By Phil Boeyen, ShareChat Business News Editor
Friday 16th February 2001
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The road to Fletcher separation may have seemed like a long one but in fact it has only been just over a year since one of the country's best-known commercial icons decided to dismantle its targeted share structure.
Admittedly that's longer than first hoped for. December 2000 was the aim, although issues like three attempts to get Commerce Commission approval for the sale of Energy (NZSE: FEG) to Shell and Apache have added to the delay.
The initial reason given for the separation still stands. The group's capital structure was seen as complex by investors, raised governance issues and meant the market discounted the share prices of the Fletcher divisions.
The company's targeted share structure itself harks back to 1993, with the formation of the Forests Division. This was later expanded in 1996 to include the Building, Energy and Paper Divisions.
Fletcher Paper was the first to go, sold in April last year to Norwegian global paper giant Norske Skog.
Paper shareholders received a premium of more than 80% on the sale of their stock at $2.50, and Norske Skog seems happy with its investment. In its latest result the company said the purchase of Fletcher Paper has doubled its revenue and increased earnings per share from the very first day.
If all goes according to plan, by the end of March only one company with the Fletcher Challenge name - Fletcher Challenge Forests - will remain on the NZSE.
Energy will have been sold with FEG shares due to stop trading on March 23rd. Fletcher Building will be a standalone business but not allowed to use the word 'Challenge' in its name, although it has permission to use the familiar lion's head insignia indefinitely at no cost.
Then there's the newcomer, Rubicon. Without a Fletcher moniker or lion's head in sight, the company describes itself as a business developer in the forestry, horticulture and agriculture sectors.
Reports by financial firm Grant Samuel into both Forests and Building concur that shareholders in the companies will be better off after separation. Given that's the whole point of the exercise, those conclusions don't break any new ground.
The trick for investors will be to pick which of the new stand-alone companies offer the most hope for an improved share price.
With a fairly unknown future, Rubicon has got to be the outsider in the field.
It's not going to pay regular dividends, instead looking to reward shareholders by way of capital appreciation. (Tech investors who have heard that line before can be forgiven for stifling a yawn or raising their eyebrows).
The initial owners of the company are Fletcher Energy shareholders, who will receive one Rubicon share for each FEG share they hold as part of their payment. That means the company effectively has share ownership by default.
An independent report into Rubicon notes that because its proposed business are very different to those of Energy, some shareholders may look to get out of the company as soon as possible, putting early pressure on the share price.
As one analyst points out, there isn't much information available to begin to try to figure what its earnings and potential might be.
"It's a company which is promising big things, but who knows if it will deliver?
"There are no pro forma cash flows or earnings statement. Because of the lack of data it's difficult to analyse, which means investors will put a high risk premium on it."
In terms of its businesses, the initial structure of Rubicon is a bit of a mish-mash.
It will start its corporate life with $312 million equity, but will use $254 million to buy the Challenge service station network, Forests' biotech assets and South American forests operations, Fletcher Challenge Forests ordinary and preference shares, and $49 million in Capstone Energy shares.
Its biotechnology portfolio is weighted towards forestry, and consists of a 31.6% stake in ArborGen, a forest biotech joint venture with equal partners International Paper and Westvaco. It is committed to pumping another US$16 million into ArborGen over the next four years.
New Zealand listed biotech company Genesis Technology (NZSE: GEN) also has a 5% share in ArborGen, and Rubicon in turn will have a 2.95% stake in Genesis - perhaps offering some exposure to the company's medical products.
Rubicon will also own a tree stock production and improvement business at Te Teko in the central North Island, a radiata and eucalypt clonal development business, and will have joint ownership or rights to US and international patents for genes which control certain growth and fibre properties for radiata and eucalypt.
An alliance with HortResearch is aimed at setting up a business to license genes to companies engaged in the commercial bioengineering of horticultural trees, and the company also plans to look at other technology areas such as environmental services and energy-saving technologies.
But, as mentioned earlier, coming under the Rubicon banner too are fuel terminals, the Challenge service station group, a 50% interest in an Argentinian forestry venture, a chunk of shares in Capstone Energy and Fletcher Challenge Forests.
All of these are slated in the company's prospectus as "businesses targeted for performance improvement and strategic reassessment", which means they could be sold at some stage, potentially offering Rubicon stakeholders a share in any value upside.
None of that is certain however, and the company's prospectus points out in particular the risk that the company could end up with 17.6% of Fletcher Challenge Forests in its initial portfolio.
"This represents a significant shareholding in that company, and the operating, financial and share price perform of Fletcher Challenge Forests will be impacted by factors outside the control of Rubicon," says the prospectus.
It goes on to say that the ability of Rubicon to realise full value from its Forests shareholding will depend on the share price performance of Forests shares, market liquidity and the availability of strategic investors.
