Fletcher Forests shareholders struggle to see wood for trees

Friday 26th July 2002

Back in the days when sharemarket floats were fashionable, Shoeshine attended a roadshow presentation by Evergreen Forests.

The directors expounded at length on how the world was rapidly running out of wood and what there was left was protected by greenies, so remote that it was too expensive to harvest or of such poor quality that it was only good for pulp.

The result, they predicted, was that New Zealand, with its renewable plantation forestry resources, was sitting on a goldmine of timber.

Investors were not convinced and Evergreen's float bombed. Listed at a dollar in 1993, the shares quickly fell and nine years later are trading at around 56c. In that same year forestry giants Carter Holt traded at up to $3.80 a share (now around $1.80) and the new-fangled letter shares representing the forestry division of Fletcher Challenge hit the market at $2.97 (now around 24c).

New Zealanders seem to have a much higher opinion of the humble pinus radiata than the rest of the world. We export millions of carefully nurtured and pruned logs to Asia, only to see them turned into boxing for concrete pourings on construction sites.

Undeterred by history and its own set of misfortunes, Fletcher Forests is bullish in its plans to repurchase the assets of the failed Central North Island Forestry Partnership.

It is back in bed with former estranged partner Citic, the Chinese government's investment arm, via a holding in tiny Hong Kong-based company Seawi, best known for the regular inquiries by regulatory authorities into its unusual price movements.

Fletcher Forests believes it can tap into significant demand for New Zealand timber in China.

"There is huge potential in this market. Large areas of China's forests have been locked up; housing is growing at 20% per annum; the use of wood for housing is now accepted," it says in documents distributed to shareholders last week.

It says it can boost operating earnings by 50% in two years and nearly treble net cashflows if the deal goes through.

Fletcher Forests is tempting fate by holding a special shareholders' meeting at Auckland's Ellerslie racecourse on August 13. It needs all the luck it can get to push the deal through.

Shareholder approval is required for every element of the complex deal. If only one is rejected, the whole proposal will be scrapped.

The transactions on which shareholders will vote are:

buying the CNIFP assets for about $US650 million ($1.4 billion);
selling 1.1 billion Fletcher Forests shares to Seawi at 37c to raise $US200 million;
borrowing $US600 million to fund the purchase price and refinance Fletcher Forests debt;
borrowing another $US65 million, if needed, to pay the GST portion of the purchase price;
swapping the Tahorakuri forest for Rubicon's Fletcher Forests shares, valuing them at 37c a share; and
transferring 131 million Fletcher Forests preference shares from Rubicon to Seawi.

Success is not guaranteed. Seven per cent Fletcher Forests shareholder Xylem Investments of the US has resigned from the board in protest, the Shareholder Association is compiling proxies to vote against the deal and more than one major institutional investor is planning to do the same.

Rubicon also may be a weak link in the chain. Many small shareholders are upset that they are not being offered 37c for their shares while more than one party is tussling for control of the company.

Guinness Peat Group has taken a 19.9% stake in Rubicon and is predicting the Fletcher Forests deal will fall over, although it is not saying whether it will try to block it. Also, US hedge fund Perry Corporation has moved to a 16% stake in Rubicon but supports the proposal. Its purchases are under scrutiny by the Securities Commission.

An independent appraisal report of the deal by Grant Samuel finds it fair to shareholders but makes it clear Fletcher Forests had little alternative.

It needs Citic for the $US200 million in cash it can inject and it has to pay off Rubicon, which the report hints is engaging in a spot of greenmail.

"Rubicon was not prepared to see its influential shareholding diluted by the introduction of a new cornerstone shareholder and advised the board of FC Forests that it would only support the special resolution to approve the acquisition of the CNIFP assets if its shares were acquired.

"Faced with the potential for Rubicon to vote against the acquisition of the CNIFP assets the directors of FC Forests agreed to the buyback of 354.8 million shares from Rubicon at 37c per share, subject to shareholder approval," it says.

Rubicon could have sold its shares directly to Seawi but that would have left Fletcher Forests with the task - and the risk - of selling the Tahorakuri forest.

"The risk of realising full value for the Tahorakuri Forest would remain with FC Forests, whereas under the proposed transaction this risk is transferred to Rubicon. This is the only difference between the proposed transaction and the alternative structure. FC Forests and its bankers were not willing to assume this risk."

The same goes for the renewed relationship with Citic, the only realistic suitor.

"It is not possible and in any event would be financially imprudent for FC Forests to fund the $US650 million acquisition price exclusively with debt. An equity component of $US200 million was required to fund the proposed transaction," the report says.

Fletcher Forests shareholders have a tough decision to make on the 13th. Either they reject the deal and let Fletcher Forests meander on its insignificant way or take some fairly substantial risks in the pursuit of growth.

If the deal is approved, Fletcher Forests will be left with high debt levels, which it says will take it "outside its current target debt ratios." The plan is to pay down debt quickly using free cashflows.

This might explain the apparent lack of investor enthusiasm for Fletcher Forests shares. Debt is certain while future cashflows are calculated guesses at best. The outcome for the company may not be pretty if those cashflows don't come through.

Grant Samuel also warns its valuations are "based on economic, market and other conditions prevailing at the date of this report. Such conditions can change significantly over relatively short periods of time."

They ain't joking. Since the report was completed on July 17, international sharemarkets have slumped, with the US down 12% by Wednesday, although it recovered yesterday.

It also notes softwood prices have declined in US dollar terms for much of the past 10 years, mainly thanks to low demand from recession-hit countries, particularly in Asia.

It is not inconceivable that those conditions will prevail, especially given the state of world share markets.

Like the proposal, which needs everything to go just right to go through, Fletcher Forests needs uniformly positive economic and market conditions to ensure success.

Shareholders better take their lucky horseshoes to the meeting.

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