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Opinion: Carter Holt's dreadful quarter may obscure wood for trees

By Simon Louisson of NZPA

Friday 28th October 2005

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Carter Holt Harvey's (CHH) dreadful quarterly report announced on Wednesday is likely to encourage some investors to accept Graeme Hart's takeover offer.

It certainly highlighted the risk of keeping shares and running with the billionaire entrepreneur.

The company also downgraded its 2005 annual profit forecast to $200 million, having just six weeks earlier downgraded the original forecast to $253 million from the original $300 million.

The bulk of the $200m will come from foreign exchange hedge contracts ($111m) and land sales ($38m) - hardly a recommendation for future earnings.

The September net profit was just $31m, with other half of that coming from forest revaluations.

Not surprisingly, CHH's share fell back to Hart's bid price of $2.50. After Hart announced his $3.3 billion bid, the share price shot up to more than $2.60 as investors bet on Mr Hart extracting more value than he paid, as has happened on all his previous investments.

Analysts reckon he will break up the forest products conglomerate and the bits will add up to $2.60-$3 per share.

Having already bought 50.1% from International Paper, Hart has acceptances for another 20%. The bid is due to close on Thursday, although it has already been extended once.

Forsyth Barr head analyst John Cairns said any investor contemplating holding shares "would certainly be revisiting their decision in the light of the dramatic fall-off in underlying earnings".

"I think this highlights the risks you are running with this thing. It's a bit of blind faith to say Graeme Hart's a guru - he's dealing with some commodity-type assets, which under Carter Holt ownership, have never produced cost of capital."

However, Tower Asset Management's fund manager Wayne Stechman said the September quarter result did not change things even though the result was weaker than expected.

"Pretty much all of the operating divisions disappointed slightly. Having said that, it was always going to be a bad result - it's somewhere near the trough of the cycle."

Investors should not value a commodity stock such as CHH at the trough of the commodity cycle, he said.

"To a degree the result is of little consequence. It doesn't change the big picture issue about what the underlying value of the business is and how they can extract it."

But the downgrade had implications for short-term earnings, so Hart might pick up more stock than he would otherwise have done, Stechman said.

While Tower has sold a proportion of its CHH holdings, it is holding on to the rest.

Stechman believes CHH is worth more than $2.50/share but he added: "It's not without its risks.

"It's not going to be crystalised immediately, so you have to take a view on how long it's going to take to be realised and what the risks are in realising it.

"Our underlying view would be (that) broken, the business is worth more than $2.50. We don't even know if he will break it up."

CHH's independent directors held firm on their advice for minority shareholders to reject Hart's offer, which falls short of the $2.55 to $2.95/share valuation arrived at by independent appraiser Grant Samuel.

"The revised 2005 forecast does not warrant a change in the recommendation," the directors said.

However, they have asked Grant Samuel to reassess its valuation, which will be published on Monday.

Just after the CHH result announcement, Hart demonstrated how he extracts value from his businesses. More details of Burns Philip's to spin off a reborn Goodman Fielder were released.

Burns Philp, 54% owned by Hart's Rank Group, will sell its baking, spreads and oil business into the new vehicle for $A1.47b ($NZ1.59b) while Rank will sell its dairy operations for $A782.6m.

That means Rank will reap a $878m profit from owning NZ Dairy Foods (NZDF) in just over three years. In August, Rank Group pulled off a deal where NZDF swapped brands with Fonterra, netting Rank $338m, $28m more than Rank paid for the entire company three years earlier.

His profit on the asset swap with Fonterra is $240m in just three months which may make a few cockies a tad angry given Hart was sold the original NZDF assets very cheap..

It is estimated Burns Philp will raise about $A2.27b from Goodman Fielder, which will come in handy when Hart has to pay his debts. He paid $1.6b for the International Paper stake in CHH and may have to pay a similar bill if he wins the rest of the company.

Hart took control of the CHH board a month ago but CHH chief executive Peter Springford reckoned it was too early to notice the change in culture. However, he added: "I'm sure you will notice change."

CHH's 10,000 odd workers will too. Nearly 5% of the workforce have been put down the road in the last year and that is likely to be just the beginning. Most of the 462 redundancies in the last year have come from Australia but locals will soon feel the pain.

Springford signalled more lay-offs in the "challenging environment" that included a high New Zealand dollar, slackening demand, low pulp, paper and lumber prices and rising costs.

There will be 150 jobs going at CHH's Rainbow Mountain mill in Rotorua and the company is in the process of selling its non-performing Oxygen Business Solutions unit which currently employs 153 staff. Those jobs are likely to be at risk.

You can be pretty sure Hart won't tolerate losses to continue much longer at its medium-density fibreboard plants including in Rangoria, Canterbury. The plants depend on exports but with the dollar so high, they are losing money on exports.

Sydney commentator Stephen Bartholomeusz said the steep decline in CHH's profitability increased the responsibility on independent directors to give investors more sophisticated advice about the heightened risk.

He said reality suggested CHH shares must be worth less today than the value placed on them by Grant Samuel six weeks ago.

"In this market, the litany of over-optimistic forecasts and the unwillingness of the directors to change their recommendations in the light of the changed circumstances - Rank's level of shareholding, the tumbling profits and the substantial falls in the market values of Carter Holt's peer companies - would have generated controversy and, perhaps, some risk," he said.

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