Saturday, 13 October 2012

Gunns the morning after

It will probably be 6 months before Gunns’ Voluntary Administrator (VA) presents his full report to creditors (the Second Report) which will reveal once and for all the mess that has been created. At that time there will be a recommendation to ...

• Hand the company back to Directors (unlikely),or

• Enter into a DOCA (Deed of Company Arrangement) where stakeholders agree to haircuts to keep the Group going. This is unlikely due to the complexity of the Group, or

• Liquidate the Group (most likely)

The forthcoming First Creditors meeting and meetings of growers and landowners are essentially procedural meetings.

Until the Second Creditors meeting we will probably have to endure more false expectation, finger pointing and blame shifting with little meaningful discussion of how we might move forward.

“Our World Class Plantation Estate”

Chief Spruiker Lara Giddings referred the other day to “our world class plantation estate”.

Meanwhile Examiner polemicist Martin Gilmour writes about the possibility of an international company, probably the Chinese, buying up the rights to Gunns’ 300,000 hectares of plantation forests, harvesting and chipping them in Tasmania before shipping overseas.

There’s only about 170,000 hectares of hardwood plantations in Tasmania managed by Gunns. Gunns itself only has an ownership interest in 65,000 hectares of hardwood plantation, and some of those are owned jointly with others. The rest of the trees are wholly owned by others although Gunns does ‘manage’ them, if you’ll forgive the overstatement.

Gunns did manage 300,000 hectare of hardwood plantations at the time it took over 130,000 hectares of Great Southern’s projects in Dec 2009 but they weren’t all in Tasmania ... 48,000 hectares were in WA, 44,000 hectares in the Green Triangle,10,000 hectares on Kangaroo Island, 16,000 in NSW and Queensland and 4,000 hectares in Gippsland. It’s doubtful these will be transported to Tasmania for chipping before export as Mr Gilmour suggests.

And what rights exactly will the Chinese buy? The forestry rights? Which implies land owners including the banks will retain the land? Or maybe the Chinese will buy the leasehold rights? Or the freehold? The lot possibly?

The 300,000 hectare forest estate is an unbelievable potpourri of legal interests. Most in Tassie but some on the mainland, some MIS crops growing on Gunns’ land, some MIS crops on leased third party land, Gunns’ crops on its own freehold land, some Gunns’ crops on third party leased land, some Gunns’ crops owned outright, some via JV/partnership arrangements on leased land even Crown leases, some where the partner is FT, even some MIS woodlots owned by Gunns itself following default by Growers with loans to Gunns.

To assert the Chinese may simply acquire ‘the rights’ to the plantations is a lazy sloppy polemic which sidesteps the realities of the situation that has been more than adequately explained in voluminous outpourings from insolvency firms appointed to wind up the affairs of the other similar failed forest companies.

KordaMentha as Receivers appointed by the banks pursuant to security held over all the assets of all the Companies in the Gunns’ Group are currently running the show, except for the role of Gunns Plantations (GPL) as Responsible Entity (RE) of 21 MIS schemes.

The banks do not have control over the assets (ie the trees) of the MIS schemes which are now run by the Voluntary Administrator (VA) having taken over from the Directors of GPL. GPL probably owns some assets which the Receiver now controls, but GPL also wears another hat, and that is to look after the tree assets of the Growers in the various MIS schemes for which GPL is the RE. The control of these assets, the trees, has not passed to the Receivers.

The VA’s first task is to find a replacement RE, without which the MISs will need to be wound up. The MISs do not generate sufficient revenue to cover costs, hence funds from GPL’s parent Gunns is required to pay the MIS bills. The VA needs to liaise closely with the Receiver in control of Gunns’ affairs.

When Great Southern (GSL) failed, in the days when Gunns’ net assets were $1.3 billion and John Gay still had a modicum of credibility before the extent of the company’s woes became public knowledge, Gunns was appointed by GSL Growers to act as replacement RE.

