Monday, 31 October 2016

Forestry Tasmania's insolvency report

Resources Minister Barnett’s recent statement following the release of Forestry Tasmania’s 2015/16 annual report was by no means the first attempt to report on problems in the forest industry.

Another report summed it up pretty well:

“I received from the Hobart Chamber of Commerce a statement on “The hardship suffered by the timber industry in Tasmania,” in which it is stated “For the past few years....... the sawmilling industry has been in a very bad state, until now, with the added effect of the general depression, the position is really desperate.”

“While the Chamber of Commerce of Hobart considers “there is every justification, nay, necessity, for assistance and relief being granted by the Commonwealth to this State,” no useful information is afforded in the shape of any practical proposal for the betterment of the methods of production.”

That’s from a Report of an Inquiry into the Financial Position of Tasmania as Affected by Federation.  Its author was Sir Nicholas Lockyer.

The date of the report? April 1926. 

Here we are ninety years later.

The current government whilst in opposition didn’t appear to realise that the margins on forest sales were still failing to cover overheads, not dissimilar to problems in1926.  For some dumb reason they thought they could grow the industry and reduce the losses, and as a consequence went to an election saying no more handouts. No more budget funding for FT.

When things didn’t work as they told us they would, $30 million was slipped in the back door from Tas Networks on 1st July 2015. That was quickly seen for what it clearly was, viz a less than honest continuation of the same sins condemned when committed by political opponents.

Since then FT has received further cash of $26.5 million from government, the latest amount on 30th June 2016 being another $4.4 million from Tas Networks, this time for a transmission network at the Southwood plant.

Now Minister Barnett has announced the government will take over FT’s superannuation liability of $158 million. The 2015/16 mill door sales after contractor payments barely provided enough to cover payments to retired foresters of $12.5 million. Only $4.5 million remained to cover remaining cash operating costs of $30 million and capex payments of $8.5 million.

Whether it’s a budget appropriation, a back door injection, an arranged asset transfer or the takeover of a huge liability, it is still a government handout. If it looks and walks like a duck there’s little doubt what it is.

Wednesday, 26 October 2016

Forestry Tasmania to reveal all?

It wasn’t really surprising to hear Resources Minister Barnett finally admit Forestry Tasmania’s model is broken, the last Tasmanian to do so.

What was a little surprising was that he didn’t bother saying anything, nor did FT’s 2015/16 Annual Report released at the same time on Tuesday 25th October, about the sale of hardwood plantations needed to cover FT’s losses for 2016 and the current year 2017.

Perhaps he will reveal all today?

Perhaps he will tell us about FT’s agreement with Gunns’ Liquidator about the MIS trees growing on 14,000 hectares of FT’s land? The very trees that will bail out FT, either as a result of the proceeds of sale of both land and trees to a third party or alternatively the harvesting  for plantation chips.

The Annual Report showed a large reduction in private plantations growing on FT land and a consequent large increase in FT plantations growing on FT land, so it was logical to assume FT had done a deal with Gunns to take over ownership.

Most of MIS trees growing on Gunns’ land were all sold to New Forests two years ago and are now managed by Forico.

Other MIS trees were growing on land leased from third parties. The biggest lessor was FT. Land owners with smaller areas leased to Gunns have been encouraged to buy the trees growing on their land for $1 rather than attempt to get the Liquidator to pay rental arrears.

But the Liquidator wasn’t going to sell the trees to FT for $1. He believed they were worth much more. Some were ready to be harvested and the remainder could either be harvested or thinned so there was immediate money to be made.

A year ago the Liquidator claimed $40 million from FT for the trees, this amount being the establishment and maintenance costs. There’s probably about 2 million tonnes of trees at this stage which makes the price $20 per tonne. New Forests when they purchased from Gunns probably paid between $5 and $8 per tonne. Incidentally that’s why plantation harvesting is currently profitable. Anything below $20 is profit for New Forests.

FT weren’t going to pay that price even if it were to offset the amount of rental arrears which as at today are probably about $6 million.

We know from court documents lodged by Gunns’ Liquidator that an agreement was reached a month ago with FT and its legal representatives Abetz Curtis.

Perhaps Mr Barnett will tell us today what was agreed.

Monday, 24 October 2016

Hydro ups ante in Basslink dispute

Hydro Tasmania has upped the ante in its dispute with Basslink Pty Ltd.

A month ago it unilaterally stopped paying the monthly facility fee for use of the interconnector linking Tasmania with the national electricity market. It is using the cable, but refusing to pay.

Basslink P/L is part of Keppel Infrastructure Trust, part-owned by the Singapore Government and listed on the Singapore Stock exchange.

On Monday last week, Keppel lodged financial statements for the period ending September 30.

