Mike Bolan

As amateurs, Gunns relied too much on Jaakko Poyry, who were in the business of selling them a pulp mill and damn the consequences. Poyry’s recommended mill was too big for the island and certainly too big for Gunns. Gunns have a lot to be thankful for…if they’d gone ahead with the mill they could have been ruined. Their latest problems have created a breathing space for them to develop a better business model, perhaps finding more profitable lines of timber business in the high value/high profit end of the market.
Original meaning – Injured by the device that you intended to use to injure others.

Last week, Gunns shares fell 25% to $1.67 before Gunns asked the stock exchange to stop trading them. Importantly, they say they can no longer ‘assure’ that they’ll complete a pulp mill (1).

From a project perspective, Gunns could never give such assurances while the project contained so many undefined risks. Given their industrial inexperience and weak financial position, all of their previous ‘assurances’ about the project can now be seen to be hollow and self serving.

Their project has left many shareholders with major losses, disrupted communities, created massive divisions and tarred many politicians who may later come to regret giving their support.

From a project management perspective, Gunns defeated themselves, (q.v. Alex Wadsley’s excellent analysis (2)), repeatedly knocking themselves to the canvas until they had no energy left to get up.

Decisions that appeared clever in the short term, have turned out to be detrimental in the longer term.

Value add or overhead?

Gunns mill fantasy appeared to be that they do nothing except assure political and financial support and resource access, while others do all the real work and take all the operating risks – Poyry et al building and running the mill, contractors doing all the grunt work and take all the fuel price risks; and the public supplying all the wood at a knockdown price. Gunns then, as the resource and permit controller, would cream whatever they wanted off the top.

Nice work if you can get it.

Trouble is, if they can’t deliver the finance, Gunns isn’t needed for that business model…they are an overhead – not a good negotiating position.

Plantation ‘investors’ could cop big losses if they only get the government ‘wood supply’ price of $15 tonne for trees that cost the ‘investors’ around $40/tonne to grow, opening the possibility for major legal attacks on those who promised a higher price e.g. Gunns.

Tax processing

The company consumes public resources, at well under market prices, and requires large subsidies. The value of these ‘favours’ has been calculated at over $250 million per year (3), a figure set to jump to $350 million per year if the mill went ahead.

It has been shown time and again that disconnecting a company from the free market with generous subsidies, can quickly lead to a lack of competitiveness as the company starts to rely on subsidies instead of becoming responsive to the marketplace. Of course, their choice to enter the highly competitive high-volume, low-value international commodities market also exposes them to substantial risks.

Subsidised industries tend to take the easiest, lowest cost path to making money – i.e. they rely on taxpayer support.

The business of forestry – Tasmania style, takes valuable resources and degrades them, selling the chipped product into a volatile low cost commodities market. A pulp mill amplifies these problems –

• decades old trees -> undifferentiated chips;
• fresh water -> toxic waste;
• clean rivers & creek -> contaminated water;
• clean air -> smelly fogs;
• native forests -> dust and ash bowls;
• food farming land -> tree plantations in perpetuity.

By relying on legal, access, assessment, resource, regulatory, disclosure and other favours, Gunns has become taxpayer dependent for many aspects of its business including its ability to post profits. It is self defeating for them to alienate so many of the taxpayers whose support they absolutely rely upon.

Oh dear…they’re down again

Here are some other examples of self harm…

•They caused plantation land to be locked into forestry use ‘in perpetuity’, thereby massively reducing the value of their land holdings because they cannot be used for higher value purposes;
• they withdrew from the RPDC to avoid proper scrutiny and thereby lost project of state significance status which prevented them from acquiring the land for their pipeline;
• they wanted a ‘world scale’ mill thus creating a massive debt requirement that they couldn’t service and that became their own mill stone;
• they got a sweetheart wood price for public timber which undercuts plantation investors and attacks the perceived sale value of their own plantation timbers;
• they wanted a benefits only assessment to help assure approval and so missed the risks that exposed them to refusal of finance;
• they wanted the Pulp Mill Assessment Act Section 11 to remove all rights of appeal against them but now it deters land owners, contractors and others from dealing with them;
• they got total government support before the project was assessed thus stimulating widespread community anger and action. Their legal attack on the Gunns 20 was similarly ill conceived as they came across as ‘bad guys’ with something to hide.

