Brian Gaynor: Forest offer heralds exciting new era

A short announcement to the NZX at 4.29pm on Friday, August 26, heralded a new and exciting era for New Zealand's financial markets.

The stock exchange release, which was made by Evergreen Forests, showed the New Zealand Superannuation Fund had made a $112 million offer for the company's forest assets.

This was the first offer by a domestic institution for a large forest estate. It highlights the Super Fund's huge potential as its total investable funds will grow from $7 billion to more than $100 billion over the next 20 years.

There are several reasons the $112 million offer is attractive to the shareholders of the listed company and the Super Fund.

Evergreen Forests was listed on the NZX on the September 10, 1993, after the issue of 23 million ordinary shares at $1 each. The funds were mainly used to buy three forests for $16.5 million.

As Groome Poyry valued the newly acquired forest estate at $19.65 million, the company started with a net tangible asset per share (NTA) of $1.09, compared with the subscription price of $1.

The original prospectus was incredibly detailed and optimistic. The first dividend was predicted for the June 2003 year and the company was expected to generate large cash surpluses each year after that.

Evergreen's first big move was the acquisition of the listed CBS Forests for an all-script consideration of $54.6 million in 1995.

This was effectively a reverse takeover as CBS was much bigger and its management team, led by Mark Bogle, took control of Evergreen.

In the June 1996 year, Evergreen's forests values fell slightly and, in the following year, the company made its first mistake. It purchased a number of forest estates, including 3300 hectares of former Forestry Corp land from Fletcher Challenge and mainly funded these acquisitions through borrowings.

As Evergreen was generating minimal sales revenue at the time, it had to fund the development of these new forests through additional borrowings.

Debt funding was considered to be a smart strategy in the mid-1990s as most investors believed that forests could only increase in value. A similar view is now held in relation to residential property.

In the June 2000 year, the company purchased several additional estates, including 3204 stocked hectares of established forests from Carter Holt Harvey for $20.9 million. Once again, these acquisitions were mainly funded through borrowings.

Evergreen's problems escalated in 2003 when the dollar rose sharply and freight costs increased. This had a dramatic impact on export log profitability and forestry valuations.

Trees can be left in the ground during difficult market conditions as they will continue to grow and add value. But organisations with a high level of borrowing have to continue harvesting and selling wood in order to meet their interest costs and repayment obligations.

Evergreen has far too much borrowing and, earlier this year, the company said it had mandated Forsyth Barr to advise on asset sales and recapitalisation options.

Chairman Peter Wilson told the NZX: "While debt has been reduced by $8.3 million since June 2004 and costs have been cut, these steps have not proved to be enough under current market conditions."

Two months later, the company said it was undertaking a competitive sale process of its forest estate. In July, Evergreen disclosed its total forest value had fallen from $121.1 million to just $90.6 million but an independent assessment of company's land had determined that it was worth $43.5 million compared with a cost of $26.9 million.

The total value of the Evergreen forest estate, including land, as at June 30 was $134.1 million, with land comprising 32 per cent of the assessed value compared with just 14 per cent three years earlier.

But the company's main problem is the debt column in the accompanying table.

As at June 30, it still had borrowings of $68.7 million, of which $25.8 million is owed to Westpac, $15.1 million to John Hancock Insurance Co in the United States, $27.1 million is outstanding on listed convertible notes and $0.6 million is in the form of convertible redeemable preference shares.

These borrowings severely restricted Evergreen's options as it was forced to cut down trees to generate income whereas the best option in difficult market conditions would be to leave trees in the ground.

On August 16, Evergreen said it would call a special shareholders meeting to approve the sale of most of its forest estate to James Fielding Funds Management for $104.2 million. This announcement was disappointing because the $104.2 million purchase price compared with a June 2005 valuation of $133.9 million (two small South Island forests were excluded from the sale).

James Fielding is the funds management division of Mirvac Group in Australia. It plans to put Evergreen's assets into its forestry focused New Zealand Sustainable Investments Fund 1.

On August 18, Wilson said Evergreen had sold its West Coast cutting rights for $3.4 million, which was in excess of the June 30 valuation. Then, on August 26, Wilson said the Super Fund had offered $112 million for the remaining forests, which have a valuation of $134.3 million.

Evergreen will hold a shareholders meeting on September 26 to consider the James Fielding bid. If this does not gain approval then the offer from the Super Fund will be considered at the same meeting.

If the Super Fund deal is also rejected, Evergreen will have to have a $20 million rights issue.

The outcome will be determined by overseas shareholders, who own well over 50 per cent of Evergreen. Among these are several large superannuation funds.

The notice of meeting estimates a post liquidation distribution of 28c a share if the James Fielding offer is approved and 32c a share, with a potential upside to 35c, if the Super Fund deal is accepted.

Forestry is an excellent long-term asset but it has to be held in appropriate investment vehicles.

Unfortunately, most of our major forest estates have been owned by highly geared listed companies that are extremely vulnerable to market downturns. Evergreen Forests and Fletcher Forests are examples.

The best vehicles for forestry assets are ungeared long-term oriented investment funds. Unfortunately, the ACC (Accident Compensation Corporation) and other long-term domestic funds have been slow off the mark as far as forestry is concerned, even though the Boston-based fund manager GMO (Grantham, Mayo, Van Otterloo) predicts that managed timber will be the best performing asset class over the next seven years.

The Super Fund offer is positive for several reasons:

* New Zealand now has a long-term oriented fund that will invest in alternative and non-public market assets.

* This fund should ensure that overseas interest will no longer be able to purchase New Zealand assets at bargain basement prices.

* As the Super Fund is expected to be a market leader, its investment in alternative New Zealand assets should encourage other long-term oriented managers to follow suit.

But more importantly the Super Fund is not expected to be a soft touch for owners of non-performing assets. It has a rigorous investment analysis process and, if successful, should do extremely well from its purchase of Evergreen's forest estate.

* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management and was a board member of the Guardians of the New Zealand Superannuation Fund until March 2004.