GMO offer adds up despite tepid report

By JENNY RUTH


It looks like one of the easiest transactions to recommend: Rotorua-based GMO Renewable Resources is offering to buy the Nuhaka Farm Forestry Funds forest for $7.168 million in cash.

The funds' auditor and forestry specialist, Chandler Fraser Keating (CFK), values Nuhaka's forest between $6.268 million and $7.054 million.

(Being a group investment fund, Nuhaka is exempt from the usual takeover and major transaction rules, including the need to get an independent expert's report.)

So GMO's offer is a great deal? You wouldn't think so if you read trustee Perpetual Trust's recommendation to unit-holders.

Damning with faint praise the higher-than-valuation offer, the trustee calls it "a fair offer in the context of the depressed market".

Whether or not unit-holders want to vote in favour of the sale depends on their attitude to risk, Perpetual says in its letter to the investors.

"To the extent that individual unit-holders feel comfortable accepting the risks associated with future returns themselves, they will not find GMO's offer attractive and will want to vote against the sale of the forest. On the other hand, unit-holders whose views are less sanguine will prefer the certainty afforded by a sale and will want to vote for it," Perpetual says.

It is certainly true that log prices are at or near historic lows, compounded by unusually high shipping costs and the high New Zealand dollar against the US dollar in which logs are usually priced.

CFK's valuation report shows domestic pruned logs are selling for $138 a square metre compared with the five-year average price of $164.

Richard Elworthy, managing director of Pyne Gould Corp, which owns Perpetual, said the underlying nature of the forest was that it was purchased for the long term. "Whether or not you want to take it or not is very much something you should decide for yourself, based on your perception of risk."

Elworthy said one reason Perpetual could not give a clear recommendation was that it could not predict how all the variables would behave in future.

"Wouldn't we look rather stupid if the dollar returns to its long-term average, which is 55c against the US, in a reasonably short term?"

The New Zealand dollar is trading around US67c to US68c, while CFK's valuation assumes an exchange rate of US63c.

The forest's value does change markedly, depending on the dollar. CFK's valuation shows that if the currency was US50c, it would value the forests between $8.8 million and $9.8 million. But if the currency was at US70c, the valuation would fall to between $5.3 million and $6 million.

But on that basis nobody would ever make a recommendation because nobody can predict the future.

Elworthy also said GMO's offer was not sufficiently good to make an outright recommendation to accept.

Nevertheless, he points out that the trustee wasn't obliged to call a meeting of unit-holders to vote on the proposal, as it has done. It could have just dismissed the offer.

"We think it's, at the very least, an interesting and worthwhile [offer] and should be considered by our unit-holders."

Elworthy talks about the offer coming "in the context of a depressed market".

The trouble with that argument is that CFK's valuation isn't based on today's depressed prices. Instead, it assumes log prices will rise.

"Nuhaka forest has a remaining life of eight years and it is CFK's opinion that this is sufficiently long for longer-term average prices to be regained by the market. These prices are built into the latter years of the cash flow projection," the valuation report says.

Without this assumption that prices will rise, CFK said it would have valued the forest between $4.8 million and $5.3 million. GMO's offer starts to look rather fancy in that context.

Also, rather than choosing a "market" value, CFK's valuation is "in use". That means the present value of the amount the fund can reasonably expect to earn if it continued to own the forest until the last tree was harvested and sold.

As Perpetual says in a letter to unit-holders, the market value of forests at or close to harvest "in recent times has been driven by sellers on one side who are reluctant to continue in ownership and buyers who base their valuations on projecting the current price of logs into the indefinite future on the other".

In other words, a "market" value would have been lower than CFK's valuation.

Perpetual argues that an "in use" valuation is more appropriate because it is under no pressure to sell the forest. "The fund is not in any sense a weak seller; we have the financial capability and expertise to take the fund through to its planned termination in 2012," it says.

Perpetual's recommendation also takes no account of Nuhaka's history on the stock exchange. It was formed in 1974 and the last 10 years paint a dismal picture: the units were trading at more than $16 in 1995 and last sold for $4.20.

Perpetual estimates that if unit-holders vote for the sale, after the costs of winding up the fund, they will get between $4 and $4.30 a unit, which will be taxable and a capital distribution between 55c and 65c a unit. That is between $4.55 and $4.95 a unit.

Ross Macdonald, of GMO, has previously said he isn't comfortable dealing with journalists and was unavailable for comment for this story (out in remote forests). But I think he would be furious at Perpetual's tepid recommendation, particularly after all the hoops his company has had to jump through.

GMO first approached Perpetual in June, was allowed to do due diligence and made its formal offer on August 27.

It is also interesting to compare Perpetual's treatment of GMO with the way it treated City Forests' takeover bid for another of its funds, the Opio Forestry Fund.

City Forests wanted to get 75 per cent or more of Opio but settled for 55 per cent when its offer closed a week ago.

Perpetual chief executive Peter Baynes describes City Forests' bid as "hostile" and tells me that company would have had an easier time if it had approached the trustee first, as GMO did.

Comparing the Nuhaka situation with the last sale of forests by a New Zealand public company, Tenon's sale (previously Fletcher Challenge Forests) earlier this year, is also interesting.

Grant Samuel didn't value Tenon's forests itself but examined the sales process. It was a competitive process and all major worldwide timber investors were contacted.

"The price of $725 million is the likely maximum price that a purchaser is prepared to pay in the current market," Grant Samuel concluded.

It had no trouble recommending the offer as fair and reasonable. Neither did Tenon's independent directors.

In Nuhaka's case, Perpetual said it considered whether it should seek another buyer in an attempt to get a higher sale price but decided it shouldn't.

One reason was because Japanese firm Juken Nissho has a pre-emptive right to buy the forest but, during GMO's due diligence, waived that right without asking to be paid for that waiver.

Perpetual also argues that GMO's offer has been public knowledge since early June and any other potential purchasers would have surfaced by now. It also doesn't want to run the risk that GMO will withdraw its offer if it seeks other buyers.

All in all, has Perpetual acted in the best interests of Nuhaka's unit-holders? I don't think so.

Nuhaka Farm

Trustee: Perpetual Trust.

GMO's offer: $7.168 million.

Valuation: $6.268 million to $7.054 million.

Market capitalisation: $7.447 million.

Return to investors if sale proceeds: between $8.067 million and $8.776 million or between $4.55 and $4.95 a unit.

Nuhaka was formed in 1974 as a long-term investment in the Nuhaka Forest, south of Gisborne. The forest is due to be fully harvested by June 2012, when the land will revert to Juken Nissho.