Friday, 19 March 2010

Gunns discovery expedition

IT WAS bound to happen.

The institutions growing weary of propping up Gunns, whilst seeing its share price plummeting.

They’ve been too kind for too long.
Gunns is now a fairly lowly ranked listed company, coming in at about 250th on the latest ASX list in terms of market capitalisation with a figure of about $450 million.

Nevertheless the institutions which control over 80% of the issued shares have no great desire to see the rest just fritter away.
That’s why the restructure plans have been floated.

But the institutions, the shareholders, are believed to have little faith in the current Board’s ability to implement any changes at this eleventh hour. That’s probably why some Board members have reportedly been asked to start lining up for a gold watch presentation.

Not dissimilar to the judgment the Tassie electorate are about to pass on the Labor government.

A timely coincidence indeed.

The few details to emerge about the restructure proposals suggest splitting the company into four separate entities, one to operate the pulp mill, one to own and operate the plantations, both hardwood and softwood, one to conduct the sawmill businesses and native forest woodchipping, with the remaining one to look after the rag bag collection of a building business, a hardware chain and a wine business.

The Gunns’ Board have long argued that the true value of Gunns’ assets isn’t being recognised by the market.

We shall soon see.

Companies go through cycles, growing, realising the synergies from mergers and takeovers, then turning round and demerging, returning to core businesses, unlocking the value.

You’ve got to admire investment bankers, they’re never short of strategy if there’s a bucket of money in the room.

It will cost Gunns plenty if the amounts they’ve forked out to the smarties in suits over the last 18 months, are any guide; $22 million paid in fees to organise the $480 million lifeline provided in new equity by shareholders in that period.

The rag tag businesses like wine, retail hardware and construction are a sign of an older style conglomerate that just grew without a clear strategic direction. Running any business is quite demanding for Directors, so how any Director is able to turn his hand at retailing, building, viticulture, woodchipping and sawmilling has long puzzled observers.

The puzzle has now largely been solved. The restructure proposals are a de facto acknowledgment that the current set-up is far from optimal.

A small wine operation like Gunns’ in a public company is a sign of dilettantes at work (at lunch maybe?) Hardnosed institutions are unlikely to be interested in such an operation in a listed company. It could well be sold. The fees for the restructure advice need to come from somewhere.

The retail hardware business is undergoing a transition as Metcash (the Third Man in Australian grocery retailing after Coles and Woolies) has taken control of the Mitre 10 franchise. Tasmanian Mitre 10 franchisees have not always been enamoured of belonging to the same club as Gunns, and would probably welcome Gunns exit, whilst Gunns’ advisers will probably have trouble justifying the continued ownership of a few hardware stores. It’s quite likely the retail hardware business will be considered for sale.

Then there’s the construction business. It doesn’t make much, sense or dollars. It’s probably not worth much more than its tangible assets. In this day and age it’s a real anachronism to have a construction division alongside a global woodchipping division in the same Company. Hard to think of the plusses. Except maybe it’s handy to have a few tradesmen on the payroll who can be sent at short notice to assist persons with house renovations when the latter just happen to be involved in critical negotiations with the Company, and have been unable to get a satisfactory price from other providers.

Gunns propose to separate out sawmilling and native forest woodchipping. From what I read, the latter has anything but an assured future

Over the last 3 years Gunns has bought Auspine for about $500 million less debt of $150 million approx so they paid about $350 million net. But they immediately sold $173 million of the pine trees, so Auspine still owes them about $177 million. Then they bought ITC Timber for $88 million, giving a total cost of recently acquired timber businesses at $265 million.

Gunns claim that when all synergies are realised the sawmilling business will produce an EBITDA of $20 million. But the price earning multiple will not be a large number given all the risks in the sawmilling business, particularly sawmilling using native forest resources. By that, it is meant the market is unlikely to value a sawmilling business much higher than 5 to 8 times EBITDA, which makes the value of the sawmilling businesses less than even the most recent acquisitions. So it is unlikely that there are any large amounts of value to be unlocked by any demerger proposal.

The sawmilling business is such that it will be unable to support large licks of debt. Gearing of more than 10% to 15% would be imprudent. It is unlikely that institutions will be clamouring to get on the share register of a listed native forest sawmilling business.

At this stage the pulp mill entity will simply have an asset of $180+ million being the money already outlaid on the mill. It is unlikely that this Company will be able to assume any debt. The value of the asset is problematical at this stage. Institutions are likely to be disinterested in a pulp mill company without a lot more detail. A helluva lot more detail.

This leaves the plantation assets and almost all the debt, $1.2 billion in assets and $420 million in debt according to the Fairfax media. The plantation assets are the source of the unlocked value, so they say. The Golden Casket? Or Davy Jones’ Locker?

It must be remembered that Great Southern always claimed its assets exceeded its liabilities. The true nature of Gunns’ plantation assets will soon be revealed, with Gunns to issue a progress report on its restructuring to ASX by the end of April. Two thirds of plantations on Gunns’ land are owned by investors and the expected return at harvest time is the implicit determinant of the value of that land. The downwards pressure on chip prices as well as disappointing yields cause a downward revision in the value of the land. Much of Gunns’ older plantations which they own are poorer yielding crops which are unlikely to bring much of a smile to bankers’ faces.

The plantation estate will be housed in an investment vehicle, to use Gunns’ words, “to facilitate direct investment in our significant plantation forestry estate, more appropriately valuing these assets and allowing us to expand it through further consolidation of hardwood plantation assets across Australia. The vehicle will also allow Gunns to maximise its investment in the Bell Bay Pulp Mill”.

One shouldn’t knock hope. Or mock lying in the gutter whilst still looking at the stars.

But the reason for optimism is not readily apparent.

The current Board which has led the Company on an expedition seemingly to discover the headwaters of that infamous creek without any Plan B is soon likely to be rueing more than the absences of a few paddles.

It’s no surprise the shareholders are revolting.

A loss of trust in management.

A familiar story in Tasmania.


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