One of the reasons for GSL’s demise was that the legacy costs, the costs of looking after the MIS Growers’ crops until harvest time, were causing cash flow problems. Growers had paid, in most cases, $10,000 per hectare, to GSL to plant trees and assist with funding the necessary costs including rent until harvest, at which time GSL was to receive an additional fee calculated at 5.5% of harvest proceeds.

But GSL spent all the money and was unable to refill the cash tin in time to meet its ongoing obligations to Growers. The Ponzi scheme ran out of fresh players and without new cash it was Goodnight Irene.

Before taking over as RE, Gunns sought a change in the conditions of the MIS Projects, for it was economically unviable for Gunns to pay all the expenses in return for only 5.5% of the harvest proceeds. The Growers agreed to pay more, an additional % impost for each year until harvest, although Gunns undertook to cash flow all expenses until harvest. Growers in the newest scheme for instance, the 2006 Scheme, with approximately 10 years till harvest agreed to a 55% commission fee to Gunns at harvest rather than 5.5%, a 50% fee for the 2005 Scheme, a 35% fee for the 2004 Scheme and so on as per an agreed scale.

In the more recent case of a wind up of yet another MIS company, Willmott Forests, coincidentally with the same Receiver and VA as Gunns, a 6 month search failed to find a replacement RE which meant there was no alternative but to wind up the Schemes. Willmott was a little smaller than FEA which managed 70,000 hectares of MISs. Most Willmott MISs were on Willmott land (41,000 hectares), 13,000 hectares of plantations were on Hancocks’ land and 2,000 hectares on land owned by the Forestry Commission of NSW.

Hancocks bought the trees growing on their land and Global Forest Partners bought Willmott land and trees plus the trees growing on NSW State forest. With only 2 lessors involved it was fairly tidy. Sale proceeds were split between the land owners (the Receivers) and the Growers.

In Gunns’ case, according to TGFA, there are 250 land owners leasing land via 600 leases to Gunns. Included is FT who is also involved with one of two partnership arrangements involving Gunns.

It’s going to be much harder to unwind.
Now to look at possible scenarios: one thing most likely to occur is a merging of the interests of landowners and growers. The existing structures don’t work at all well in practice. Another sure bet is that few of the existing tree owners will own trees after the reconstruction, Gunns because it will disappear and most of the 49,000 Growers who are unlikely to stick around.

Ex Great Southern MIS Schemes

There’s probably only 115,000 hectares remaining of the GSL MISs. Of the 9 Schemes (from 1998 to 2006), it is believed the 1998 and 1999 Schemes (of negligible size) have been harvested, and harvest has commenced on the 2000 Scheme.

Almost certainly the GSL trees will be purchased by the land owner, New Forests who acquired the land when GSL fell over. But the growth rates are appalling. The best of the Schemes is only achieving a Mean Annual Increment (MAI) of 18 pa (in other words growth of 18 tonnes per hectare per year), whilst the worst is doing 13 pa. The original estimates were for 25 pa. New Forests will be in the box seat in any price negotiations. It’s even possible that New Forests will have to be paid to take over trees in some of the Schemes, as the costs of replanting will exceed harvest revenue. Gunns’ Receivers will be entitled to their admin costs plus a reduced fee that Gunns would otherwise have received at harvest leaving Growers with a return of somewhere between 0% and 20% of their original contribution, before paying the ATO its entitlement, the inevitable quid pro quo for full deductibility of the original investment.

What an absolute disaster.

A triumph of hubris, mismanagement and rank incompetence.

Gunns’ MIS Schemes

It is less than likely that a replacement RE can be found for GPL’s 106,000 hectares of plantations spread across 9 different Schemes.

The Preliminary Final Report for 2011/12 revealed that Gunns’ future income from managing the GPL MIS “world class plantations estate“ would not be sufficient to cover future plantation maintenance and leasing costs. The shortfall was estimated at $102 million. This suggests a replacement RE would need to be paid at least $100 million by Gunns to take over as RE if Gunns’ financials are to be believed.

