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Forest grump

By Jenny Ruth

Tuesday 1st April 2003

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 Jenny Ruth
When he took the helm at Carter Holt Harvey in 1999, former chief executive Chris Liddell described himself as a competitive boss who demanded results. Did he achieve them? Three-and-a-half years on, our second largest listed company (market capitalisation $3 billion) still isn't earning its cost of capital, its share price is in the doldrums, and it's still a commodity-based company whose fortunes are hitched to the global price cycles of logs, pulp and paper.

Much has changed at Carter Holt under Liddell's stewardship - he's universally acknowledged as an outstanding and innovative manager. But much has stayed the same: the forestry industry was a dog when he started, and it's still a dog. And commodity prices have just kept trucking south.

Now Liddell has moved on. He's taken a senior executive role at the Connecticut head office of International Paper (IP), Carter Holt's 50.1% parent and the world's largest forest products company. Typically affable and up-front, he's happy to concede that the results of his tenure as CHH chief executive have fallen short of expectations.

"I'm the first to admit the economic returns and particularly the share price didn't achieve what I would've liked to achieve." But, despite the disappointments, Liddell is widely credited with having left the company in as good a financial shape as it could be, given the commodity situation, and well positioned to benefit from any pickup in international prices.

Liddell himself prefers to accentuate the positives about the progress that's been made by the company, and the shape he has left it in for his successor, Peter Springford. "I think the company has achieved an amazing amount over the last three or four years," says Liddell. Among what he sees as the highlights of his tenure is the $2.5 billion sale of its 30% stake in Compania de Petroleos de Chile (Copec) in late 1999. That was at a premium to the $1.9 billion book value and whopping return on Carter Holt's original $NZ332.5 million investment, although at a discount to Copec's then market price.
"That was probably one of the best investments by a New Zealand company outside of New Zealand anywhere at any time," Liddell says.

Selling the stake not only removed the management distraction of endless squabbles with the company's Chilean partner, it provided the funds to vastly strengthen the balance sheet and allowed it to invest in some high-returning Australasian businesses.

These include buying the medium-density fibreboard and particle board businesses of Australian building materials group CSR as well as its Australian sawmill for $56 million in early 2000, opening a new $132 million wood processing laminated veneer lumber plant at Marsden Point in Whangarei in early 2001, and buying the Tasman pulp mill at Kawerau from Norske Skog for $231.5 million.

The CSR business was number one in the Australian market while the laminated veneer lumber plant was the first of its kind in New Zealand and one of only four in the world. And while you might think Carter Holt had more than enough pulp and paper assets, Liddell points out that the company paid less than half the Tasman mill's replacement cost and that even with pulp prices at the bottom of the cycle the mill has been earning its keep.

Even with those additional investments, the balance sheet has continued to strengthen. By the end of 2002, net debt was only 19% of total capitalisation, down from 25% a year earlier. That's the strongest it's been in at least 15 years and makes it one of the strongest balance sheets in the forest products industry worldwide.

"We've built up a very good position in Australia, unlike a lot of New Zealand companies - we're now first or second in virtually everything we do in Australia," Liddell says. He adds that every Australian family uses a Carter Holt product almost every day, a claim few Australia-based companies can make. Those products range from tissues, paper towels and disposable nappies to packaging to building materials for furniture and houses. Everyday brands like Treasures, Sorbent, Handee and Libra are among those in Carter Holt's Australasian fold.

Liddell's view is that in future such value-adding acquisitions should be relatively small and gradual. "There needs to be a re-balancing of the company. It needs more branded products, to be more value-added and closer to the customer. I think that's going to be a slow continuation of what we've been doing."
He's well aware of the traps. "You've got to buy businesses well, but you also have to integrate them. It isn't easy."

Carter Holt's approach has been to buy in relatively small chunks; a $100 million acquisition here, a $50 million purchase there. It has avoided going for the "big hit" type investment, particularly in Australia, which has tripped up so many New Zealand companies - Telecom with its AAPT purchase, Baycorp with its merger with Data Advantage and Tourism Holdings with its disastrous Britz camper vans acquisition, for example.

"The type of progress Carter Holt has been making is the right way," Liddell says. All acquisitions have been designed to move the company slowly up the value chain and away from simply selling raw logs so it's less at the mercy of global commodity prices.

Liddell also instituted a companywide restructure, splitting the company into 35 smaller units, ranging from major forest products units like Kinleith to Oxygen, an IT business consultancy spinoff from Carter Holt. Liddell also instilled a desire to be internationally competitive, and created systems designed to encourage innovation including setting up a venture capital fund and i2b, an innovative way of tapping employees' ideas and turning them into business.

David Stanley, head of research at Macquarie Equities, says that slicing the company into smaller businesses allowed the managers of each unit to focus more sharply on the performance of their particular parts. "With the strength of the reporting systems, they were able to analyse the performance of each business." Managers could be rewarded for good performance and further investment could be made in those businesses that were performing well. Those that weren't performing well were highlighted, and remedial work attempted. After further rationalisation, 26 units remain.

