30/04/2009 - 00:00

Timbercorp felled by mountain of debt

30/04/2009 - 00:00

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AGGRESSIVE and often controversial managed investment scheme (MIS) operator and latterly, corporate agriculture company, Timbercorp, has succumbed to the weight of its ever-increasing mountain of debt.

Timbercorp felled by mountain of debt

AGGRESSIVE and often controversial managed investment scheme (MIS) operator and latterly, corporate agriculture company, Timbercorp, has succumbed to the weight of its ever-increasing mountain of debt.

An inability to refinance this debt, combined with shrinking value of its land bank and other investments, have forced Timbercorp's bankers to pull the plug. For a while at least the bankers will become proud owners of some of Australia's most productive farming and forestry land, potentially offering an opportunity for new owners to step up to the challenge and pick up some bargain deals.

This company's corporate demise puts at risk billions of dollars of future tax payments to the Federal Treasury. Briefcase wonders if, in the final wash up, all MIS-driven agricultural companies have simply been transferring money from the public purse into the pockets of the MIS promoters, taxation accountants, financial advisers and 'product' marketers.

For the uninitiated, MIS schemes are effectively pooled investments, run by a promoter on behalf of individual investors who are offered a tax deduction, in the year of making a subscription to set up a crop, such as blue gum plantations or vineyards.

Investors expect, or at least are encouraged to believe, that when their crop of grapes, almonds or woodchips, as the case may be, is harvested by an MIS scheme operator or its contractor, a profit will be earned and tax will be payable to the Treasury, offsetting the tax benefit engineered at the beginning of the investment period.

Along the way, these investments throw off a golden stream of fees to the MIS operators. There are fees for planting, fees for management, fees for provision of finance, fees for harvesting and fees for marketing product.

The technical and financial performance of many early blue gum plantations has fallen well below original estimates. Poor tree growth rates, rising costs and weaker markets for product have left investors with little to crow about, except that they were able to reduce their tax liability for the original 'investment'.

Early blue gum plantations have delivered about 50 per cent of originally estimated woodchip yield at harvest, while wine grapes have been a disaster for many. Glutted markets, poor horticultural practices and poor land selection have sent many schemes to the land of the liquidators.

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Taxpayers have every right to be concerned that the business models run by Timbercorp and its peers, such as ITC (now owned by Futuris) and Great Southern Plantations will not deliver value either to the investors who subscribed, or as often borrowed funds to grow blue gums and horticultural products such as wine grapes, mangoes and almonds in the heavily promoted, glossy, tax avoidance schemes. The one exception to this claim could well be sandalwood plantations, since the price of sandalwood and sandalwood oil has skyrocketed, making some of the earlier plantation deals, before the costs of buying in went up, look very attractive.

Tax-driven agricultural projects have come in for well-earned criticism by rural groups and communities. The usual gripes rest on distortions to the market caused by large volumes of 'city money' flowing into selected crops. The money was seen as being misdirected at front end loaded, monoculture, disrupting local communities by raising the price of land and everything else in the country and ultimately destroying markets for end products. These effects are no more noticeable than in the wine industry, where tax driven operators, such as Palandri, established vineyards against a backdrop of a grape and wine glut, destroying markets for its competitors.

Amazingly, Palandri was able to get away with establishing a vineyard on land which it leased from one of its original directors, using investors funds, however the investors were only entitled to benefit from the sale of fruit grown on their plots for about 20 years, after which the fully established and by now desirable 25-year-old vines, were returned to the full ownership of the director. Nice deal.

Meanwhile, Timbercorp's story is extremely educational. During the past four years, the company's accounts record that it made $246 million of net profit after tax. However, over that same timeframe, the business consumed $63 million of cash within its operations, net of all operating income, and in addition it used a net $627 million to buy land and other investments. So all up, the company needed to support its $690 million spending habit with an addiction to debt and new equity from unsuspecting shareholders.

While this party was happening, management rewarded itself with about $17.9 million in wages and bonuses for a job well done. Tellingly, each year, the company spent about $22 million on marketing. Thus, Timbercorp's marketing expense grew from representing 28 per cent of net profit after tax (NPAT) in 2006 to reach 48 per cent of NPAT in 2008 while executive remuneration represented 6.5 per cent of NPAT in 2006, but grew to 9.2 per cent of NPAT by 2008.

Fees paid to financial advisers in the MIS industry are the stuff of legend and have paid for many a European family skiing holiday for the advisers concerned. By comparison, if you subscribe money for a managed fund, you can expect an annual management fee of between 0.9 per cent and up to 1.8 per cent with no entry or exit fee. When you buy shares, your adviser might charge 0.3 per cent to 1.5 per cent of the purchase price for the service, depending on the size of your purchase.

MIS schemes come with fees to advisors ranging from 6 per cent and up to 13 per cent, if all the hidden kickbacks and trailing fees are added up. These investment products were effectively shoved down the throats of relatively reluctant buyers by 'highly motivated' financial advisers, who were regularly duchessed at the company's and ultimately the investor's expense.

If MIS schemes offer such a good deal in their own right, investors should be queuing down St Georges Terrace to buy them and there would have been no need to offer such generous fees to intermediaries. Instead, sophisticated financial engineering was used as a lure, so that well-heeled investors paid virtually nothing to 'buy' highly geared investments in order to avoid paying tax and not because they thought the MIS offered a good investment beyond its tax advantage.

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How far behind the curve is the IMF really? Recent poor predictions by the IMF represent a lagging indicator at best. Last week the IMF said unemployment in Australia would reach 7.9 per cent next year. Yeah right. Even the treasurer is saying that 10 per cent is a possibility, so Briefcase recommends that readers completely ignore the golden word of the IMF's highly paid economists and watch the gold market instead.

Recent strength in commodity prices, especially copper, where inventories have fallen 15 per cent over the past couple of months, possibly reflects a change in policy by the Chinese central administration.

Given the option of holding $US4,500 for the next year with virtually zero interest rates, or buying a tonne of copper, they are opting to hold the copper, which at a minimum will be consumed and be some use to the country, but China's concern about the long term value of holding US dollars is more than likely to be well founded.

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The global financial crisis has not caused a looming food shortage to disappear; it is just being hidden. The Food and Agriculture Organisation (FAO) in its first assessment of the upcoming harvest said it expected global cereal production would drop 3.1 per cent to 2,217 million tonnes this year. Inventories of cereal have been in a downwards trend for nine years, but this year the ratio of world cereal stocks to consumption rose to 24.6 per cent from 20.2 per cent in the previous season, probably due to a decline in consumption, because crops were not huge last season. The FAO expects wheat production will fall 4.9 per cent and course grains such as corn to fall 3.7 per cent while rice production is set to rise 0.7 per cent on a year ago.

n Peter Strachan is the author of subscription-based analyst brief StockAnalysis. Further information can be found at Stockanalysis.com.au.

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