When Gunns needed funds to pay for pulp mill earthworks a payment of $23.5 million was arranged from IGA funds for retrospective compensation for the surrender of native forest harvest rights, so it shouldn’t be too hard to arrange for a payment of $100 million from IGA funds to persuade someone to take over management rights of part of this magnificent estate which currently, the Premier neglected to mention, is recorded as a liability in Gunns’ books rather than an asset?

Alternatively the Schemes will need to be restructured in a manner similar to GSL before a new RE would be remotely interested in the task.

But the most likely occurrence is that GPL’s MIS will be wound up.

Approximately 50,000 hectares is grown on leased land. The land owners are unlikely to pay big $s to acquire unwanted trees, and will be reluctant to agree to an assignment of leases to new tree owners. It’s also very difficult to envisage the scenario offered by Mr Gilmour as being possible, whereby the landowners will each grant a plantation right, presumably a forestry right pursuant to the Forestry Rights Registration Act 1990, to allow the trees to be transferred to a party from the Middle Kingdom.

Whatever happens there won’t be a lot of joy for the Receivers.

Not much joy for the landowners either as any ensuing income from their properties will most assuredly fall (see more on this below).

The VA will recoup some admin costs maybe.

The remaining GPL MISs are on Gunns land so it may be possible a la Willmott Forests to sell the land and trees as one, and split the proceeds between Gunns’ Receiver as the land owner and the tree owners after the Receiver first creams off amounts owing under the reduced harvest commission arrangement and his fees and those of VA. If it is to be sold as one lot then only a few large players like New Forests and Global Forest Partners will be interested.

Gunns’ own plantations

Gunns’ own plantations on its own land could be sold as separate lots but as it includes the old slow growing Surrey Hills plantations acquired from North Forests it may be difficult to get any sort of reasonable price in the current climate, not dissimilar to the situation 2 years ago when Gunns sold unwanted native forests. Prospective post harvest reestablishment costs by a new owner will keep a lid on prices.

Gunns also owns plantations on leased land. In most cases the leases are believed to be similar to the external leases of land used to grow Gunns’ MIS crops.

The Notes to Gunns’ financial statements discloses future commitments (other than those included as liabilities on the balance sheet). The latest full financials (for 2011/12) listed non cancellable operating lease commitments (most of which are believed to relate to land) of $31 million for 2011/12 and $27 million over each of the ensuing 4 years. Hence there’s a fair bit of leasehold land involved.

Gunns also has an interest in 2 joint venture operations, most of which is thought to be on leased land. It has a 62% interest in Tamar Tree Farms along with Mitsubishi Paper Mills and the Fukushima operator Tokyo Electric Power, and a 15% interest in Plantation Platform of Tasmania along with FT and some Japanese paper companies. FT lists in its Annual Report 8,500 hectares of JV hardwood plantations on Crown land and 15,000 hectares of private plantations on Crown land. These probably mostly relate to Plantation Platform and Tamar Tree Farms respectively.

Given that the Crown is likely to own much of the underlying land used by the two JVs, it would normally be best placed to take over Gunns’ interests. But it hasn’t got any money. Let’s hope we don’t see a repetition of the scandal whereby the FT/GMO softwood JV arrangement which owned 46,000 hectares of softwoods on Crown land via a forestry lease for 57 years recently sold its interest for $156 million. The buyer, New Forest acquired the forestry right which entitles it to free use of the land for tree growing for 57 years. The entire purchase price was allocated to the tree owners, FT and GMO. At the time, given the term of 57 years was only a few years shy of perpetuity, the implicit prepaid rent component of the transaction, the present value of future implicit rents would have been little different to the market value of the land, about $90 million in other words. If it were a leasehold crop the sale of 46,000 hectares of softwoods with a 57 year prepaid lease would have been split $90,000 to the Crown as landowner with $66 million for the trees split between FT and GMO.

But alas…..

