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Who would buy a wall of wood?

By Shoeshine

Friday 25th July 2003

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Hindsight is a wonderful thing and it's always interesting if you can look back on failed deals and see how they would have panned out.

Take last year's joint bid from Fletcher Challenge Forests (FFS) and Citic for the Central North Island Forests.

The pair overpaid for the forests in 1996, which saw them go into receivership five years later with the loss of $525 million in FFS' case and $650 million in Citic's.

Last year they were back again with a plan to buy the forests back from the banks for $US650 million ($1.4 billion at the time).

Citic was to pump in $US200 million of equity through an FFS share placement and up to $US665 million would have been borrowed to fund the purchase and to refinance existing FFS debt.

The deal struck many shareholders, including notably Xylem Investments, as highly risky and both Xylem and the Shareholders' Association lobbied holders to vote it down.

One of their main concerns was the disclosure in the information memorandum that a 10% fall in product prices, if sustained for six months, would result in FFS breaching its banking loan covenants.

That would most likely have meant the whole FFS-CNI entity going back to the receiver, with the probable loss of all shareholders' money.

FFS chief executive Terry McFadgen rubbished those arguments.

Almost exactly a year ago, he said such a fall over the next year was "extremely unlikely if not impossible," arguing log prices couldn't fall much further without going below their extraction cost.

The rest is history. Prices have fallen by all of that and more. Last week Carter Holt Harvey said it was suspending up to one million tonnes of its timber harvest ­ that is, log and transport prices mean it isn't worth cutting those trees down.

Carter also signalled a $900 million (31%) writedown in its forests' value.

So FFS shareholders, and Citic, have a lot for which to thank the Shareholders' Association and Xylem's Stephen Hurley.

Various other people have some food for thought.

Guinness Peat Group, for instance, also argued against the deal, although its main exposure was through its 19.9% stake in Rubicon, which owns 19.9% of FFS.

But from Rubicon's point of view the deal was highly favourable; Rubicon would have swapped its FFS shares for the Tahorakuri forest at a price equivalent to 37c an FFS share, compared with a market price of 24c before the deal was announced.

So while GPG may have done FFS shareholders a favour, it didn't do its own holders any.

The banks that have owned the CNI forests since February 2001 also have cause for reflection.

Banks aren't in the business of tree ownership. Had they not insisted the Fletcher-Citic consortium pay the full $US650 million value of their loans, FFS shareholders might have approved the deal.

Sure, the banks would have lost money. But they would have washed their hands of the whole sorry affair ­ those at least who weren't daft enough to put their money back into the new deal.

It now looks as though they'll be stuck with the forests for quite a while.

And they might be losing money anyway. Hedging saved Carter's bacon this year. Without it Carter would have made an $8 million loss.

Receiver Michael Stiassny isn't saying whether export log sales out of the CNI forests are hedged but it's unlikely the banks, which advise clients on risk management, would have neglected their own.

Carter and the banks have a common cause in a joint venture log export company, Silva Forest Products, making its first orders this month.

The picture for forestry, once hailed as one of New Zealand's economic saviours, could hardly be gloomier. With the fabled "Wall of Wood" of maturing trees building up fast, at least 16% of the country's forests are up for sale.

Research by investment bank ABN Amro predicts the next six months will be tough for market pulp and logs.

ABN reckons there is far more downside risk for Asian log prices than upside.

Asian pulp prices have fallen by $US60 a tonne in less than five weeks. There's no sign of recovery in the US or Europe, although ABN expects pulp prices will recover eventually.

Wood products markets aren't looking flash either. Australian and New Zealand housebuilding is slowing and the US dollar price of moulding and better grade lumber has fallen 31% in six months.

Lest anyone accuse Shoeshine of being a Cassandra, here are a couple of spurious cheerful thoughts.

First, leaving the wall of wood where it is will take some pressure off roading infrastructure, for the time being at least, leaving the government more money to build roads for Aucklanders like Shoeshine.

Second, all those trees are soaking up the greenhouse gas emissions of the nation's sheep and cattle herds. That should make the farmers happy ­ but it won't.

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