The trouble is, Liddell's many achievements are utterly swamped by the poor performance of the company's two albatrosses: its 330,000ha of mainly radiata pine plantations and its Kinleith pulp and paper operations. The most recent figures from the company show that at the end of 2001 (see "Shot commodities", above), the forests alone accounted for 44.8% of total assets. Pulp and paper and tissue assets accounted for a further 28%.

Liddell hasn't had any help from Lady Luck. Before becoming chief executive in May 1999, he had been Carter Holt's chief financial officer since 1995. Almost as soon as he joined the company, prices of the company's commodities turned sour. They've been bumping along the bottom of the cycle ever since, with prices well below their long-term averages. Unforeseen events like the the Asian crisis, the dot-com bubble bursting and the fallout on the key US economy, the September 11 terrorist attacks and the looming threat of a Middle Eastern war have all contributed to the tough environment.

While Carter Holt's operating earnings before interest, tax and one-offs doubled between 2001 and 2002 to $333 million, the cash flow return on investment improved only slightly from 6% to 6.9%, compared with the company's cost of capital of about 11%. That's because forests returned only 3% in 2002, up from 2.8% in 2001, and pulp and paper only 4.4%, down from 5.9% in 2001. Both are cyclical commodity businesses and both cycles have been in the doldrums for years.

"The 1990s were, overall, a lost decade for the [forest products] industry. There was only one good year," says Frances Loo, an analyst at USB Warburg. And the current decade, given the uncertain outlook for the global economy, isn't shaping up any better so far.

Carter Holt's share price has languished between $1.40 and $2.20 throughout the last three years and, at $1.76 in late February, doesn't look like going anywhere in a hurry.
It seems that extracting more value from wood when the commodity cycle is against you is a huge task. "Unfortunately, there's no silver bullet, otherwise I'm sure Chris and the boys would have found it," says Springford.

While Liddell brought an outsider's perspective to the company, having been recruited from Credit Suisse First Boston, Springford's career has always been rooted in the forest products industry. He has previously held a senior executive position at Carter Holt and before that worked for Fletcher Challenge for more than 10 years. For the four years before his appointment as chief executive, Springford was in charge of International Paper's Asian operations.

And while Liddell's strengths are on the financial side (Macquarie's Stanley describes him as "a very strong strategic thinker"), Springford specialised in marketing for his MBA and his experience has been "running businesses and plants, very much at the operating level".

Springford, who took over the reins from Liddell in December, says one of his key aims will be to cut costs. "We think there's an opportunity to take considerable costs out. It's not necessarily about [shedding] people, but getting better productivity out of what we've got," he says. But then all Carter Holt's recent chief executives have made similar statements about needing to cut costs. Springford says there's nothing surprising about that. If you assume commodity prices through the cycle are declining 1-3% a year on average and inflation is creeping up 1-3% a year "it means we have to take $160 million a year out of our cost structure every year just to stay alive".

Springford also expects to draw on his most recent experience with IP in Australia. Traditionally, Carter Holt has relied on agents and a handful of people on the ground in Asia. "We need to put more resources into developing relationships with our customers and working on the channels and costs of delivery," he says.

The man does have a track record in Asia. When he started with IP, the American company didn't have any investments in China. IP now has nine packaging plants, some wholly owned, some in joint ventures, and the company employs some 2000 people and is turning over about $US600 million a year in China.

Springford says ever since he returned to New Zealand, people have been telling him nobody makes money in China, but he insists that's wrong. IP's Chinese investments are profitable, he says.

He's aiming to have Carter Holt positioned to take advantage of China's new building code that will allow houses to be made of wood, including radiata pine, for the first time since the 1950s. That code is still being written but should be finalised within about six months.

Avoiding the mistakes the New Zealand forestry industry made in Japan when CHH goes into China is a key goal. Lack of coordination, inconsistent marketing and a failure to ensure radiata pine was properly used in higher value applications such as house building means the wood in Japan is now regarded as industrial grade, fit only to make packaging and plywood. "That is added value, but it's not much added value."

A $1 billion business in China by mid-2005 is a prime goal. "We were able to deliver with IP. I'm confident we can deliver here as well." Loo says the challenge for Carter Holt in China isn't so much growing its sales as achieving profitable growth. "It's going to be a very important market. The challenge is going to be to grow the Chinese market in a profitable way," she says.

But back to those two problem children, the radiata pine plantations and the Kinleith mill. Bruce McKay of Saffron Capital, who describes himself as one of the grumpier analysts, believes Carter Holt should be copying Fletcher Forests' strategy. It should find a different long-term owner for the forests, such as a pension fund, that would be prepared to accept a 30-year return of, say, 7%, rather than the 11% the share market wants from Carter Holt. He doesn't think it's good enough for the company to simply wait until the cycle turns in its favour and log prices recover closer to their long-term average.

"That's a bit of a wimp-out. It would be preferable to see management being more proactive," he says. And who's to say how the current cycle will develop and how long the low will last?

