Money Trees

One thing I can’t resist is timber land. It may be the world’s best long-term investment. Otto von Bismarck, the "Iron Chancellor" of the German Empire in the nineteenth century, couldn’t resist it either. More than a century ago, he built a fortune and bought up land and trees, convinced that the repository of true wealth was the land on which you could grow trees.

His theory was that the price of land would gradually appreciate in line with population growth, or about two percentage points annually. He calculated his real return from timber land would be about 4.75% a year, in a time of negligible inflation.

Investors can make money from timber land and get paid for it '” again, and again, and again. Here’s what it will look like (assuming land and timber prices stay constant to keep the arithmetic simple):

We buy a hectare of land for $6000 and sell it immediately for $9000. In 10 years, we sell it again for $9000, and for another $9000 10 years after that. After 100 years, we’d have sold that land 10 times for $90,000, while still retaining full ownership. It sounds too good to be true: We get timber land, and somebody else pays for it, again and again. Let me explain how it’s possible,

West Australian-based Great Southern Plantations is in the timber business. Here's how it increases its land base, and gets somebody else to pay for it. For $3000, Great Southern sells individual investors in Australia the rights to the harvest of a third of a hectare of timber land, 10 years into the future. The buyer does not get the land, just the proceeds from the sale of the timber, less Great Southern’s take.

The land might cost Great Southern $6000 a hectare, but it is selling one-third-hectare plots for $3000 each, giving it $9000 a hectare from investors. Great Southern plants eucalyptus trees, harvests them about 10 years later and concludes the contract with the investor.

Great Southern still owns the land, and can sell it again for $3000, even though its “cost” is now zero. And it can do this over and over again. The first chunks of timber land were sold to small investors in 1994-95 and the trees are reaching maturity. They will be harvested and the land resold.

The Australian Government wants its citizens to invest in sustainable forestry, so has offered a 100% tax-deduction on investments in this kind of timber deal. Investors on the top tax rate of 48.5% can buy one of these projects for $3000 and get a cheque back from the Government for almost $1500.

The average investor stumps up $30,000 and can expect to receive their Government cheque without even putting up a cent.

Here’s how: Great Southern can lend investors the money to buy their stake and receive their cheque. Great Southern charges 12% interest on these loans, which it sells to the Bank of Adelaide to minimise its risk. The deal sounds almost irresistible to taxpayers, with its cashback guarantee and prospect of profits. Financial planners love it too: they get paid commissions of up to 10%.

THE CRACKDOWN

Too good to be true? Alas, yes. A lot of shady companies got into the timber business, essentially to extract tax money from the Government. In the late 1990s, the Government cracked down on these abuses.

People would “buy” into a socially conscious tax scheme, but put down no money. The scam was just to get the tax cheque from the Government. The “investors” would collect their $15,000 cheques, but never actually part with the $30,000 they promised. They were just scamming the Government.

In 2001-02, the Government passed a ruling on this, calling many of these deals fraudulent. Many investors got stung: they were asked to pay back-taxes on their years of shady deals, and given stiff penalties to boot. Sales of such tax-related schemes collapsed. Investors were scared off '” they didn’t know which firms to trust, or whether they Government would change its mind again some day.

Great Southern came out of the scandal a big winner. None of its investors got tax bills. But its competitors fell apart. Great Southern was even able to cherry-pick its competitors' assets. “We would have paid more than we did for some of them,” a representative at Great Southern says.

Australians remain wary after the rulings of 2001-02, but it’s all changing fast. Great Southern’s shares were obliterated back in 2001-02, and have recovered nicely. Sales have recovered dramatically, too. From $50 million in 2001-02, sales grew to $300 million in 2004-05. Sales in 2005-06 could easily exceed $400 million. And as financial planners that have just been added to the sales force get going, 2006-07 could see sales of $500 million.

For a company experiencing this kind of growth, you might think these shares would trade at growth-stock prices. You’d be wrong.
The consensus estimate of earnings from analysts in Australia for next year is 57¢ a share. At a share price of $3.50, that puts the price/earnings multiple of Great Southern (based on analysts' estimates) at about 6 times. That’s cheap!

Great Southern pays out a nice dividend too '” in the 5% range. The sweet spot for Great Southern really gets going in 2009. I say this because this is when the big “rollovers” start to happen with existing timber lands. Right now, Great Southern’s cash flows aren’t great, because they still have to use the cash coming in to buy timber lands.

But by 2009, they’ll have about 20,000 hectares a year rolling over, land they can “resell” at no cost to them. At the moment, business is almost too good. Great Southern is able to sell more investment products than it has available land. So it’s been borrowing money (by issuing what are basically convertible bonds) to buy chunks of land.

DIVERSIFICATION

Great Southern has acted opportunistically. It has used the proceeds from these convertible bonds to acquire some existing grape plantations in the Margaret River area, south of Perth, and some cattle lands. They can package and sell these as investments similar to their timber deals, with returns coming to investors much quicker than with timber land.

This also diversifies Great Southern, so they don’t have to always rely on timber land. In short, they’re expanding their product mix.
The biggest concern to me here is shareholder dilution, as Great Southern’s preferred method of buying properties lately has been to use convertible debt. But there’s one thing that makes me comfortable enough to recommend Great Southern, and that’s the stake held by John Young, Great Southern’s managing director.

Young owns nearly 50 million of the 300 million shares on issue. As of the latest annual report, he owned no convertible bonds.
The last thing he’d do is dilute his own wealth by issuing any more convertible bonds than are absolutely necessary to run the business properly. So although I have concerns about future dilution of shareholders, I know that Young will be looking out for his own shares, and will do his best to limit hurting his own wealth.

Great Southern’s timber lands were independently valued in June 2005 at $620 million. Its latest balance sheet showed about $120 million in cash '” earth and cash alone represent almost $750 million. Yet the stockmarket values Great Southern at about $1 billion. Beyond that are the loans (paying Great Southern 12%), and its loyal customer base (60% of its 30,000 customers in the latest year were repeat customers), and its distribution base of 5000 financial planners.

Remember, the investment product Great Southern sells is irresistible to individual Australian investors. It gives the average investor a $15,000 tax benefit immediately, and a nice return on investment in 10 years time. It’s also irresistible to financial planners, as Great Southern pays out large commissions.

Great Southern can practically grow as fast as it wants. Remember, the big profits will start to show in 2009, as larger tracts of land are able to be resold. Australians are still sceptical about tax schemes, so the shares are unloved. For now, Great Southern is cheap at a forward price/earnings multiple of six and paying a dividend yield of 5%. But the uptrend since 2002 is clearly in place.

All this is well and good. But it’s not the important thing. The important thing is the land that Great Southern gets paid every 10 years to hold and increase. That is the jewel.