Thursday, 24 May 2012

Wilful blindness and the new forest industry

Just what is happening with Gunns?

On 15th May 2012 it requested ASX extend its listing suspension pending recapitalisation which it anticipated might take an indefinite period.

Gunns advised that

·        The Victorian Heyfield timber mill sale agreement was finally executed. The enterprise value was reported at $28 million.

·        The sale will end native forest operations for Gunns in Victoria following similar moves in WA and announced intentions in Tasmania.

·        The sale of Green Triangle assets was proceeding (as it has for the last 12 months)

·        Indicative offers had been received for the mainland plantation assets (in other words the Great Southern MIS management rights) and the Portland woodchip facility and a structured sale process had commenced.

·        Mr L’Estrange had his term extended until 31st December 2012.

The sale of the company’s last hardwood sawmill at Heyfield in Victoria has been close to completion for a long time. The enterprise finally achieved a sale value of $28 million. At 31st December the enterprise was valued in Gunns’ books at $44 million according to the February 2012 Analysts’ Presentation.

When the term ‘enterprise value’ is used it usually means that liabilities such as accrued employee benefits as well as assets such as receivables and inventory are taken on by the purchaser. It is not known whether the monies reportedly owing by Gunns to the Victorian Government have been paid or will be assumed by the purchaser. The Age reported on Feb 4th 2012:

“Last financial year Gunns owed Victorian taxpayers $7.2 million for sawlogs from state forests. The company says it has started to pay back this debt.”

The sale of the remaining Green Triangle assets comprising 33,000 hectares of plantation land and 12,000 hectares of land and softwood plantations has been a tortuous process.

Together with the 33,000 hectares of softwoods sold by Gunns 2 years ago to GMO Resources, these assets are being rebundled into a new entity to be managed by New Forests.

“Funds managed by New Forests have taken a controlling interest in the 46,000 hectare Auspine estate. New Forests’ Australia New Zealand Forest Fund is the lead investor in the transaction, which includes the land and trees of the 64-property estate, formerly owned and managed by Gunns Limited. The plantation estate will be managed by Sydney-based New Forests, an investment manager specializing in sustainable forestry and associated environmental markets.”

Gunns has an interest in this new entity which it says is worth $120 million. It is trying to sell this interest as part of its debt reduction strategy.

The way this deal has been structured emphasises the ownership structures that are largely replacing the ridiculously inefficient MIS structures and moribund State owned plantation businesses.

Timbercorp was the first major MIS Company to venture into Voluntary Administration and then Receivership. Some of the MIS schemes were on externally leased land, some on Timbercorp’s land, a total of 95,000 hectares of trees of which 39,000 hectares was on Timbercorp’s land.

The Receivers acting for the banks controlled the whole deal. Leases weren’t being paid, the banks wanted their money so the Receivers wound up all the MIS schemes and sold the land and trees collectively for $345 million. Growers, many of whom felt they were being shafted by the sale process, ended up with $198 million, just over $2,000 per hectare, much less than their initial investment. The 39,000 hectares of land was therefore worth $147 million.

The Great Southern wind up took a different course. The early schemes were continued until harvest, Gunns took over 9 schemes and the 2 newest were wound up.

The Australian reported on 13th January 2010:

“THE Perth office of receiver McGrath Nicol has begun a formal legal application to wind up two orphan elements of defunct rural operator Great Southern Group, its 2007 timberlot plantations and its 2008 renewable fibre project.

The two elements of the group’s managed investment schemes attracted no interest from potential replacements as Responsible Entity, unlike the nine schemes planted between 1998 and 2006 whose management was taken on just before Christmas by Tasmanian timber group Gunns.

Without an RE, the two most recent Managed Investment Schemes appear to be doomed as they are a long way from harvest, and insolvent.”

Great Southern had earlier tried to buy back all woodlots as part of Project Transform announced in September 2008. One quarter of owners agreed and swapped their woodlots with soon to be worthless Great Southern shares, but Great Southern continued its inexorable journey into Administration and Receivership.