McKay also advocates Carter Holt considering whether it should give up on the Kinleith pulp and paper mill and mothball it. Springford and Liddell strongly disagree. Part of the reason log prices have been so depressed since the mid-1990s is that vast tracts of virgin forests in Russia are being felled simply for immediate cash flow. Both men see this as a short-term problem. "It isn't sustainable. Their costs are going to go up," Springford says.

Liddell says one only has to look back 10 years or so when the prevailing view was that the world was facing a shortage of wood and foreign buyers were desperate to buy New Zealand forests. Currently the view is the opposite, but that can change just as easily, he says.

Other analysts tend to back the company's view. Loo says unless the company could find a buyer willing to pay significantly more for the forests than the current market price, which is unlikely, "you're not really achieving anything" and certainly adding no value.

"If someone was that optimistic about the industry, they would have already looked at buying the Central North Island Forests Partnership (the Fletcher Challenge/CITIC joint venture now in receivership). It's not as if there has been any shortage of forests for sale. Those kinds of buyers are pretty thin on the ground," she says.

And as for mothballing Kinleith, Springford says he's certain it's possible for the mill to earn its cost of capital over the cycle and to be cash positive at the bottom of the cycle. "We have to be realistic - it's a cyclical product, but there's plenty of demand. There's a significant shortage of softwood pulp in China."

Stanley agrees that having spent $300 million on upgrading Kinleith in 1997, the company is better off persevering with efforts to get a return on that investment. "The returns it's generating are sufficiently good that they're a long way away from considering [shutting it down]".

Like Liddell, Springford's number one goal is to get the company earning its cost of capital. You can only wish him luck.

The basics
CHH in brief
Founded as Robert Holt and Sons around 1900
Founding fathers: Francis Carter, Robert Holt and Alexander Harvey
Market capitalisation: $3 billion
Sales (2002): $3.75 billion
Operating earnings before interest, tax and one-offs in 2002: $333 million
Cash flow return on investment (2002): 6.9%
People: 10,800 employees, including 7500 in New Zealand
Largest forest owner in New Zealand, with 330,000 hectares
Listed on New Zealand and Australian stock exchanges
Group made up of 26 independent businesses
Ownership: 50.1% by $US28 billion, Connecticut-based International Paper

Liddell's legacy
It's hard to find anyone in the financial community with a bad word to say about Chris Liddell
David Stanley, head of research at Macquarie Equities, describes the former Carter Holt Harvey chief executive as "one of life's natural enthusiasts". Certainly, his role in public life in recent years stretched much further than heading up New Zealand's second largest listed company.

He and his wife, former stockbroker Bridget Wickham, have been prominent in the push to build partnerships between business and government. Wickham was chairman of The Icehouse, Auckland University's business incubator unit, and director of the Knowledge Wave Trust until Liddell's appointment late last year to a senior executive role at the Connecticut head office of International Paper. Liddell also took a keen interest in the trust and both were back in New Zealand in February for the latest conference.

While he has been unafraid to disagree with aspects of the current government's actions, Liddell has accompanied Prime Minister Helen Clark on a number of overseas missions. "He's a straight shooter. He will provide balanced arguments and put the pros and cons," Stanley says.

Liddell is also a sports fan: he played rugby in his youth, served as a director on the New Zealand Rugby Board, and encourages fellow executives to jog with him during lunch breaks. It's an interest that would certainly have helped in his relationship with Carter Holt chairman Sir Wilson Whineray, a former All Blacks captain.

If Liddell has any faults, Whineray isn't about to reveal them. "He's an outstanding fellow - we haven't heard the last of Chris Liddell," says Whineray, who will shortly relinquish his role after 10 years as chairman.

Whineray will admit to a few "discussions" and "debates" over the years, rather than disputes.

As for Liddell's inability to make Carter Holt achieve its cost of capital, Whineray says: "The things outside your control are larger than the things you can control ... When you think you're getting ahead of things, along comes a Desert Storm or an Asian crisis or a market crash."

Despite the adverse global environment, Liddell has left Carter Holt in as good a shape as it's ever been, he says. The balance sheet is showing net debt to total capitalisation of only 19%.

Bruce McKay, analyst at Saffron Capital, calls Liddell "a smart guy, there's no doubt about it". But it's hard to see whether any chief executive could quickly change Carter Holt's essential problem - namely, its exposure to merciless commodity markets, McKay says.

Liddell was head of stockbroking firm Credit Suisse First Boston before joining Carter Holt. Frances Loo, an analyst at UBS Warburg, says his background outside the forest products industry allowed him to bring a fresh perspective to Carter Holt. While the company's overall returns are still inadequate, the acquisitions Liddell made are performing well, she says.

Whineray sees one of Liddell's strengths as encouraging the people around him to maximise their contribution. His restructuring of Carter Holt "brings management accountability closer. [Individual unit bosses] feel they're influencing the part of the group they've got some control over." But Whineray says that structure may not last forever. "There might be one or two bits he might tweak ... Nothing lasts forever. Times change and people change."

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