And finally Gunns grows trees on third party lands via JV arrangement with individual land owners, and splits the harvest proceeds on an agreed basis, for instance 34% to the landowner and 66% to Gunns as tree owner and manager. It is not known how many hectares are in these types of arrangements.

Problems with Land Leases

One of the few journalists to attempt to find out what was happening with plantations, Airlie Ward in her 7.30 Tasmania show on 28th September, talked to a farmer leasing 300 hectares to Gunns to grow softwoods.

Whilst growing softwoods on leased land is the exception rather than the rule the $ figures were quite interesting. The annual lease was $70,000, say $233 per hectare, and probably CPI indexed. This looks a very attractive rate of return, especially for grazing land under the Western Tiers, and appears to be in line with leases in the writer’s experience where landowners were given an offer they couldn’t refuse of an 8% return indexed annually.

Things which can’t last forever generally don’t?

An 8% return implied the land had a value of roughly $3,000 per hectare. Few farmers achieve a rate of return of 8% pa and it is little wonder they agreed to the deal with such unbridled enthusiasm.

But with a shrinking of the timber pie, such a rate of return to one of the stakeholders is quite unrealistic.

The returns to landowners were predicated on what happened during the MIS boom which at the time was assumed to have eternal life.

Forecasting was seemingly done with sharpened pencils and a ruler pointing skywards. The historical pattern of falling real prices for commodities such as woodchips was ignored as the dawn of a new era beckoned where the old rules no longer applied.
Our world class plantation estate was thus born.

Airlie Ward’s interviewee described how pruning and plantation maintenance was not being performed. This is similar to the experience of Gunns’ Option 2 MIS Growers who elected to grow longer rotation peelers rather than short rotation chippers. Gunns’ maintenance costs and market uncertainties were further adding to the liability flowing from the contractual arrangement Gunns had entered into with Growers to tend the crops until harvest. So Gunns allegedly arranged for a costly consultant’s report from Poyrys to justify abandonment of their contractual obligations to longer rotation sawlogs, which the Government keeps telling us will become the cornerstone and saviour of the forest industry.

The matter of the current split up of the timber pie may be best described with a few ‘back of the envelope’ figures of notional annual returns from a hectare of plantations. These figures are illustrative only.

Let’s assume a hectare of land is valued at $3,000 per hectare. An 8% return is $240 pa. Now further assume the MAI and the net stumpage price is at the lower end, of 13 pa and $20 per tonne respectively. This implies one hectare grows in value by only $260 pa. With rent at $240 pa this only leaves $20 pa for the tree grower.

Plugging in Gunns’ average MAI of 18 and a stumpage price of $25, the annual increase in value is only $450, less rent equals $210. But this won’t produce a profit over 10 or 12 years given the initial outlay for MISs was between $7,000 and $10,000 per hectare.

Even the original yield promised to investors of a MAI of 25 combined with say a stumpage of $35 per tonne implies increased value of $875 pa less rent of $240 pa equals $635 pa, hardly enough to recoup the original outlay let alone produce a profit over 10 years.

The split up of the pie will have to be renegotiated if we are to move forward. Land owners can’t expect 8% return indexed in future. It’s likely to be at least 50% less. And tree growers will need a much better return if they are to be enticed to remain in the industry.

Private Forests lost in the woods?

It’s difficult to be precise about the exact plantation area, the age, the owners, whether it’s a freehold or leasehold interest of all the Tasmanian plantation estate. This is precisely the job for Private Forests Tasmania (PFT) an independent statutory authority. It is mandated to provide strategic planning and policy direction for private forestry in Tasmania.

PFT where are you? A check of the website finds a poorly maintained site with out of date information.

Specifically PFT’s objective are set out in Schedule 1 of the Private Forests Act 1994.