Great Southern owned about 270,000 hectares of land of which 167,500 was considered productive. In January 2011, a syndicate managed by New Forests comprising Alberta Investment Management Corporation, a Canadian pension fund (73%) and Australia New Zealand Forest Fund (27%), the same entity involved in the purchase of Green Triangle and Forestry Tasmania’s JV assets, acquired the land from the Receiver, McGrath Nicol for $415 million, reportedly at a 40% discount to the original cost price.

At the time the possibility of buying the MIS woodlots was floated as a possible future course for the New Forests managed syndicate.

This is now increasingly looking like a distinct possibility.

When Gunns took over as Responsible Entity of the nine Great Southern Projects, the rules were changed. Originally Great Southern contracted with grower/investors to manage the Projects on a deferred fees basis in consideration for the high entry fee paid, all of which was spent. A new Responsible Entity would incur huge losses if it were to proceed on this basis.

Accordingly the investors agreed to reimburse Gunns at harvest time for costs incurred by Gunns during its management period. Growers are now awakening to the reality that the meagre future harvest proceeds will be further hammered by the reimbursement required to the Responsible Entity. Future expected yields of about 160 tonnes per hectare revealed in September 2008 as part of Project Transform haven’t shown much improvement and now Growers will lose even more of their harvest proceeds.

The Growers have been softened up enough for a possible low ball takeover by New Forests. To combine the ownership of both land and trees makes economic sense for New Forests.

Gunns purchased the management rights to nine Great Southern projects, which was widely interpreted as part of Gunns’ plan to ensure they had sufficient plantation feedstock for the pulp mill.

The February Analyst’s Presentation listed the Great Southern MIS business as an operation ‘to be discontinued’ not as ‘an asset for resale’ but a business to be discontinued. This appears a little strange because Gunns has been bringing to account as future income its share of future harvest commissions so it appeared to believe it was worth a lot more than the purchase price. But now the business will be discontinued.

There doesn’t appear to be a categorical statement from Gunns confirming what is proposed and there has been no talk of a replacement Responsible Entity which is mandatory if the MISs are to continue.

Which suggest the purchase of trees from the Growers is a distinct possibility.

New Forests would almost certainly be the likely purchaser.

If Gunns resigns as Responsible Entity and New Forest gets control over the trees at a bargain price, New Forests may be more favourably disposed to acquiring from Gunns its interest in the new Green Triangle entity.

The possible downside for Gunns is if it needs feedstock for the pulp mill it will have to pay more. Naomi Edwards in her January 2011 pulp mill analysis update included the stumpage price for Great Southern plantation timber at $20 per tonne. An investor like New Forests would require a higher figure, possibly somewhere between $35 and $40 to give it an acceptable rate of return.

The third example of a MIS company wind up is FEA. The Voluntary Administrator is running the company for the benefit of the shareholders, creditors and grower/investors subject to the right of the secured creditors, the banks, who have appointed Deloittes to look after their interests as Receivers and Managers.

The Administrator no doubt has learnt from the experiences of Timbercorp and Great Southern although factual situations always differ in some way.

The Administrator found “the group’s affairs were restructured over time in ways that have tended to enhance the interests of its secured creditors at the expense of unsecured creditors, shareholders, and investors in the Managed Investment Schemes.”

Furthermore he wryly observed that ”the secured creditors have indicated that they regard themselves as uniquely entitled to market the land and trees for sale; to do so without reference to other creditors, and subject only to limited duties owed under the Corporations Act. They also contend that all of their debt, inclusive of penalty interest, and the costs of the Receivers and Managers, ought to be paid in priority to the claims of both Growers and unsecured creditors of the companies. All these issues remain to be resolved…”

There is “a need to preserve Growers interests ......within the context of steps taken by the Receivers to terminate internal leases.”

FEA growers have been more fortunate than their Timbercorp counterparts as the Administrators have battled with the Receivers acting for the banks who would have preferred a Timbercorp style solution.

