Brian Gaynor: Forest giant left clutching at straws

By BRIAN GAYNOR

Fletcher Challenge Forests' sharemarket performance continues to go from bad to worse. While the company is experiencing improved trading conditions, its share price is at an all-time low of 20c.

The poor performance can be directly attributed to the group's involvement in the Central North Island Forest Partnership, which is in receivership. The company has written off $1.1 billion associated with this investment and has botched its first attempt to buy back the assets from the receivers.

Fletcher Forests is still in a position to buy these assets, but its board and management have yet to prove they have the desire or the skills to pull off the deal.

The partnership was the vehicle used to buy the state-owned Forestry Corporation for US$1.092 million ($1.6 billion at the time) in September 1996. Fletcher Forests and China International Trust & Investment Corporation (Citic) both owned 37.5 per cent of the partnership and Brierley Investments the remaining 25 per cent. Citic is fully owned by the Chinese Government.

The partnership was funded by a combination of equity, subordinated loans from shareholders and bank debt. Fletcher Forests also acquired the management contract over the partnership assets, and its share price, which responded positively to the deal, was about $2 at the time.

The partnership assets consist of cutting rights over 162,000ha of plantation forests in the central North Island and a number of small processing plants. The land is subject to a Waitangi Tribunal claim and has remained in Crown ownership.

The partnership pays an annual licence fee equal to 7 per cent of the land value and this goes to the controversial Crown Rental Forestry Trust, an organisation that pays for Maori forestry claims. This week the receivers paid the annual licence fee of $23.9 million, a $5.2 million increase over the average amount for 1999-2001.

In December 1998, Brierley Investments sold its shareholding to the other partners, leaving them with 50 per cent each. Citic paid cash and Fletcher Forests issued 46.7 million new shares to Brierley, which sold them at 93c each a few months later.

But falling log prices and a high level of debt had a negative impact on the partnership and, in February 2000, the leading banks appointed Michael Stiassny and Grant Graham of Ferrier Hodgson as receivers to manage the sale of the partnership assets.

Fletcher Forests was forced to write off $1.1 billion associated with its investment in the partnership.

Another feature of the partnership was the total breakdown in relations between Fletcher Forests and Citic. Citic filed significant legal claims against Fletcher Forests relating to the management of the partnership and the valuation of assets Citic originally bought from the Fletcher group.

The courts subsequently found that only the receivers, or the subsequent owners of these assets, could pursue these claims.

Meanwhile, the receivers appointed Morgan Stanley as their advisers and, in August last year, released an Information Memorandum to potential buyers.

On March 28, Fletcher Forests told the Stock Exchange that it had an exclusive deal with the receivers to acquire the partnership's assets.

Twelve days later, the receivers announced they had a "back-up agreement" for the sale of the partnership assets to an unnamed party.

This party was later revealed to be Peter and Philip Vela, who have extensive interests in the fishing and bloodstock industries.

The Fletcher bid was in conjunction with the Hancock Timber Resources Group of Boston, Massachusetts. Hancock, which is a wholly owned subsidiary of John Hancock Financial Services, has more than US$2.4 billion ($5.2 billion) of assets under management in the United States, Canada and Australia.

The Fletcher/Hancock consortium was offering approximately US$650 million ($1.4 billion), an amount equal to the partnership's current bank debt. The purchase would be financed by US$450 million ($977 million) of debt and US$200 million ($434 million) of equity. Fletcher Forests' equity contribution would come from internal sources and a number of the banks with an existing exposure to the partnership were willing to fund the Fletcher/Hancock consortium.

According to Fletcher Forests chief executive Terry McFadgen, the consortium was virtually assured of bank funding and only a few operational issues had to be sorted out before the transaction was finalised.

But the deal fell apart at a meeting held at Ferrier Hodgson's offices in Queen St on April 23, the day the Fletcher offer expired.

There are conflicting views of this meeting. Fletcher Forests claims that it asked for an extension but was refused.

The receivers argue that no extension was requested and the Fletcher/Hancock consortium walked away from the deal.

Fletcher Forests told the Stock Exchange the following morning that it would not proceed with the March 28 agreement.

Subsequently, Fletcher's agreement with Hancock has been terminated and the price of its ordinary and preference shares has fallen from 24c to 20c.

Fletcher Forests' strategy raises some important questions:

* Why did the company claim it had an exclusive deal with the receivers when it hadn't?

* Why did it say it had five weeks to meet the conditions when it had a self-imposed deadline of three weeks and five days?

* Why was it unable to clinch the joint bid with Hancock when the deal was extremely bankable?

* Why has the agreement with Hancock been terminated when there is considerable uncertainty over the Vela brothers' ability to raise US$200 million of equity?

* Is Fletcher Forests having serious discussions with another potential partner?

McFadgen would not respond to the latter question but there are reasons to believe that he may be negotiating with Citic. McFadgen said that his relationship with Citic was positive and several senior executives from the company's Beijing head office were in Auckland this week.

The outcome of negotiations with Citic or any other party has huge implications for Fletcher Forests' share price.

According to Stiassny, the partnership is meeting all its objectives and is reporting good profits after all interest cost deductions.

McFadgen also reports that trading conditions for his company are continuing to improve and it will report a strong second half to the June 2002 year. Average export realisations are now 12 to 15 per cent higher than for June to December.

In view of the improved trading conditions, it is imperative that Fletcher Forests either obtains an interest in the partnership or retains the management contract. The loss of the management contract would cost the group $5 million to $10 million a year and mean that it could not recover any of the $1.1 billion it has written off on the partnership.

It would also be another major blow to the credibility of the group's board and senior management.

Investors have lost almost all confidence in Fletcher Forests after it failed to clinch the partnership deal last month.

At yesterday's closing price of 20c a share, the group had a sharemarket value of only $556 million, compared with shareholder funds of $1 billion.

The company is trading at a 49 per cent discount to net asset backing even though the partnership investment has been written off and its forest assets are revalued to market every six months.

The best news for Fletcher Forests' 47,000 shareholders would be an announcement that it had signed a firm deal to buy the partnership's assets in conjunction with a strong and friendly partner.

This would boost its earnings potential and share price and give investors more confidence in the board and management.

Any sharemarket response to improving market conditions will be extremely slow if the group fails to acquire a stake in the partnership and loses the management contract.

* Disclosure of interest: Brian Gaynor is a Fletcher Forests shareholder.

* bgaynor@xtra.co.nz