (or FIFO) worker accommodation facility;

• the management and 9% co‐investment in the Aspen Parks Property Fund.

The accommodation industry generally has strong long term characteristics – including being an enduring customer need, with relatively stable demand and efficient capital utilisation. The accommodation industry is also highly fragmented.

These are all very desirable characteristics.

Through the Aspen Parks Fund, we have a strong leadership position in this industry, being one of the largest operators in this market segment. There are clearly currently some cyclical challenges with the mining capex and services downturn and whilst I do not wish to minimise these, mining industry related properties comprise less than 30% of the Aspen Parks portfolio.

Our value strategy here is to focus on creating value from our existing management platform and market leadership position.

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Our commercial property portfolio comprises interests in 4 office and industrial properties, with a value of $311 million.

Our value strategy here is to look to dispose of the entire portfolio.

The rationale for looking to dispose of the portfolio is as follows:

• there is a very large value gap between the current share price and the NTA of the business . As I said , this is not a tenable position . The realisation of the commercial portfolio represents a very substantial part of the business’ asset base;

• strategically, the commercial portfolio is diffuse. We do not currently have a leadership position in any of these markets and little immediate prospect to create such a position. It is probable that these assets have other, more strategic owners;

• market conditions are broadly supportive – in particular interest rates are low by any historic standard; and

• the financial position of the business would improve and there is much greater financial flexibility, to reduce debt but in particular to return capital to the shareowners.

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We expect to commence the disposal process shortly.

The current expectation of use of proceeds is to:

• pay down of debt;

• return capital to shareowners; and

• potential investment for other business purposes.

To this end, we will be seeking shareowner approval at the upcoming AGM to conduct a share buy‐ back programme. Other forms of capital return are also under consideration.

For illustrative purposes only, this table outlines potential cash realisations from a disposal process. I emphasise that this is on a pro‐forma basis for the position as at 30 June.

Assuming the portfolio is realised for book value would achieve $311 million.

There are three debt amounts that we currently expect would be released from proceeds:

• the corporate debt facility of $118 million;

• the debt with respect to the special purpose vehicle in which the ATO Building Adelaide is owned, of $74 million;

• debt in controlled entities of $33 million.

This would leave $86 million or 7.3 cents per share in pro‐forma cash for other potential purposes including a special distribution to shareowners, undertaking a buyback programme and other purposes, which for the business as it would then be, focussed in the accommodation sector.

I would emphasise that there is no certainty that any transactions would be achieved or of the prices obtained, and that this information is based on the pro‐forma 30 June position and ignores any transaction costs.

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This next chart illustrates the business value proposition in these three areas. This builds to the assessed NTA per share of 22 cents.

As Aspen is quite complex, I would like to spend a bit of time to clearly go through this NTA build. In the interests of clarity and transparency, there is a reconciliation and explanation of this chart in the Appendix which reconciles to the financial statements:

• the commercial property portfolio represents 26 cents per share.

• the accommodation business comprises 5.3 cents per share. This comprises tangible assets. There is no value taken up in the Aspen Group balance sheet for the management of this Fund.

• non‐core gross assets represent 7.8 cents per share, adjusted for the post 30 June settlement of the Diversified Property Fund. The largest component is Aspen Development Fund at 4 cents.

• cash on balance sheet is 4.2 cents per share, adjusted for cash from the sale of the Diversified Fund that settled post 30 June 2013, but also post the distribution since paid to shareowners last Friday;

• net other assets ( trade receivables, p a y ables etc ) net to about zero;

• debt on corporate balance sheet totals 16.5 cents per share;

• there is 4.7 cents of debt in ADF and other managed entitles related to the non‐core assets;

• this totals to an assessed NTA per share of 22 cents

As I just mentioned on the potential disposal of the commercial property portfolio, on a pro‐forma basis, there would be no debt on balance sheet and additional cash of 7.3 cents per share. This would mean that about half the assessed NTA would be cash.

I again emphasise, that there is no certainty that any transactions would be achieved or of the prices obtained and that this information is based on the pro‐forma 30 June position.

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I turn now to the financial results for FY13.

The year has seen major changes to the Group financial position, including the equity raising conducted in September 2012.

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Core earnings here are as defined at the time of the equity raising and comprise earnings from what are now designated the commercial property portfolio and the accommodation business.

The Group’s core operating result for FY13 was $23.4 million or 2.0 cents per share. This exceeded the guidance provided at the time of the equity raising in 2012 of 1.8 cents. Distributions declared for FY13 totalled 1.5 cents per share, in line with the guidance.

Revenue from the commercial property portfolio was up over the year, largely on the back of the completion of the ATO property in Adelaide and stronger leasing at the Spearwood industrial property in Perth.

Earnings generated from Aspen Parks were down over the year. Management fees were up 5% to $6.3 million, but contributed earnings from the co‐investment at $1.6 million were down reflecting lower earnings in the fund.

