Cautionary Tale: Money Does Not Grow On Trees, You KnowSydney...

Cautionary Tale: Money Does Not Grow On Trees, You Know
Sydney Morning Herald

Thursday November 20, 2008

Elizabeth Knight


This is a story about an investor - let's call him John Smith - who five years ago had a small amount of money to invest over a 10-year horizon but didn't want to put it into the stock market. Rather, he wanted to buy a more tangible asset.

He didn't necessarily require an ongoing income stream from that investment but was looking for a payback with capital gain in 10 years.

John decided to buy trees - or a woodlot - being offered by a managed investment scheme (MIS) company, Great Southern Ltd. For $3300 (inclusive of GST) John bought a woodlot and waited for the trees to grow.

They would ultimately be sold to Asian investors for pulp mills. It sounded like a great idea at the time. It was tax effective, it was a carbon sink, environmentally sound, and it should have earned him a nice return.

Fast forward five years and John is reading an explanatory memorandum from Great Southern which is offering him, in return for that $3300 invested five years ago, shares worth around $1000. He has received no distributions along the way.

John, along with many others that invested in these plantation lots and cattle lots, does have the opportunity to vote on this company-transforming proposal on December 1.

It will require a 75 per cent majority.

If the vote is in favour, the other group of Great Southern investors, the shareholders, will need to approve the issue of shares to pay the MIS lot holders for their trees (partly grown) or cattle.

The question is why is John looking down the barrel of such a disastrous investment. Even the highly positive investment report from broker Austock Securities concludes the returns from forestry assets were poor and were sold with yield assumptions that have not eventuated (this seems like a pretty major understatement).

"This is not necessarily the fault of management - more a function of a new industry in its infancy," says Austock.

The company has reports from reputable auditors that if the plantation investors tried to sell their lots into an illiquid market they would get less money than they would from the shares that they would receive as payment for their woodlots.

Either way, it's a pretty sad state of affairs.

If the 2003 woodlot investors wait until their trees are actually mature, and capable of being sold for pulping, the outcome may be better than that which is being portrayed. Let's face it, the valuation from the company has been wildly wrong once already.

But these investors may never get to know the answer to that. This depends entirely on how the vote stacks up.

From the company's perspective, and that of its shareholders, the scheme makes plenty of sense.

At this stage, the company, Great Southern, owns the land but it doesn't own what's on it - cattle, plantations, grapes. Indeed, Austock says Great Southern owns valuable forestry and cattle land but is encumbered by investor growers who own the trees and cattle and the value of the assets is not reflected in the share price.

But the share price does reflect the fact that Great Southern is overgeared in a market where too much debt is a recipe for disaster.

Austock says if the scheme goes ahead, "Great Southern will generate solid EBIT margins for the next five to eight years for forestry as trees are harvested. The scheme turns the cattle business into a positive EBIT contributor."

(These are the same trees on which John apparently can't get any good return once they are harvested.)

The other big benefit for Great Southern is that if the owners of the trees and the cattle sell their investments and become shareholders, it would give it greater flexibility to sell assets and reduce gearing.

And if the scheme doesn't get approved, the company will be heavily reliant on strong forestry MIS sales for it to break even.

Austock also notes that company debt will have some refinance risk in the next couple of years and interest costs may increase to the point where the interest-cover ratio may be breached as EBIT margins are reduced.

Sounds like a disaster scenario if the scheme gets knocked back.

To take this one step further to its logical conclusion, the company needs to convert these MIS investors into shareholders in order to save its own balance sheet.

The stock issue that will be required to pay out the owners of the trees and the cattle will be hugely dilutionary, but it's better for the company than being cash flow negative.

So much for save the trees. This is about saving the shareholders.


? 2008 Sydney Morning Herald