Tuesday, 9 June 2009

Gunns after the deluge

Surviving MIS companies Gunns and Forest Enterprises are at pains to distance themselves from their fallen comrades, Timbercorp and Great Southern.

The boss of Gunns Plantations Ltd Ian Blanden was reported in Business Spectator on 25th May 2009 as saying,“(o)ur business model is very different ………. We are a forest products company who have established an agribusiness investment or forestry investment arm. We’re not an MIS company………..we’re an end user looking for a resource, not a resource searching for an end user and we have a very diversified source of revenue, MIS making up somewhere between 10 and 15 per cent of our annual revenue to the Gunns group.”

An opinion writer using the byline ‘Bruce Felmingham’ followed with a piece in the Sunday Tasmanian on 31st May 2009, by saying in part “ A brief analysis of Gunns Plantation Limited’s business plan reveals some notable differences between the Gunns plantation business and the Timbercorp and Great Southern operations. The main point is that….Gunns’ MIS represents only 10 to 15 per cent of the group’s total revenue.”

A brief analysis indeed.

A particularly fleeting one.

From the same hymn book.

Merely looking at revenue can be terribly misleading.

In the 2007/08 year Gunns’ MIS revenue comprised 14% of total turnover but it contributed 29% to the bottom line

In the 2006/07 year MIS revenue was 21% of the total but it contributed 50% to the bottom line. Forest products (woodchips, sawn timber etc) represented 63% of turnover but contributed only 46% to the bottom line. Balancing amounts were contributed by the retail hardware, building and wine businesses.

One feature of Timbercorp and Great Southern is that over time an increasing number of MIS projects had to be serviced, hence the gross profit from MIS activities gradually fell.

Apart from a cash flow bonanza upon establishment, MIS companies experience a cash flow drought until harvest when a small commission is received.

Falling MIS sales further contribute to a fall in gross profit from MIS activities.

In Gunns’ case, for 2007, the MIS sales of $145m produced a MIS gross profit of $70m or 48%.

The following year MIS sales of $124m produced a gross profit of $45m or 36%.

This current year is not expected to show any improvement. Both turnover and gross profit are likely to decline.

What occurred with Timbercorp and Great Southern was their new MIS revenue was insufficient to cover new plantation establishment costs plus the costs of looking after existing plantations.

This caused a MIS deficit that needed to be funded from other sources, which in their case didn’t exist. They were insolvent. No cash in the kitty. Unable to pay their way. But they still had net assets. These however will soon disappear. The Administrators and Receivers will have to be paid. Investors and shareholders have little control over these fees which one of Great Southern’s creditors described at the recent Creditor’s Meeting as being of sufficient size to choke a hippopotamus.

Gunns does have other sources of revenue. But to imply that MIS is only a minor part of Gunns’ business is misleading. It’s been a significant contributor in the past.

And what percentage of Gunns’ assets is employed in the MIS segment?

In 2007/08 $1.1b of net assets produced a gross profit for the forest products segment of Gunns’ business of $105m. In the case of the MIS segment $110m of net assets produced $45m of gross profit, a good result but not nearly as good as the previous year when $60m of net assets in the MIS segment produced $70m of gross profit.

More assets become tied up with MIS schemes over time. At the same time the ensuing profit falls.

Mr Blanden further stated “. out of the 200,000 hectare estate that we manage about half of it or 100,000 hectares is owned by investors in our forestry investments” What he meant is that the trees are owned by the investors. But a further 33,000 hectares of trees bought as part of the Auspine deal were sold recently to GMO Resources at the insistence of ANZ Bank in an attempt to get Gunns’ debt under control. For all intents and purposes these are similar to MIS trees, in that Gunns is looking after someone else’s trees growing on their land.

In total, 2/3rds of Gunns’ estate referred to by Mr Blanden appears to be growing trees belonging to investors.

There’s a lot of money to be made at establishment but not a lot thereafter.

Now to reiterate and reinforce the above points.

First, in assessing the importance of MIS to Gunns, it is necessary to look at the contribution to the bottom line, not simply the share of turnover.

Second, it needs to be recognised that over time the costs of tending existing MIS plantations will erode MIS profits. Great Southern directors referred to these costs as legacy costs that have to be met out of current income. When increasing legacy costs occur simultaneously with falling MIS sales problems occur, and with Timbercorp and Great Southern the speed of these problems caught most unprepared.

Third MIS companies in their early stages are all extremely profitable in terms of the assets employed and most have grown quite rapidly. In their enthusiasm to grow borrowings became too high and certainly too much cash leaked out of the system to all the paper shufflers and hangers on, although to some extent the well remunerated sales departments probably helped MIS companies achieve their high rates of growth. The good times were assumed to last forever. They didn’t. It’s delusory to blame the GFC or drought. The train wreck was bound to occur.

From a cash flow viewpoint running MIS companies after the first flush has proved a difficult exercise. To date MIS companies have been unable to make the transition to a mature state with a more stable business model.

Gunns’ problems were exacerbated by the Auspine takeover. It was not one of Mr Gay’s crowning achievements. The entire purchase price required new capital. And then Gunns sold most of the trees acquired. So what was the point? To buy the underlying land? Mr Blanden proudly asserts than Gunns is a forest products company. Then why pawn the trees?

Gunns is more of a MIS company than it’s ever been.

Gunns are certainly better plantation managers than Timbercorp and Great Southern.

Despite this there are as many similarities as differences between Gunns and other MIS companies.

Gunns are very keen for MIS to survive. It’ll be more difficult convincing a joint venture partner about the pulp mill if new plantations have to be internally funded.

When asked about the positive benefits of MIS Mr Blanden replied “Well from our perspective we see positive benefits for investors… bringing funds in general from urban areas back into regional and rural areas. Providing employment for people establishing, maintaining and adding value to these plantations…. we also see great value for land owners …. we provide choices to those land owners. … it’s a diversification of farm income which provides them some great security and to other landowners it provides some choices if they wanted to exit the farming arena”.

Sounds fantastic. Who could argue with that?

Although he has adopted the Paul Lennon approach in overstating the benefits and neglecting the costs.

He did conveniently omit to mention the overwhelming rationale for MIS schemes from the viewpoint of a company like Gunns. And that is to get someone else to borrow money to fund an exercise from which Gunns is the principal beneficiary. Outsource borrowings and remove risks. A similar business model to that perfected by Macquarie.

Whether MIS schemes will continue depends on policy makers deciding whether or not it is sound economic policy to entice an investor to borrow say $10,000 to invest in trees with a cost price of $2,000.

There’s scant evidence a sustainable business in today’s world can be built on that basis.


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