Clarky's Comment - November 2010

I detect an interesting trend emerging in forest ownership in New Zealand. The jury is still out but with one major sale to Chinese interests announced and other potential forest sales in the pipeline, my guess is we will see a trend of forest ownership moving from institutional funds to entities seeking security of log supply.

Institutional funds typically apply strong discipline around their due diligence, going into considerable detail to ensure the forest resource is well-described and understood, and logistical and market risks are fully factored into the buy price. The fund's only income from the forest is from the spread between buy and sell price, and cash generated during the forest ownership period.

An entity that is purchasing to ensure access to a log resource will be factoring in the opportunity to add value by either trading logs or processing those logs into wood products that they may then sell, or even partly use in their own construction business. Some may be seeking to become established in New Zealand as a stepping stone to secure additional logs via stumpage purchase from other owners or to buy logs delivered to wharf. For this reason the "resource security" buyer of a forest can take a more strategic view of their NZ forest investment, linking forest ownership to revenue streams outside of that particular forest gate, and therefore perhaps put less emphasis on the detail of the forest description and assessing market and price risks.

The big question is what this trend may do to New Zealand forest values going forward and whether that generates further change in forest ownership. Once 3 or 4 material sales of this nature have taken place, and the valuers start building implied log prices paid into their valuation models, we could see forest values rise to the point that earnings rates become unattractive for institutional investors – meaning their best option is to sell.