It revealed the woes of its wholly owned subsidiary Basslink P/L. Basslink is a reasonably simple operation. It owns an interconnector cable. Hydro has an agreement for exclusive use of the cable for another 15 years. The facility fee varies from month to month, depending on whether it is available for use, the electricity price differences between Tasmania and the mainland, and prevailing interest rates.

During the outage from December 2015 to June 2016 the facility fee was zero. It resumed again after the repair, roughly at the rate of $75 million per annum, until a month ago when Hydro stopped paying.

Basslink owes $700 million to its banks. The estimated amount Hydro owes Basslink is $500 million. That is the estimated facility fee over the next 15 years in today’s dollars.

If Hydro doesn’t pay Basslink, then Basslink has trouble paying its banks. With no income from Hydro during the outage it managed to keep paying the banks, but found itself in breach of loan covenants. It found itself unable to meet the minimum debt service coverage ratio and therefore was required to agree on a new long-term financing plan. Basslink’s $700 million of borrowings are listed as current liabilities, meaning they are repayable in this current year. A new long-term financing arrangement is the only other option.

Just as Basslink’s $700 million loan is being renegotiated with its banks, Hydro played its card. It stopped paying the monthly fee. Hydro was not insured against the Basslink outage. Hydro may have to prove Basslink was at fault to recoup damages from Basslink. But Basslink’s insurers accepted the outage was a force majeure event, an act of God, and have paid out compensation of $40 million. Hydro does not accept it was a force majeure.

The immediate problem for Basslink is that while $11 million went to partially pay for the cost of interconnector repairs, the balance was snookered by the banks. It is yet to be released. The banks are hanging on to it, pending finalisation of the new long-term financing plan.

Hydro just made Basslink’s cash situation even worse.

Everyone has a different agenda. The banks would like to see their exposure lowered, I guess. Hydro would like some compensation, no doubt. I’m sure it would accept a lower fee. It is a classic standoff. Either Basslink’s parent has to put in more, or Hydro has to resume paying, or both, else Basslink is insolvent. Basslink is an Australian registered company, so Australian insolvency laws apply.

The worst-case scenario for an insolvent company is liquidation. This is possible, but unlikely. Basslink’s banks will not want to take control of the interconnector in an attempt to recover its loans.

Yet Keppel, Basslink’s parent, will not want to tip in too much unless it can be assured the interconnector asset is worth it. What the interconnector asset is worth, however, depends almost entirely on the revenue it receives from Hydro. It is difficult to envisage a situation where someone other than Hydro operates the cable.

Has Hydro made a strategic play? A risky one perhaps?

Whether Hydro manages to negotiate a lower fee with Basslink might not have any effect on the $350 million it owes Macquarie Bank in respect of a poorly judged side deal to protect itself from interest rate rises impacting on the facility fee. Macquarie agreed to pay Hydro any extra fee that resulted from a rise in interest rates. In return Hydro agreed to pay Macquarie the fee saving resulting from a fall in interest rates. Interest rates started falling the minute Hydro agreed to the side deal. It pays Macquarie Bank about $30 million a year. Hydro will not reveal the actual figure. It is commercial in confidence.

Basslink was insured against physical loss and also business interruption. Unlike Hydro. At the parliamentary inquiry on August 4, seven weeks after the interconnector resumed, Hydro chief executive Steve Davy, in response to a question as to whether Hydro will insure against future outages, said: “We have not, as a corporation, considered or entered into discussions with other parties about covering that possibility.”

There you have it.

Imagine almost writing off the family car and then saying, “gosh I didn’t expect repairs to take so long and be so costly and I didn’t anticipate paying for hire cars for six months. How was I to know it was going to cost $180 million? It was a one-in-2600-years event, but will I insure the car now that it’s back on the road? I haven’t considered that.”

Imagine saying that?

The Basslink deal is an example of a public private infrastructure arrangement. Essentially the interconnector forms part of Hydro’s generating assets. The traditional way was to fund these was with debt. The annual finance charges of $100 million paid by Hydro to Basslink and Macquarie Bank  are de facto finance charges and were these added to interest  payable on Hydro’s other borrowings of $900 million , the total would place Hydro close to a breach of its own loan covenants.

One thing for sure is there’s plenty of water yet to flow under the bridge.

Thursday, 20 October 2016

Federal Hotels treads water

It’s been 13 years since the government and Federal Hotels agreed to an extension of the original 1993 exclusive gaming license covering table gaming, electronic gaming machines (EGMs) and Keno in Tasmania.

Federal Hotels’ 2016 financial statements lodged with ASIC last week revealed another $15 million paid as dividend to shareholders. This takes the total to $199 million in 13 years, an average of $15 million per year. The dividends represent 60 per cent of after tax profits, an extraordinarily high payout ratio for a capital intensive tourism business. These fully franked or tax paid dividends are equivalent to a before tax return of $22 million per year.

