Rationalizing Timberland Managed Investment Schemes

The Changing Landscape of Australia's Forestry Sector

Updated: January 2011 -- In the late 1990s Australia was facing a growing deficit for wood products. The Federal Managed Investments Act of 1998 responded to this supply shortage by creating a retail investment structure that allowed investors to take a personal income tax deduction for investing in reforestation and agribusiness activities through Managed Investment Schemes (MIS). The creation of timberland MIS was more successful than anticipated. New companies were formed to offer MIS to the retail market, and the sector grew quickly in response to investors wanting to manage capital gains tax bills associated with the bull market of the Australian Stock Exchange (ASX). The MIS sector has driven almost 1 million hectares (2.5 million acres) of plantation establishment in Australia over the past decade. In the peak year of 2006-07, investors placed over $1.2 billion dollars in MIS projects.

To meet the surging demand, MIS companies needed to acquire substantial land assets. However, land acquisition is not tax deductible to the investor under the Managed Investments Act, so the MIS companies financed land purchases on their balance sheets with substantial bank debt. The recent combined effect of a volatile share market, reduced demand for MIS products and an inability to roll over debt facilities has led to a somewhat disorderly re-structuring of the MIS sector over the past 12 months. In 2009, MIS sales fell to under $AU300 million, and in 2010 fell even further to under $AU100 million. With major MIS companies being liquidated and a negative public view of the MIS sector, it is unlikely that the sector will ever return to its heyday. The opportunity now is to rationalize the land and forestry assets--1 million hectares of plantation likely worth $AU3 to $AU4 billion--into an institutional timberland asset.

How MIS Products Work

The MIS sector is a direct product of tax legislation designed to encourage investment in plantations. This was particularly effective as a means to drive forestry investment because the early tax deduction was seen as balancing the risks associated with investing in newly established plantations that require 10-14 years of growth before the timber becomes marketable. Tax deductions are awarded in the year the investment is made, and the MIS companies were allowed to charge for all the reforestation costs, management costs and leasing costs as a single-up-front payment--often in the order of $10,000 per hectare. In many cases the MIS companies financed the investments with up to 100% debt, allowing the investor to gain the tax deduction with no up-front payment.

Forestry MIS companies establish and manage the plantations and market the timber products on behalf of the individual investors in the scheme (known as "growers"). The MIS company is typically paid a management fee and a share in the harvest proceeds. Upon raising the funds, the MIS operator has 14 months to secure land and undertake reforestation operations.

Rise and Fall of the MIS Industry

The MIS industry first rose to prominence in the late 1990s as rising stock markets drove interest in tax minimization products. In 2000 the Federal Government of Australia tried to limit the growth of the schemes by requiring that the reforestation occur in the year of investment, but as the stock market contracted in 2001, the entire industry went into a near collapse. The government reversed its tightening of regulation, and the commodity-led boom of the early 2000s led to recovery and further expansion of the MIS sector. This resulted in a kind of land grab, as firms competed to fulfill their tree-planting quotas within the required 14 months of selling an MIS product to the retail investment market.

Investments focused primarily on bluegum plantations near ports for woodchip export, which are attractive because of the relatively short rotation length. There have also been MIS projects for radiata pine and tropical hardwoods, including sandalwood. While there is high demand for many of these quality wood products, MIS cost structures were generally considered too high to make commercial sense, and the companies began facing financial difficulties.

In 2009 the government moved to curtail the MIS sector, but again the effort was poorly timed, coming as global markets felt the shock of the credit crisis. Most MIS operators were listed on the ASX and quickly came under pressure from falling sales, falling share prices and a refusal by the banks to continue to extend or roll over their debt facilities. Timbercorp and Great Southern Plantations, the largest MIS companies, went into administration/receivership in April/May 2009, leading to questions about the viability of the whole sector. Such turmoil has been a challenge for the many tens of thousands of grower investors, but the resulting restructuring and sale of assets also creates the opportunity to institutionalize forestry investment in Australia. The rationalization should lead to a stable, high-quality forestry estate on many former MIS landholdings.

Market Activity

Over the past two years, the rebalancing of the sector became evident in the downfall of several prominent MIS operators with several large properties changing hands and companies entering Administration:

In early 2009, Great Southern Plantations, the largest MIS operator with over 40,000 investors, offered to buy out its growers in bulk. Only one-quarter of the forestry investors accepted an offer to trade their woodlots for shares in Great Southern. Subsequently, Great Southern was unable to service its debt and went into Administration and Receivership in May 2009. The management rights to the plantations were sold to Gunns in December 2009.
In the case of Timbercorp, the schemes were wound up and sold collectively as a timberland asset. There were approximately 95,000 hectares of trees, most on leased land but also 39,000 hectares of freehold land. This sale was widely publicized during October 2009, when the assets were purchased for $345 million by Australian Bluegum Plantations, an Australian company managed by US-based Global Forest Partners. A portion of the purchase price was used to repay the bank debt and release the security charge over the land, and a portion was distributed among the company's 15,000 investors and growers.
Forestry Enterprises Australia (FEA) was placed in Receivership in April 2010 owing $215 million in debt. The company has an estimated 77,000 hectares of plantation land in Tasmania, New South Wales and Queensland which will likely be sold in the coming months.
In May 2010, Rewards Group, which managed 12,000 hectares of forest and horticultural plantations, including teak, went into Administration, leaving the fate of $250 million of MIS investor funds uncertain.
In July 2010 Willmott Forests entered a trading halt after its MIS sales missed projections, and in September 2010 was placed in Receivership, owing $120 million.
Elders Forestry announced the conclusions of a review of their forestry business and assets in May 2010. The result included a write-down of $133 million, an announcement that the plantations in Queensland had failed due to fungal attack and a reduced forecast for the productivity of plantations in the Esperance region of WA. Elders' MIS sales in 2010 were negligible.
Gunns undertook a number of asset sales in 2010, exiting from Walnuts and Grapes, and also selling down private landholdings.
In late January 2011, Alberta Investment Mangement Corporation and New Forests' Australia New Zeland Forest Fund acquired the 270,000 hectare forestland holding of Great Southern Plantations from the Receiver, McGrath Nicol for $415 million. This is the largest private forest land holding in Australia and will be central to the future evolution of the forestry industry. It will be managed by New Forests.
New Forests also acquired 10,000 hectares of Green Triangle land in January 2011, which are under lease to Australian Bluegum Plantations who now manage the ex-Timbercorp plantations.

Ways Forward for Investors

The current challenges facing MIS companies and their grower investors have created opportunities for sophisticated investors. The Australian Financial Review reported in June 2010 that the MIS players who are surviving in the market rationalization have done so through successfully tapping into new finance. For example, MIS companies Elders and TFS have announced that they are seeking access to new sources of capital, such as wholesale finance from forestry investment funds.

Options such as land sale and leaseback transactions and purchase of woodlots provide entry to the asset class with opportunities to further enhance investment returns over time. For example, changing management of certain MIS lands may be profitable, particularly where higher value mixed agricultural uses for the land are available (e.g. dairy or viticulture). Other operational management decisions such as diversifying the species grown or altering rotation lengths at the conclusion of the MIS rotations can affect valuation and future sales. In addition, environmental market opportunities such as the recently announced federal Carbon Farming Initiative may be additive to existing asset values. The changing landscape in Australia's forestry investment sector creates a pool of assets that are available at attractive discounts and/or yield rates with potential upside optionality.

Footnotes

Note: Commentary is current as of January 2011. Reproduction is permitted with proper referencing to New Forests Asset Management Pty Ltd, Sydney, Australia.

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