One would expect a finance director from the property industry to be somewhat bleary-eyed and wild-looking after the rough ride the industry has been through.
The Lehmans crash sent property prices through the floor without touching the sides. With 40 percent sheared off property prices, most owners came face to face with the prospect of breaching their banking covenants.
But Graham Prothero, FD at smallcaps property development and investment outfit Development Securities, seems very much at ease. That is not because his company escaped the industry’s collapse unscathed, because it did not. Development was no exception in that it, like many of its peers, had to address its banking covenants when the crisis hit.
Prothero had seen much of this before. While serving as FD for the property business at cement manufacturer Blue Circle in the late 1990s, he saw similar wranglings against the backdrop of a punishing recession.
“While at Blue Circle I saw the last appalling crash. One of my first roles in the property business was the refinancing of a major scheme with a syndicate of about six banks, two of whom wanted out,” Prothero tells Financial Director.
“It was quite early in my career, but I think that until you have lived through something like that, it is difficult to imagine the kind of things that [recession] does: the way it makes people think about the world, the behaviour it drives and the panic that it induces,” he adds.
Prothero thinks that this formative experience and those of his peers on the board have converged to make Development a very risk-averse business.
“It is only an experience of that kind of situation that enables you to set up a business in a properly risk-averse manner,” he says. “It is no coincidence that three members of our board lived through that crisis. That’s why we are risk-averse: it’s a salutary lesson. Even when times are tough and our share price is down, the analyst community is very generous when they talk about our balance sheet.”
That said, Prothero had to go to the markets twice in 12 months, completing two £100m rights issues to shore up the business as property dwindled ever further.
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The first came in the first quarter of 2009 when the financial markets were reeling and the real estate industry was in the doldrums. Prothero concedes that Development was not the only firm going to market with rights issues. But there was one telling difference.
“Many of our peer companies had gone charging out to their shareholders to say, ‘Eek, can we have some cash from you so that we can pay down the banks?’ We didn’t need to do that,” he says. “We basically said to the shareholders, ‘Well, you’re giving all this money to everybody who is in trouble, all these rescue rights issues. We think there are opportunities in the market to take your money and spend it on very well-priced kit.’”
“We invested something like £40m of that £100m very quickly and picked up a return on our year-end valuation. Almost £6m of that return was off the £40m we had invested – that’s something like a 15 percent uplift in those properties,” he adds.
Getting the message out
The second issue was a bit different. Through the fourth quarter of 2009 and the first quarter of 2010, a lot of the low-hanging fruit in terms of appetite for rights issues had been picked. The 10 percent yields had disappeared as Development and companies like them ate them up.
There were still opportunities in the market, though, and Prothero did not want the business to have to wait while it raised more capital.
“As we saw ourselves getting through that first £100m of equity, we went to the market and said, ‘Look, we have spent £60m of it, we have committed £30m of it and we have got potential for another £50m.’” he says. “We were not out of money but we could see we were coming to the end of it and we didn’t want to give a message to the market that we had spent all of our equity.”
The problem was that Development could not go to the banks for a standard loan. The banks had lent far too much to the sector. With about £250bn of debt lent to the real estate market, and six consecutive quarters of reduced lending, only the biggest players were getting cash.
“If you are a small regional player or maybe a private company, perhaps you don’t have the long track record with the major banks,” Prothero says. “You are not going to be able to borrow from any of these lenders. It’s not even worth picking up the phone.”
That meant, as with the first issue, the ability of the finance function to clearly articulate its message to the market was vital to its mid-term future.
“We have always believed firmly in being very transparent, being very open with our shareholders, and we try to keep up a strong relationship with our shareholders and our debt funders too. That is a key part of my role,” Prothero says. “We have a very open dialogue with all our major shareholders and with as many shareholders as are interested to spend the time with us.
“Whenever we make an announcement – at least twice a year – we will tramp around the City and spend an hour with all the key guys. That means that over the years they build up a good understanding of what we do. They know we will tell them the situation as it is. We won’t hide anything, or pretend we are achieving something that we are not. They trust us, and I think that transparency means that they can make a very good decision.”
By being risk-averse – one of Prothero’s key principles is to keep debt gearing very low – Development may not always deliver stunning outperformance. But it does not promise its stakeholders that anyway.
“Even when the market is in a bullish phase and everyone has forgotten that things can go down, and banks are throwing all the equity and debt you could ever want at you, we tend to resist the higher levels of gearing,” Prothero says. “It means that we tend to lag behind the market a bit in terms of performance in the bull phase, but it means that we can sleep soundly in our beds at night.”
Being risk-averse actually gives Development a rather unusual business model for the era in which it operates. Prothero says there is a list of five golden rules that the company always sticks to. One is low gearing; two, not to invest outside the UK; three, not to stray outside the sectors it understands in terms of projects; four, to maintain a low-yielding investment portfolio that is regular; and finally five, not to develop major projects – such as its flagship development at Paddington Central – on its own balance sheet.
“We will procure the scheme, obtain the planning permission and get it ready to go. But before we put a spade in the ground we forward sell that to a major fund which is large enough not to fall over if the building does not let quickly enough,” says Prothero.
“There are examples of operators in the market now who are just sweating on whether their buildings are going to let, because if not, they will take the company under. It means that we sacrifice some of the gain but the company is not at risk.”
Cut the risk
Prothero can kibosh deals that bring unpalatable risk to his door. He says the executive management spends a lot of time together talking through every aspect of the business. On the day Financial Director meets him he is fresh from a conversation with Development’s investment advisors picking through a potential acquisition.
“On this one deal they were very keen to do, I looked at the tenant purely from a financial perspective,” he recalls. “I said, ‘I don’t like the smell of that tenant. We have got problems coming down the line.’”
He sees and contributes to every potential deal coming through the door. “That to me is a key part of the role,” he says, “though we don’t spend all of our day poking our noses into what each other does.”
And being risk-averse means knowing what risk actually looks like. At Blue Circle, where he started out as group chief accountant and rose to finance director for its property business, he spent some time in between focusing on mergers and acquisitions.
“That gave me very good exposure to all the key financial and risk management areas of the business as a student of the role,” he recalls.
What of moving from a business the size of Taylor Woodrow into a smallcaps business?
“It was a great time to be at what was then a FTSE-100 entity, and a great time in my career because I was able to move around several of the disciplines,” he says. “But part of the fun of being in a company the size of Development is that we are much smaller, so we cover a broader range of functions ourselves. Being inside Blue Circle for eight years and seeing those functions first-hand was a great grounding for what’s now a broad role here.”