Paranoia among the pine trees: What's wrong with Fletcher's Kaingaroa deal?

Friday 21st June 2002

Nothing done under the Fletcher Challenge banner is ever simple, so the complexities of this week's deal to buy the Central North Island Forest Partnership should come as no surprise.

What might have surprised Fletcher Forests (FFS) directors was the market's apathetic reaction.

Given how long and loud they've insisted this "world class" forestry asset is a must-have for the company, you'd have expected the shares to be propelled through 30c or 40c.

Maybe investors don't agree FFS has to have the CNI forests. After all, they paid up big for them once and lost $525 million.

Under the latest deal FFS pays to the receiver the $US650 million ($1.34 billion) owed to the partnership's bankers.

It will fund this by issuing 1.1 billion shares at 37c each to raise $US200 million or $412 million.

The remainder of $US450 million or $928 million will come via a new bank facility from a consortium led by BNZ and HSBC, which will extend a further $US137 million to replace FFS' existing facility, provide working capital, and fund transaction costs.

So FFS' term debt position post-deal will be $US587 million ($1.21 billion, or about 40% of tangible assets), up from under 30% pre-deal.

That doesn't look too scary although the company has acknowledged it's too high and will have to be reduced with surplus cash from its forest harvest.

That was also the plan the last time around, when FFS, Citic, and Brierley Investments paid just over $2 billion (33% more) for the same assets.

The partners aimed to accelerate the harvesting of douglas fir to rapidly pay down the debt burden.

Sadly in 1997 the Asian crisis hit and log prices plunged. Cashflows dried up, interest bills couldn't be met and in came the receiver.

This time around, barring another economic crisis, things should be different.

Log prices are already way off their lows and are improving. China's wood deficit is forecast to grow hugely over the next few years, as is CNI's log harvest. And, geared up though FFS will be, the debt backing CNI is some $200 million lower than the last time.

CNI has also been paying, without any obvious effort, penalty interest at 2.5% above the basic rate. The deal will see this cost disappear.

Some are worrying the complex deal between two former bitter foes won't go ahead. And judging from the grumpy reaction in online investor chatrooms some FFS shareholders seem to feel their board hasn't done right by them.

The sentiment won't be helped by the resignation of director Stephen Hurley of US forestry investor Xylem, FFS' second largest holder at 7.6%.

Hurley said he wasn't satisfied the deal was fair and reasonable for minorities. Others say Xylem itself had an eye on the CNI forests and Hurley found himself with a conflict of interest.

There is already talk of shareholders voting against the package and then invoking the Companies Act's minority buyout provisions, which could allow them to require the company to buy back their shares at an arbitrated price.

They would presumably argue they're entitled to the 37c Rubicon got. But as that's also the price Citic-controlled South East Asia Wood Industries (Seawi) is prepared to pay if the deal goes ahead they might do better to just vote in favour.

In the longer term the big uncertainty is Citic's intentions. Seawi is a Hong Kong-based plywood maker and marketer with a poor pedigree. It listed on the Hong Kong exchange at $HK2 in September 1997, just in time for the Asian crisis.

Its share price plunged. Former vice-president Lau Kin Chung tried to shore it up with a little market manipulation and got caught and fined by the Securities and Futures Commission.

In 1999 it lost $HK399 million ($105 million). It made a $HK41 million profit in 2000 but lost $HK10 million last year.

That's when Citic arrived on the scene with a $HK1 billion ($264 million) loan which was to be used only for funding "a specific investment opportunity."

Seawi repaid the loan in January by issuing to Citic $HK1 billion of redeemable convertible notes.

Citic has four directors on the board and the company's banker is Citic Ka Wah Bank.

Seawi will pay FFS $US200 million for its 1.1 billion shares. Fletcher offshoot Rubicon will sell it further FFS shares to take it to 35%.

The question is this. If Citic had a spare $264 million kicking around to invest in FFS, why did it choose to do so through this two-bit panel processor rather than directly?

The answer is probably simply that Citic, having once got its nose bloodied here, wants some Hong Kong deal-making expertise on board to make sure the people's capital doesn't go missing a second time.

Seawi's Peter Kwok has a finance PhD from Berkeley and lengthy experience in US investment banking with Bankers Trust. He is likely to have one of the two Citic board seats along with his partner Ma Ting Hung.

One conspiracy theory, which has had a constituency ever since the legal trouble between FFS and Citic brewed up, is that the Chinese company is hoping, by keeping everyone off balance, to eventually pick up the prize - the CNI forests - on the cheap.

This one is surely starting to look a bit bedraggled.

Citic has already lost all the $US306 million equity it invested in 1996. It now proposes to put a further $US200 million at risk, for no more than a 35% stake in FFS.

It will have only two directors on the six-seat board. According to FFS, it has no log supply or processing contracts with FFS.

Citic is a very big company by New Zealand standards. It wants trees. If it wanted only the CNI forests it could easily have made the receiver an offer.

With 35% of FFS it could now bid for both the CNI forests and FFS' assets. That, presumably, is why FFS' directors insisted on a two-year standstill period.

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