No easy solution to forestry fiasco

By GEOFF SENESCALL

A sense of deja vu pervaded Fletcher Challenge's Penrose head office this week, when an errant media statement was mistakenly released.

After all, it was a similar embarrassing error within the company last year which blew up recently into a huge insider trading scandal.

But, ironically, this time around the rogue statement was not sent by Fletcher. It was sent to Fletcher by Citic, its feuding Chinese Government-controlled joint-venture partner in the central North Island forest estate.

If the contents of the statement had not been so personally insulting to Fletcher Challenge chairman Dr Roderick Deane - one of this country's best-known and well-respected businessmen - the company might have seen the humour in it. But instead it has served only to intensify the ill feelings between the two parties.

This latest fiasco unravelled on Wednesday when the public relations firm Network Communications, commissioned by Citic, felt the need to issue a statement slamming Fletcher.

Inadvertently, however, it sent out a wrong draft of a press release, which included comments accusing Dr Deane of racism.

Adding insult to injury, the angrily worded statement was released in the name of Citic's New Zealand managing director, Cui Peisheng.

The error was realised when a media frenzy ensued.

Network quickly moved into damage control and sent out a memo asking people to "destroy" this version. In a new release, it omitted all references to Dr Deane and allegations of racist overtones.

But the die was cast. Certainly Fletcher chose not to ignore the earlier statement and responded by rejecting the allegations of racism, which Dr Deane later described as defamatory. He has taken legal advice on the matter.

The tragedy of Citic's error shows just how bitter the dispute between these two parties has become.

Essentially the dispute boils down to control over one of the largest plantation forestry estates in the world, Kaingaroa.

This prime 163,000ha site in the central North Island was sold by the Government in 1996 to Fletcher Challenge for $2.026 billion.

To get the deal up to an acceptable price so the Government would sell, Fletcher needed to pass the magic $2 billion mark so the Crown did not have to book a loss in its accounts.

Fletcher, which held on to the management contract, then backed the 62.5 per cent of asset into a waiting consortium which included Citic and Brierley Investments.

At the time, this transaction was celebrated as a coup for New Zealand. Not only were two of this country's best-known corporates working together but had introduced a Chinese partner to lubricate the channels of what was seen as a ready log export market in Asia.

Unfortunately, there were ill omens right from the outset. Just after the deal was secured the Douglas fir price halved. The plan had been to harvest the mature fir trees in the Kaingaroa estate and use the cash to reduce the short-term debt used for the purchase.

But the price fall put a spanner in the works and caused cashflow difficulties. Consequently, the partners had to put money in early on.

The following year (1997) the Asian economic crisis hit, which dropped the price of logs and cut the value of the partnership's forestry estate, putting further pressure on the relationship.

A year later, faced with its own financial difficulties, Brierley Investments called on an exit clause in its contract and sold out of the partnership at a loss.

The other two partners bought Brierley's 25 per cent stake - Citic paying cash and Fletcher settling with shares in its forestry division.

In doing so both parties also pumped a further $US126 million into the partnership. Since then more cash has been injected.

Not surprisingly, tensions grew. In 1998 Citic - an investment vehicle of the Chinese Government which makes strategic investments overseas - appointed Mr Cui to manage the New Zealand operation. He is the sole Chinese executive and reports directly to head office in Beijing.

One of Mr Cui's briefs was to resolve issues with Fletcher.

Everything came to a head at the end of last year as relations with Fletcher hit rock bottom.

This saw Citic file papers in the High Court last December seeking the dissolution of the partnership. In March, the court told the two parties to go away and work things out.

Since then there has been claim and counterclaim as lawyers on both sides square off - Buddle Findlay for Citic and Bell Gully for Fletcher.

Trying to figure out who is right and who is wrong is like trying to discover which child threw the first punch while your back was turned.

The Fletcher view is that Citic is scaremongering and trying to get the asset cheap.

Certainly, the timing of Citic's assault comes as Fletcher Challenge is in the midst of a restructuring, which involves either selling its three remaining businesses or spinning them off into standalone companies.

According to Dr Deane, the Citic dispute frightened off potential bidders for Fletcher Forests, which, even setting aside the partnership's assets, is a major forestry owner.

Citic then came in with what Fletcher viewed as a low offer of $218 million to buy it out of the partnership.

After being shown the door, Fletcher reckons Citic is now trying to disrupt the company during its major $427 million rights issue. These funds are crucial to refinance Fletcher Forests' ailing balance sheet.

But Citic is unrepentant. It argues it has been unhappy from the start.

Citic believes that Fletcher Forests has mismanaged the partnership and is seeking $159.5 million in damages through the court.

This is based on claims that Fletcher Forests has been overcutting the estate. It also contends that Fletcher Forests has sold logs from the partnership too cheaply to its own mills.

This is why the partnership is in the position of breaching its bank ratios, Citic says.

Caught in the middle of this dispute are the banks, which financed the partnership to the tune of $US650 million.

By most broker estimates the equity value in the partnership is zero, owing to the depressed state of the international log market.

Saving the banks from a potential haircut is $US230 million of junior debt.

This is held by Fletcher Forests and is still largely intact, according to analysts.

But the partnership will be in breach of its banking covenants by the end of the year. Unless both Citic and Fletcher Forests inject more cash into the forestry estate, the banks could pull the plug on the partnership.

The problem is Citic and Fletcher are unwilling to do anything while the dispute rages. Fletcher does not want to put in cash while there is litigation outstanding. Citic does not want to tip money into the asset if it benefits Fletcher Forests. Certainly, given the financial state of the partnership, any cash put in will effectively help underpin Fletcher's junior debt position.

Thus the word receivership is one talked by both parties. Again, Fletcher says that if this happened it would not necessarily be a bad outcome for the company, as it stands to get some or all of its $US230 million junior debt back.

Citic, on the other hand, warns that it has substantial legal claims against Fletcher. Furthermore, it disputes Fletcher's right to the junior debt because the bulk of it is made up of what it says are spurious tax losses - the $US161 million worth of tax benefits, which were sold to the partnership by Fletcher in 1996.

The battle has as many twists as the US elections.

While receivership slips easily off the lips of the partners, it is a word banks find hard to swallow. Banks are conservative by nature and they will certainly be fingering their worry beads.

Over the coming weeks, they will be exerting as much pressure as they can to bring the warring parties to a peaceful solution or at least a truce long enough to inject the necessary cash.

From the outside the problem looks simple. Both parties paid too much for the asset - much to the pleasure of the taxpayer. They have to accept that.

But forestry assets are notoriously cyclical. One day the $1.6 billion price tag might look cheap. Then we will see who is arguing. But sadly, the way things are going the partnership is not going to see that day.