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Moving to the overall Group financial result.

Non‐core operating profit relates to the non‐core assets that were described previously. This generated an operating loss of $7.0 million or 0.6 cents per share over the year.

Below the operating line, there were non‐cash valuation adjustments through the year, including changes to the property values. Most notably there were $48 million of writedowns of inventories and assets held for sale . Most of these were incurred in the first half or previously announced in July.

This totals to a statutory earnings of a loss of $34.3 million for the year, or 2.9 cents per share.

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Turning now to the statutory balance sheet.

We have covered off the balance sheet in the build of value in quite some detail a few moments ago.

The key observation I would make on the balance sheet is the decline in gearing achieved over the year, from 46% to 40%.

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Moving to the assessed NTA.

The Group’s statutory NAV per share as at 31 December 2012 was 26 cents per share . This was down from NAV of 41 cents per share as at 30 June, largely due to the impact of the entitlement offer.

Since 31 December, the changes in NAV have been smaller. The largest negative contributor being the non‐cash valuation writedowns I spoke to a moment ago.

This gives a statutory NAV of 24 cents per share, reconciling to the statutory balance sheet net assets of $284 million. From this statutory NAV per share, we have made two adjustments to come to an assessed NTA “ ” per share o f 22 cents per share.

Firstly, we have deducted the value of deferred tax assets of $12 million or 1 cent per share from our assessment of net tangible assets.

Not including the deferred tax asset in assessed NTA has no effect on, nor is any reflection of, change of status of these tax losses. These tax losses total $89 million and there is detailed information of these tax losses in the financial accounts .

The second adjustment is minority interests. Aspen Group’s statutory accounts consolidate three majority owned managed entitles, Aspen Development and Aspen Whitsunday Shores as well as Aspen Diversified Fund, the sale of its assets which settled post 30 June.

Both the Development and Whitsunday Shores funds have negative equity. Therefore, in the consolidation process for the statutory accounts, these negative minority interest amounts are deducted from Aspen Group’s minority interest. Deducting a negative amount is in effect adding it back.

This treatment is in line with accounting standards and confirmed by our auditors.

However, from a commercial perspective, there is no ability for Aspen Group to receive such amounts from the minority shareholders. Therefore, we show the assessed NTA without adding back these minority interests in the column at the right, this shows a net asset value of $11 million less than the statutory balance sheet or 1 cent per share.

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Turning now to our debt structure.

As I just mentioned, gearing has fallen over the last 12 months from over 46% to currently 40%.

During the year, the core debt facility was extended by one and a half years to August 2015. 5 year term debt was also put in place with respect to the ATO building Adelaide, in which we have a 50% interest .

Aspen has a debt reduction programme across the Aspen Group and managed entities, out to June 2014 covenanted with its primary financier. We have met this programme to date. There is a further required reduction of $25 million as at December this year. Sales programmes of non‐core assets are underway with respect to this amount.

This excludes potential disposals from the commercial property portfolio. As I mentioned, a key objective of any such disposal is strengthening the financial position of the business.

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As I said at the outset, a key consequence of complexity is that it is both difficult to manage and expensive to manage. This has been reflected in Aspen’s overhead which has historically been very high.

Now that we are now simplifying the business, we are now accelerating the reduction in overhead.

Administrative expenses over the year were down, prior to restructuring charges.

There was a restructuring charge of $3.7 million. Of this $1.3 million relates to changes implemented in FY13 and $2.4 million relates to restructuring in the business now underway in FY14.

Post 30 June for FY14, staff base costs have been further reduced at an annualised rate of about 30% (although it will take time for the full year effect to come through).

Occupancy costs were up over the year, as we moved the head office from Septimus Roe, an owned building, to leased premises. As a result of staff cuts, since 30 June we have sub‐ leased one of the three floors at the head office in Perth. We have also closed the North Sydney office.

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I will now turn to a brief examination of the operational performance of our business lines, commencing with the accommodation business.

This is a strong business, albeit one which is currently experiencing the impact of the very significant downturn in mining related capital expenditure.

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Aspen Karratha Village is a 180 room Transient Worker Accommodation (or TWA) facility, designed for FIFO (Fly‐in, Fly‐out) workers for the resources/mining services industry.

In terms of market positioning, the property is at the upper end of specification for TWAs and it is a smaller scale project. For example, the Aspen Karratha standard room size is 28m[2] , as compared to a more usual market standard of 14‐18 m[2] , in facilities that might have a thousand or more units on a single site.

The valuation of the property is $50 million as at June , down 12% over the year , reflecting the impending lease expiry in January 2014 as well as weaker market conditions.

In terms of market conditions, the mining services and capital expenditure cycle has turned down very significantly in this area and as a result, so has the TWA market. Our key management focus is the upcoming lease expiry.

