Between the lines: Forests punters due pain before gain

Fireworks can be expected when Fletcher Forests shareholders meet on November 2 to vote on a $427 million rights issue.

But unless a knight in shining armour appears between now and then, shareholders have little choice but to accept the pain.

Such medicine is hard to swallow when hopes had been running high that a buyer would be found for Forests.

Certainly, there appeared to be no shortage of candidates lining up. Companies said to have looked through the books included US forestry investors John Hancock, Weyerhaeuser and Plumcreek.

But after months of Fletcher Challenge courting different parties, no one fronted with the money. Or if they did, Fletcher executives did not think it was enough.

Failure always attracts blame. No doubt the brokers handling the process, Merrill Lynch, will cop some flak for not being able to entice a buyer. Fletcher Challenge will get it in the neck for running a loose process. Some blame will likely be levelled at Citic - Fletcher Forests' Chinese joint venture partner in the Central North Island Forestry Partnership - over its disruptive legal challenge against Fletcher.

Despite such accusations, you can't get away from the fact that Fletcher Forests is a lame asset requiring significant recapitalisation.

As it sits, Forests has term debt of $776 million (June 30, 2000) supporting shareholders' funds of $1.4 billion. But the problem is that the company is not generating sufficient earnings and cashflow to service that debt.

Furthermore, Central North Island Forests needs more money by the end of the year to stop bankers from potentially calling in their funds.

With the planned injection of funds the balance sheet will look much better, with term debt falling to $342 million and shareholders' funds rising to $2.167 billion.

But to get there shareholders are going to have to endure a fair bit of discomfort as the magnitude of the two-for-one rights issue at 25c depresses the share price.

Already we have seen the shares under pressure, falling from around 60c to 38c yesterday as investors ditch their positions or lighten their holdings.

Potentially there could be more pressure once rights trading begins in mid November.

At 38c, the theoretical price of the rights will be just 4c.

The pressure will come from the fact there will be some 1.7 billion rights floating around and only 855 million shares. It is likely the rights will therefore dominate the price of the shares.

But there is a silver lining. Once the restructuring of Fletcher Challenge is complete at the beginning of next year, Forests will be a financially sound stand-alone vehicle. If the market does not re-rate its shares it will soon attract the attention of a corporate buyer.