Timbercorp one of the best AGMs ever

December 4, 2008

This is the report sent to Mayne Report subscribers hours after the Timbercorp AGM finished on February 21, 2008.

Dear Mayne Report subscribers,

That headline doesn't mean the Timbercorp chairman and CEO were hung, drawn and quartered - although both departures were announced at today's meeting.

No, the Timbercorp AGM today was fabulous for the quality of the debate. There wasn't a single dud question from the ten shareholders who delivered about 90 minutes of exchanges.

And this is what happens when professionals get involved. Leading the charge was boutique Sydney-based fund manager Fred Woollard - the man who almost demutualised Britain's venerable Standard Life. Also down from Sydney was former Macquarie Bank executive turned editor of The Intelligent Investor, Steve Johnson.

Then you had farmers, the Australian Shareholders' Association and long-time investors in Timbercorp's MIS schemes all asking good questions about returns, water rights, debt and the forthcoming ATO test case.

Whilst it took a few goes to get a really clear picture on the debt questions, the overall detail of answers provided was very good, with no less than five different directors answering questions. At the end of the inquisition, Timbercorp shares recovered 8.5c to $1.105 so the board should be well pleased with their efforts.

Directors margin loans

Have a listen to the opening salvo asking about margin loans on board and executive shareholdings.Founder and chief executive Robert Hance came straight out and said his 52 million shares were geared to less than 10% and he had plenty of other resources available. The accounts show the company has lent him $2.4 million so he's basically saying there are no other loans against the $55 million stake and he's going straight onto The Mayne Report Rich List.

At 72, the impending retirement of chairman Kevin Hayes wasn't a surprise, although handing over to another former chairman of the Victorian Racing Club in Rod Fitzroy is a little in-house.

Hayes was the closest thing to an independent director of Timbercorp. Real estate luminary Fitzroy certainly isn't given he sold his almond plantations to Timbercorp for 3 million shares two years and is two years into a five year consultancy that hums along at $400,000 a year but isn't included in his modest $60,000 annual fee. Have a listen to how that issue was dealt with.

That said, Fitzroy also answered the margin loan question on his 4.1 million shares, saying it too was geared at less than 10%. We'll be adding his name to The Mayne Report Rich List shortly as well.

Lacking independent directors

The Timbercorp board would not please the corporate governance box tickers. CEO Robert Hance, the largest shareholder, is retiring on July 1 so deputy CEO Sol Rabinowicz can take over - but the founder is remaining a director.

Another director John Vaughan has been on the board since 1992 and took up an executive position in 2002. Then you've got the long-time external accountant Gary Liddell who has been a director for 11 years, is a past chairman and now chairs the audit committee.

Just like MFS and Allco, Timbercorp is lacking in quality independent directors - but that's not to say the vast experience on show today wasn't quite impressive.

The largesse of racing sponsorships and financial planners

Asking this double-headed question about debt and racing sponsorship allowed chairman Hayes to ignore the bigger gearing issue. Thankfully, he informed us that the "400,000 Timbercorp Australian Stakes" at Moonee Valley on Saturday only cost $35,000 and CEO Vance personally looked after half of that.

Hayes reckons it was great value, especially because it allowed Timbercorp to entertain loads of financial planners and advisers who are the "backbone" of its investment management business. This opened the door for a follow-up question about the ethics and structure of financial planning in Australia, covering everything from Alan Kohler's planners jihad to commission-hating industry funds and the Rudd Government's potential threat to the industry.

Timbercorp admitted to paying juicy commissions, albeit lower than many of its rivals, but said some moves to a fee-for-service model were already underway. Hayes said he would love Timbercorp to be able to afford to fund its own in-house sales force but it was just too expensive.

Answering the debt question

Timbercorp's listed debt instruments are yielding more than 20% which suggests the market believes there is considerable risk involved. Fred Woollard and others honed in on the $280 million in current debts out of a total of more than $860 million, suggesting a gearing ratio of 60% was on the high-side in a credit-constrained world.

Sol Rabinowicz said more than $100 million had already been rolled over this year and much of the rest was lease liabilities and margin loans that will always be classified as current. There was no detail given on who banks the company, but we were told about a number of smaller facilities which gave greater flexibility and funding diversity.

My final debt question pointed out that the problem with Centro, Allco and MFS was something called cross-collatoralisation where a vehicle looks separate but liabilies can spread to the parent company in certain circumstances, such as a default. When this happens, you then get a run on the fund and once you freeze redemptions your reputation is shot.

The reassurances from chairman Hayes, auditor Sandy Pelusi and Rabinowicz were emphatic. There is one $20 million loan facility that is guaranteed and on the balance sheet, but the rest are completely at arms length.

The future of Timbercorp

I walked out the meeting thinking that Timbercorp was a speculative buy after plummeting from $4 to $1 in just 18 months, giving it a market value of $350 million against claimed net assets of $520 million. It is facing regulatory risks but the company has built up huge land holdings and water rights over a staggering 100,000 mega litres.

It is well placed to ride the soft commodity boom and we were regaled with those familiar statistics about the world needing to feed an additional 87 million new mouths a year. Competing with Chinese garlic and Spanish olives is also important for our current account performance.

That said, the company does appear to have overpaid for some of its land-holdings. Investors who bought into the early eucalyptus schemes 10 years ago are only now getting their final payouts and the annual returns have been between 2-4% on a pre-tax basis.

Rabinowicz predicted they would get better over time and possibly even reach double digit figures - but this is hardly spectacular. Whilst the ATO and Rudd Labor could well kill off the MIS model, Timbercorp has a powerful argument in pointing to the huge investment it has made in regional communities.

Many farmers haven't enjoyed the tax-driven corporatisation of farming, even though a number have cashed out their land holdings to Timbercorp. The company has strategically built a huge amount of water entitlements but these are difficult to sell on a stand alone basis, although there was talk today of spinning out a separate water fund. Many dairy farmers now find their water rights are more valuable than their properties but it usually makes sense to sell them together.

The company was fortunate that it managed to raise more than $60 million in a placement and SPP two months ago because it has been tanking in recent weeks.

Based on what I heard today, the company has been unfairly tarred by the demise of other complex investment managers such as Centro and MFS. However, it could simplify its structure and improve governance to try and win back market confidence. New Agriculture minister Tony Burke would probably be impressed by such a move as he drives a review of the MIS industry

As Fred Woollard said today, why leave your debt securities trading on a yield of 20% and lend almost $400 million to growers at about 9%. Then again, that's the business model and Timbercorp enjoys a margin clipping the ticket on the way through, as does its army of advisers. Indeed, Timbercorp's annuity income is predicted to rise from $240 million to $300 million this year which seems rather high given the low returns tax-driven investors have enjoyed so far.

All up, it was a very good meeting. My five questions are packaged up here and I'd rate the exchanges amongst the best 10 of the 300-plus AGMs I've attended over the past decade.

Do ya best, Stephen Mayne