It is currently fully leased until January 2014, but the tenant has not exercised its option to extend its lease term. Therefore, the process of new leasing of the property, including seeking out and evaluating alternative occupants, is underway.

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Aspen Parks Property Fund is an unlisted property fund managed by Aspen.

As at 30 June, there were 21 parks in the portfolio with a total value of $311 million. Gearing, net of cash, stood at 36%.

Distributions per/security for the FY13 year were 10.9 cents per security. Given the fall in income from the mining related parks, the current distributions from the fund are currently at an annualised rate of . 7 4 cents per security .

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Our priorities for the fund are essentially three fold.

Firstly, the performance of the mining related parks. These are not TWA facilities like Aspen Karratha, but have been providing accommodation to mining services users. These assets (three in the northwest of WA and a fourth in South Australia) represent 28% of portfolio value. Whilst maintaining focus on mining services customers, we are also looking to increase tourist revenues at these parks.

Secondly , we are looking at capital recycling to optimise the portfolio mix . One property was bought during FY13. Since 30 June, one property has been sold. We will continue this portfolio rebalancing.

Thirdly, we are examining our management processes to maximise revenue opportunities and cost efficiencies. This includes our marketing strategies, enhancing our yield management systems and digital presence, sustainability initiatives and the flexibility of our cost structure.

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Turning now to the commercial property portfolio. The portfolio comprises interests in 4 properties, with a total value of $311 million. The weighted average cap rate was 8.8% and WALE was 5.6 years.

All these are 100% freehold interests, save for the interest in the ATO Building, Adelaide which is a 50% holding in a special purpose trust.

Key achievements over the year were:

• completion of the ATO building. It is 98.2% leased with exceptionally strong tenant covenants from Commonwealth entities, with a 14 year average lease duration;

• extension of a lease at the Spearwood property to give a weighted average lease duration of nearly 4 years.

As I mentioned , our strategy here is to undertake a disposal process .

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We remain focussed on the disposal of all non‐core assets, realising value in an orderly manner, at the same time minimisin g costs and cash re q uirements.

During the year, $203 million of non‐core assets were sold, including the assets in the Diversified Fund that settled post 30 June. This is a significant achievement, particularly for these style of assets. The good momentum is continuing.

On balance sheet non‐core assets as at 30 June had a total carrying value of $26.1 million. The majority of this , $20 . 2 million , related to the Ballina Retirement Village . Since 30 June , it has become subject to an unconditional sales contract, with settlement due in December. This sale will also extinguish the residents’ loans liability of $12 million. This will leave 3 small non‐core investments on balance sheet with a total book value of $5.9 million.

Aspen Group also has non‐core exposure through its managed funds. Historically, Aspen has had co‐investments in, and provided loans to, these funds. Substantial write‐downs were taken of these positions in FY12. As at 30 June, the carrying value of the remaining positions was $23 million. There is fund‐by‐fund detail provided in the Appendix.

The major remaining exposure is related to Aspen Development Fund (ADF). The two major assets of ADF are Adelaide City Centre development site, and the Byford development site. The Byford site is now subject to an unconditional sales contract for $9 million, with settlement due in September .

Our focus with ADF, as with the other managed entitles, is an orderly sale, whilst minimising costs and any cash injections.

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To sum up, with our action steps for FY14

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As I mentioned at the outset, FY13 was a year of making progress on business focus and s im p lifi cat i o n. In FY14 w e will co n t in ue wi t h t hi s goa l.

The immediate priorities of action in our strategy to restore value are as follows:

• commence the disposal process of the commercial property portfolio;

• continue the non‐core asset divestment programme;

• continue to aggressively reduce corporate overhead in line with the ongoing sim p lification of the business ; and

• seek approval from the shareowners to undertake a share buyback programme at the upcoming AGM in late October.

Operationally, our key focus is to manage the Operationally, our key focus is to manage the impact of the downturn in the mining capital expenditure cycle in our accommodation business:

• re‐leasing the Aspen Karratha Village TWA; and

• optimising the returns from Aspen Parks Fund.

This upcoming period is expected to be one of major change for the business. As a result, it is not appropriate at this time to provide earnings or distribution guidance for the full year FY14.

However, for the first half to December ’13, we expect, assuming retention of the commercial property portfolio in the first half and no material change in operating conditions, distributions to be 0.75 cents per share. This is an unchanged rate from FY13.

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There are no doubt challenges within both our operating environment and Aspen itself.

However, we are very committed to a strategy of restoring value. This strategic process is accelerating. Looking to dispose of the commercial property portfolio is a major new step in this strategy.

This would leave the business more simple and much more focussed, in the accommodation sector , with a leading market position , in an industry with good structural characteristics. This gives us strong optionality on ways to create value.

We have a lot of work to do. However, there is good clarity on the path forward, the tasks at hand, and the business is now better positioned to create shareowner value.

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