However Growers have been required to dip into their pockets to provide funds to the Administrator to keep their Projects alive.

The banks have further distinguished themselves by refusing to make contributions in respect of the Woodlots which they now own as a consequence of default, usually loan default, by Growers. Needless to say, this has jeopardised the future of the Projects, which is precisely what the banks have been trying to achieve.

The Administrator accepted a detailed plan, which eventually failed, whereby Rural Funds Management RFM planned to restructure FEA by introducing institutional funds of $85 million for a 50% interest, with growers having a 48% interest and FEA creditors being granted a 2% interest, plus an extra $100 million to be advanced by a NAB. The gross assets therefore had a market value of $270 million after restructure costs. With $34 million of cash working capital and the 67,000 hectares of plantation belonging to the Growers valued at $113 million, this left only $123 million as the implied value of the productive land being the FEA land growing investors’ crops of 44,000 hectares (the balance of Growers crops are on leased land).

That implies less than $2,000 per hectare for the trees (equal to the costs of establishment), and about $3,000 per hectare for the land.

The trend towards aggregating land and trees into one entity is sure to continue and is almost certainly occupying the mind of Gunns’ de facto Voluntary Administrator as plans for a $400 million capital raising continue.

The multitude of leases to MIS growers severely inhibits any dealings with the land even more so than the mortgages and it’s finally dawned on Gunns that it needs to tidy up the ownership of the land and trees.

Even if a pulp mill does not proceed it is clearly in everyone’s interest to tidy things up lest a repeat of FEA’s mess ensues.

Gunns has chopped and changed plans for its hardwood plantations and trees over the years, whether to retain them within Gunns? to sell to a third party? (who would buy with all the MIS leases in place?) and now it would appear, whether to purchase the Woodlots from Gunns’ MIS growers?

What are the woodlots worth? With 106,000 hectares of Gunns’ MISs at about $2,000 per hectare makes $200 million. Less say $100 million if New Forests buys Gunns’ interest in the new Green Triangle assets.

There’s about 58,000 hectares of Gunns’ own plantations including those in JV arrangements, Tamar Tree Farms etc. These are listed in the books at $3,000 per hectare, or $187 million in total, which seems to be a little higher than recent market sales. Plantations vary a lot, Gunns has some good ones but also some pretty crappy paddocks. The Surrey Hills plantations aren’t known for rapid growth.

It will be interesting if Gunns makes an offer to its MIS growers and what that offer will be.

Gunns’ plantation land of about 150,000 hectares is listed in the books at about $3,000 per hectare or $418 million in total. Again it’s difficult to compare with recent market sales, some land may be better, some worse, with the Surrey Hills spread struggling to register a value, if James W Sewall Company, FT’s valuer, applied their methods. See

Hence if Gunns does consolidate the hardwood plantation trees and land, say 150,000 hectares, they would have to be worth at least $600 million, which together with what been spent to date at Longreach may be enough to stay in the poker game. Even so this doesn’t guarantee a JV partner fronting with a matching stake.

As a fallback position, at least Gunns will have some freehold plantations worth something, albeit well underwater when compared to the amounts contributed by shareholders.

Gunns’ February Analysts’ presentation detailed the cost of pulp landed in Shanghai at US$355 with the exchange rate at $1.05 and after netting off the revenue from selling surplus electricity into the Tasmanian grid. The gross manufacturing costs for one tonne of pulp were US$ 387, with a wood fibre content of US$245.

In AU$ terms the implied figure was $233 for the costs of the wood fibre, or $58 per tonne of green chips. This is a mill door price which suggests that some of the wood must be from internal sources which seems to further suggest that a buyback of MIS woodlots is on the cards.

Naomi Edwards estimated in January 2011 that the average stumpage for Gunns’ woodchips was $28 per tonne green, but this was weighted down with the cheaper chips from Great Southern plantation. If Gunns loses control of the latter then the price will rise.