Fletcher Challenge Forests
Which brings us rather neatly to perhaps the most controversial of the Fletcher stocks, its Forests division (NZSE: FFS), which CEO Terry McFadgen admits has financially not been performing up to scratch.
Many Forests shareholders will still be licking their wounds from last year's sharp drop in the price of the stock, which sold down as low as 24 cents while the rights were going for 25 cents - not a bargain in anyone's books.
In a letter to shareholders in the Forests prospectus Mr McFadgen says the separation of the company into a stand-alone business should lift the share price and either allow the company to raise new capital or participate in industry consolidation.
Although laying much of the blame on the company's performance on poor international log prices Mr McFadgen appears a realist and says the company can't rely on price recovery alone to boost financial returns.
"The company will continue to strengthen its position in the four key markets it currently targets - Australasia, North America, Japan, and Global Logs and Industrial Lumber - and to add value through processing and marketing initiatives," he says.
Mr McFadgen is also promising to trim costs by $15 million over the net year or so, focusing the cost reduction programme on corporate functional areas.
One possible avenue for Forests investors to make money on their shares would be a takeover of the company once it is separated.
The independent report into Forests says the prospects of the company receiving a takeover offer will be "significantly greater than under the current structure".
However it goes on to point out that because Fletcher Challenge itself was unable to find an acceptable buyer "the company may not be an attractive acquisition candidate at the current time".
That will come as no surprise to investors who shelled nearly a dollar a share last year on the hopes that Fletcher Forests would become another Fletcher Paper, with a buyer willing to pay a premium for the company.
The independent report says not being able to find a buyer possibly reflects concern about the disputed Central North Island Forestry Partnership, the outlook for Radiata pine prices, and the legal structure of the company and the complex separation process.
"In part, these may be timing issues and it is conceivable that more interested purchasers may appear at a later time, particularly once the CNIF Partnership issues are resolved."
But, as investors found to their cost last year, a white knight could be some time in coming.
Some of the separation risks for Forests are similar to those for Fletcher Building. For one thing, it will have to borrow independently in future rather than relying on the backing of the Fletcher group, which could provide considerably more expensive.
It will need to set up its own corporate function, and although it will continue to sell product to Fletcher Building, its possible those supply arrangements could change if Building was taken over.
"Forests is going through a down cycle," one analyst says.
"This year will be very weak, and the $35 million restructuring charge will eat into the cash flow. 2002 is also likely to be weak, which means the risk is definitely on the downside."
Despite these concerns, it would appear more than a few brokers consider the stock undervalued.
A table in the independent report, which summarises recent broker valuations, puts the lowest valuation for Forests at 39 cents and the highest at 56 cents.
That same table also suggests Fletcher Building (NZSE: FLB) is trading at a market discount, with the lowest valuation at $2.76 and the highest at $3.10.
The solid if not spectacular Fletcher Building stock was thrown a curve ball recently when it was announced that the company's CEO-in-waiting, Alexander Toeldte, would not be taking up the job.
Fletcher Challenge has not fully explained why Mr Toeldte wouldn't be coming to the party, but it left the company in the awkward position of publishing a prospectus without a letter from an ongoing and committed boss.
Fletcher stalwart, Michael Andrews, has taken the reins in the meantime and points out his immediate priority is helping to get the CEO position filled.
He also says the company "can clearly improve its performance". That's echoed by an analyst, whose firm is still recommending the stock.
"The construction outlook will be softer for a while but we believe the stock is undervalued."
Fletcher Building has investments in a diverse range of businesses including building products, concrete, steel, construction, property, housing and distribution, both in New Zealand and overseas.
Turning it into a stand-alone business is possibly the least messy of the Fletcher separation transactions. It will basically be exactly the same company as now, with the same assets and liabilities it is currently trading under.
In many ways this also makes it the least interesting proposition - the market knows this stock already, and indeed even Michael Andrews can only summon a few hard-worn phrases for the company.
"For the short to medium-term our main focus will be on increasing profitability, cash generation and capital productivity to international levels," he says in the prospectus.
But he is also promising the company will get tougher, getting out of businesses that are not "key to being a market leader in the building products industry".
Like Forests, the independent report into Building cites the enhanced opportunity for corporate activity as one of the most important benefits of the separation process.
"As a stand alone entity with an open share register, Fletcher Building will represent a relatively straightforward opportunity for a party wishing to expand in the building and construction industry," it says.
However once again it points out that if the business was attractive, an offer could have been made before now. It's also worth noting the separation process will cost FLB a cool $45 million.
So, which stock to pick?
Fletcher Building at this stage looks to have the least downside. However, as usual, it will all be in the timing.
"Do you buy before the interim result, before the separation or afterwards?" says one analyst. "If investors wait too long they could well miss the boat."
For those willing to take the plunge, and who are keen to keep a finger in a Fletcher pie, sooner may be the better option. Others might be better off waiting until February 28th, when the half-year results are revealed, to see if Fletcher is still worth a flutter.
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