The objective of the Authority is to facilitate and expand the development of the private forest resource in Tasmania in a manner which is consistent with sound forest land management practice.
2. Without limiting clause 1, the objectives of the Authority include the following:
(a) to promote the development of private forestry in Tasmania;
(b) to foster competitive markets for private forest growers;
(c) to provide strategic planning and policy direction for private forestry in Tasmania;
(d) to foster progressive and incremental funding from all private forest growers to fund the Authority;
(e) to foster commercial wood production forestry on private land in Tasmania;
(f) to foster the use and values of trees in sustainable land management.

A pretty comprehensive charter.

Unfortunately PFT was unable, due to time and admin constraints, to provide data for the Independent Verification Group (IVG)of the IGA. Data from the Federal Department DAFF was utilised instead. Unbelievable. Just when they’re needed they’re missing in action.

Treading water

Aside from Gunns’ plantations discussed above, the remaining hardwood plantations in Tasmania are largely comprised of those still run by FEA’s VA (approx 35,000 hectares) and FT’s 30,000 hectares including the 13,000 hectares recently planted with TCFA funds ostensibly with a longer rotation in mind.

The Pitt & Sherry Study for the IVG confirms there are 193,000 hectares of private hardwood plantations in Tasmania,94% of which are E Nitens. This probably includes private plantations on Crown land. The only other plantations are FT’s 30,000 hectares.

Pitt and Sherry estimated future timber production from plantations. But without any plan to fund the costs of future plantation maintenance and replanting it was little more than a pointless exercise for the remaining attendees at the Roundtable wake for the forest industry.

The Government outsourced its decision making and has sat back and waited and waited for a plan to emerge by people who understand neither cash flow or profitability nor the capital requirements for the future.

Mr Hodgman and Mr Gutwein both assure us they have a plan to grow the forest industry without any IGA funds and without any of the Government’s budgeted 4 year $110 million cash injection into FT. We wait in anxious expectation for further details of this proposed miracle. As yet there is scant evidence there is anything except air inside their befuddled heads.

Not that befuddled thoughts are the sole preserve of the Libs. Most observers and commentators adopt a narrative view of the history of the forest industry and overlook the imbalances that have crucially contributed to the mess we’re in today. The imbalances have been created by the terrible twins of woodchipping and MISs which provided 90% of Gunns’ operating profits and operating cash over the last 10 years.

Woodchipping went from a sideshow to become the main event and with help from FT via favourable wood supply agreements, selflessly granted to its own detriment, Gunns was able to do to its rivals the same as it was doing to native forests ... clearfall ‘em. The result is a hollowed out capital-deprived industry.

The cash bonanza from MISs further distorted the industry. The distortions will cause suffering for a few more years as the ownership of land and timber are reorganised and everyone adapts to a different era.

MISs schemes have carpeted 150,000 hectares of land in Tasmania over the last 15 years costing $1 billion. Grower losses will be about 80%. Then there are the losses of the trading entities themselves. In the past 5 years alone Gunns’ has suffered balance sheet losses of $1 billion and FT $500 million from adverse trading and asset write downs. The scale of these losses cannot simply be papered over. Merely chopping down trees and producing cash for tomorrow is neither realistic nor sustainable if balance sheets are being eroded. This is the reality that is being ignored. Trying to divert attention by instancing the contribution made to Gross State Product GSP or the numbers employed can’t hide the harsh reality that this industry has presided over losses in excess of $2.5 billion. But these balance sheet losses are largely excluded from GSP (and GDP) figures and the value added figures spun to spruik the industry. The resultant loss of capital however is crucial for the wellbeing and future growth of the industry. This unfortunately has failed to rate a mention.

Gunns, the onetime industry bully spent its last days scarcely able to pay rent to landlords at the rate Gunns itself had determined. From a feudal despot to an insolvent serf in the space of a few years has been quite an achievement.