Then there are the costs to the mill door estimated by Naomi Edwards to be between $29 and $37 per tonne of green chips. These costs have a habit of rising in real terms. The $58 figure for a mill door delivered tonne of green woodchips, derived from Gunns’ figures, seems to be at the bottom of the possible range.

Then there’s the question of where will all the chips come from? OK so Gunns has 150,000 hectares but about 250,000 hectares will be needed to feed a mill. FT has about 56,000 hectares but much of that is supposed to replace the native forest resource in the future.

Private growers will require $35 to $40 per tonne if they are to be attracted to growing plantation trees for pulp. There haven’t been many plantings in the past 3 years and future plantings will inevitably lag any pulp mill go ahead decision by a few years, so it will be some time before there’s any chance of increased private plantings.

If Gunns has to fund all the new plantings then the cash flows will look a little different.

The entire unanswered questions will remain so until details of the capital raising are announced and the trading suspension lifted.

But the odds are firming that we will see a continued aggregation of land and trees.

Meanwhile as the world changes and adapts to life after the GFC without MISs, the extraordinary admission in Thursday’s State Budget that the State Government is contemplating funding Forestry Tasmania FT is a reminder that plus ca change plus c’est la meme chose.

The responsible Minister, Bryan where-do-I-sign Green, continues to astonish with the revelation that FT is being considered for a $100 million boost in addition to a refund of the payment to the Government of $10 million in 2012/13 relating to the sale of the softwood resource which involved the de facto lease of Crown land to a cashed up investment fund New Forests rent free for the next 57 years.

That’s $35 million for next year and $25 million per annum thereafter.

Apart from native forests and a small area of softwood, FT is now only responsible for about 56,000 hectares of hardwood plantations. Of this 23,000 hectares is privately owned, either outright or as part of a JV with FT, about 13,000 hectares are ‘the most expensive plantations in the world’ planted with the $90 million TCFA monies which won’t produce a positive cash flow for 20 years, leaving about 20,000 hectares, not much bigger than a large farm. And they’re going to get another $110 million? Not to plant more trees I hope. The last of the 3,000 TCFA hectares is still not planted according to 2011 reports ostensibly because of lack of suitable land.

To put this into context, if one were to exclude the 50 % of FT’s revenue that relates to harvesting and transport to the mill door or wharf as the case may be, which is immediately paid to contractors as reimbursements, in other words to include as revenue only the stumpage sales, FT’s income next year will be lucky to be $35 million.

Yet Mr Green proposes to give the company an amount equal to its revenue, to help meet changes in circumstances, most relating to circumstances which every other business has had to face without Government assistance or which wilful blindness prevented the Government and FT from seeing when it was obvious to everyone with an enquiring mind.

The failure to factor in a decline in native forest woodchipping was an act of wilful blindness.

As was overlooking the fact that MISs were a bubble waiting to explode. How could such a sham last forever? How could a North Shore dentist leasing 1/3rd of a hectares to grow poor yielding timber notwithstanding he might have agreed to a Constitution, a Lease or Forest Right Agreement with a Responsible Entity, a Compliance Plan, a Plantation Management Agreement, a Lease with a Landlord and possibly a Loan Deed be regarded as sensible and sustainable public policy.

Yet Mr Green as Minister continued to support MISs via submissions and approaches to the Federal Government to the very end.

Wilful blindness and non cooperation with the Auditor General prevented an early release of his damning report into FT by at least 2 years.

Wilful blindness and procrastination delayed the appointment of a Review into FT.

Wilful blindness led to the appointment of URS to conduct a review into FT, overlooking URS’s contribution to FFIC ‘s now lapsed New Forestry Plan which forgot to eliminate intermediate goods and services when listing the output of the New Forest Industry, leading to a virtual doubling of proposed turnover of the industry.

With the forestry peace combatants lying semi comatose on the canvas at the end of the 14th round of their scheduled 15 round contest, wilful blindness is now preventing recognition of the fact that the old forestry industry is dead.

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