The other party helping itself to the cash tin was the bank whose borrowings were further reduced by $16.5 million. There was a time when the reverse was true. From 2003 to 2011 bank borrowings increased almost fourfold from $56 million to $200 million, but with the gradual erosion of gambling revenue prompting a decline in net profits, the banks obviously decided enough was enough. Since then borrowings have been reduced to $123.5 million, all of which is now listed as a current liability. This suggests borrowings are to be renegotiated during this current year.

Overall player losses from gaming have been declining since 2009 due to fewer EGM losses. Keno has bucked the downward trend. Its relative share of the gaming pie has almost doubled since 2004, which combined with low tax rates has made Keno an important contributor to Federal Hotel’s bottom line.

Federal Hotels’ opportunistic 2015 request made in response to Mona’s David Walsh’s interest in a casino license, to extend its sole license so that it could fund $100 million of upgrades to its casinos and a new venue at Port Arthur that’s been on the drawing board for years was a peerless display of chutzpah. After the 2003 extension/Saffire trade-off, the Port Arthur project sounded like déjà vu all over again? And the need for casino upgrades wouldn’t have anything to do with the decline in EGM revenue relative to pubs and clubs coinciding with a decline in overall EGM turnover would it?

If funds are needed to upgrade existing facilities they should be sourced from retained earnings, borrowings or shareholder contributions just like every other business. It shouldn’t require another special deal. This is not a start up company that may require encouragement. This is a major player in a mature industry competing with many others who aren’t given the same advantages.

It was fortunate Federal Hotels stashed a little away following the sale of its regional tourism assets at Strahan, Cradle Mountain and Freycinet in 2014, because much of it was needed to meet the demands of both the bank and shareholders in 2016. But when it came time to pay for the Newstead Hotel, the twelfth pub in Federal’s Vantage stable, all ranked in the top 24 pokie performers across the state, Federal Hotels could only come up with 20% of the purchase price from its own sources. A loan from a third party of $8.6 million was needed. The bank must be a little wary with the exclusive gaming license having a 2023 sunset clause?

With the abandonment of its regional tourism strategy and the walkout from the West Coast Wilderness railway, Federal Hotels has been long on promises, if the 2003 parliamentary inquiry into the Deed extension is a guide, but short on delivery. The only new tourism asset built since, is the mandated Saffire at Coles Bay. Other capital additions have been existing businesses, either lucrative pokie pubs or bottleshops. Even the impending, much trumpeted MACq 01 development is just a fit out.

When Federal Hotels operated its regional venues, advertising and promotion had the effect of promoting tourism across the State. The original 1993 agreement required Federal Hotels to spend at least $8 million a year promoting and marketing tourism. This clause or one with similar intent is absent from the now operative 2003 Deed.

Even critics begrudgingly admit that Federal Hotels’ advertisements had spill over benefits for the whole state. Whatever was good for Federal Hotels was good for Tasmania. But its retreat from regional Tasmania has left it back in the peloton hanging off David Walsh’s coattails like everyone else in the Hobart accommodation business.

Any attempt to link EGMs and Keno with the tourism industry should be resisted. For too long the tourism industry has acquiesced to Federal Hotel’s dominant position in the industry because in part there were spill over benefits. After 2011 however reality struck Federal Hotels and its strategy changed with more emphasis on EGM pubs and less on regional tourism. Acting as Federal Hotels’ praetorian guards as it plunders the pockets of pokie players and secures a competitive advantage for itself against others in the hospitality industry, is a bit much to behold, especially when in the next breath, the industry makes further demands on government to underwrite advertising across the entire industry and to fund AFL matches and other major events.

It is sometimes forgotten that whilst Federal Hotels dominates the electronic gaming scene in pubs there are another six or so groups with multiple venues, who in total, together with Federal Hotels own or run 90 percent of the top 50 EGM pubs. Any push to retain existing privileges will be strongly resisted by this band that largely operates on the periphery of the tourism industry, more in the broader hospitality industry servicing Tasmanians. Will they all stick together or will it be as in the case of the Lone Ranger and Tonto facing a hostile enemy when the Lone Ranger said: “It looks like we’re in a lot of trouble old friend”, to which Tonto replied “What do you mean ‘we’, Paleface?”

With the expiry of current gaming arrangement in 2023 few will be able to argue they haven’t achieved an adequate return on their gaming investments. There is no need for the government to pander to anyone. Super profits from gaming could have, for example, funded the State’s social housing backlog instead of ending up in the pockets of a few. It’s an opportune time to change the landscape.