Yet all we get is finger pointing and blame shifting. Blaming the Greens for Richard Chandler’s exit for instance. Yeah right ... just ‘cos Mr L’Estrange said so. He would say that wouldn’t he? After all he needs to maintain the pretence that Gunns always had a reasonable chance of being able to pay its debts as and when they fell due, if not he’ll find himself up the headwaters of that mythical stream in a barbed wire canoe without means of propulsion. It was pretty obvious to most observers that a malodorous waft was noticeable at least 500 paces up wind of Lindsay Street so it was no surprise that a quick peek at the books was enough for Richard Chandler to hot foot it out of the data lockup. The truth about the books became public in July 2012.

Blaming others for Richard Chandler’s exit may be politically adroit but the commercial reality is that Messrs Hodgman and Gutwein are aiding and abetting Gunns’ Directors establish an alibi ... that Gunns always had a reasonable expectation that it could pay its debts. This is to the detriment of aggrieved creditors.

Whose side are you on guys?

Mr L’Estrange has also let it be known that he was within a whisker of restructuring Gunns when the banks pulled the pin. He would say that wouldn’t he? The media dutifully reported this, assisting to retrofit Mr L’Estrange’s raison d’être and Gunns’ claims it was always solvent, but most neglected to mention that the restructure involved getting the banks to agree to a haircut of between 35% and 45% of their $500 million plus debt. Why the banks would agree to roll over the entire debt in January for a $40 million fee which was never paid and barely 8 months later agree to write off over $200 million, seems a little hard to believe. It’s just a story probably; just part of the same fabrication, to maintain the pretence Gunns could pay its bills.

When Gunns became insolvent is an issue that will no doubt attract the interest of the VA. Forest contractors have been led up a dry gulch into an ambush but they may be able to get some money for work done after the date of insolvency, if that can be determined, as the Directors may be liable for the debts. The August 6th ASX announcement appeared to be a de facto admission that Gunns was insolvent and dependent on bankers for life support which apparently was forthcoming. If contractors subsequently did work after that date based on that statement then someone must be liable to pay, surely?

The insolvency date could even have been earlier, especially in light of Mr L’Estrange’s confession that Gunns had some pretty shaky systems in place? What exactly did the banks agree to do in January 2012 when loan repayments were deferred? And what was Gunns’ side of the bargain at that stage?

Gunns’ Directors would have received mild indigestion reading Friday’s AFR over their cornflakes bowls. Great Southern’s Liquidator is claiming damages against seven former directors, alleging financial reports leading up to the 2006 fiscal year neither complied with accounting standards nor gave a true and fair view of the company’s financial position. “Specifically” AFR reports, “it is alleged directors failed to disclose that they had subsidised returns paid to investors in earlier timber schemes and planned to do so again in the future. This type of structure has been likened to a Ponzi scheme because returns for some investors are artificially lifted by using deposits from others.”

Mr L’Estrange reportedly told Magistrate Reg Marron at John Gay’s preliminary hearing into insider trading charges last week that Gunns’ internal compliance policies were a ``nightmare’’ and it did not ``have a culture of compliance’‘. What a shock. It sounds a bit like Mr L’Estrange starting to establish his defence in expectation of future lines of inquiry? The VA is required to have a look at these matters, but if serious problems are identified it’s usually the subsequent Liquidator who will pursue matters in the Courts, as has occurred with the above GSL proceedings.

Matthew Denholm in last Friday’s Australian newspaper reported Mr L’Estrange as saying that the mill project would be dented if the Receiver failed to dispose of the Tasmanian plantation estate to someone interested in the mill. It’s as if the plantation estate is one monolithic monoculture in a single ownership interest that can simply be transferred to a willing buyer.

Nothing could be further from reality.

Detachment from reality is the major problem.

Just as we thought we had solved the problem of business cycles the GFC revealed the reality that the system we had created was highly unstable built with huge layers of complicated debt products which have since been papered over as the world limps along to nowhere in particular.

The forest industry is the same. Whilst the GFC provided an exogenous shock, the industry was inherently unstable and unsustainable. It too is limping along to nowhere in particular. It’s probably going to take the full report to Gunns’ creditors by the Voluntary Administrator to point the way forward.

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