The ANZ bank has just ejected 8 senior managers who failed to loan money to reasonable banking standards thus exposing the bank to serious losses (4). The ANZ has also been reported as being particularly exposed to business debt failures or corporate loan obligations (CLO) with more write downs being forecast (5). ANZ’s appetite for corporate risk is likely to decrease even further which will magnify their worries about Gunns $1 billion overdraft, let alone their ability to repay an extra $2 billion for a pulp mill.

Unpleasant sums

When Gunns share values drop, their company declines in value (share value X shares issued) and their loan collateral becomes an ever shrinking portion of their debt.

As their collateral shrinks so their repayments increase, and if the ANZ has exercised normal prudence, Gunns will have to stump up some pretty big cash sums to cover the increasing risk. It was $170 million 14 days ago and quickly changed to $440 million as their shares plunged.

Their current profit forecast of $64 million would have been calculated after they had deducted the interest on their loan (up to $100 million per year).

If they’d bought their $2 billion pulp mill, they would now owe $3 billion and be paying up to $300 million per year in interest, putting them into an annual loss making position. With $64 million profit this year, that would put them in negative territory until the mill started being profitable.

As amateurs, Gunns relied too much on Jaakko Poyry, who were in the business of selling them a pulp mill and damn the consequences. Poyry’s recommended mill was too big for the island and certainly too big for Gunns.

Gunns have a lot to be thankful for…if they’d gone ahead with the mill they could have been ruined. Their latest problems have created a breathing space for them to develop a better business model, perhaps finding more profitable lines of timber business in the high value/high profit end of the market.

Finding a business partner

Gunns company is worth around $750 million (say), their debt is $1 billion and their profits are $64 million. They aren’t great returns, and business partners would probably have to accept the Gunns management team as part of the package, so there’d be significant cultural issues.

Gunns is in a poor negotiating position. The result of a partnership arrangement would dilute Gunns shareholders and divert a fair bit of income into the pockets of the partner – unless they go for a separate joint venture.

An Asian country may be interested, but would lead to a shift in ownership requiring a range of government approvals in the face of promised local opposition.

Could Poyry or a similar pulp/paper operator be interested? Poyry sells mills to buyers who take all the risk. It’s hard to see why they’d want to reverse that in the current financial climate.

The super sized mill would still need $2 billion or more and wouldn’t produce anything for a couple of years during build, meanwhile the interest bill keeps piling up. Meanwhile fuel prices, water availability, political support and other variables could all be changing rapidly.

We live in very uncertain times, hardly a good time to bet $2 billion on a pulp mill that requires so many resources and returns so little over the next couple of decades. Armaments, oil and energy are all much safer investments with significantly higher returns for anyone with a couple of billion to spare.

Separate joint venture

Gunns has tried to invoke the ‘magic’ of a separate joint venture with them supplying the trees, contractor relationships and political connections and the venture partner supplying most of the cash. To put up $2 billion will require at least a further $600 million in interest before the mill starts to earn anything, all in order to get a $7 billion return over 20 years – not very attractive. For this to work, the venture partner would need to take most of the financial risks while Gunns contributed little. Such asymmetry isn’t very appealing.

I’m led to the same question – who wants to stump up $2 billion plus for a pulp mill in Tasmania when world oil prices are looking highly volatile, when rainfall is decreasing, when cash & credit is in such short supply and when the venture partner is Gunns?

Pop goes the bubble

The IIS and mill project information can now be seen as a marketing puff piece signalling total government support and a benefits only ‘analysis’, all to shore up an $X billion loan against plantations as collateral and consume publicly owned trees to pay it all off.

Gunns directors would presumably fly around in helicopters toasting their success while the millions rolled through their banks and John Gay added more floors to his mansion.

Trouble was, the puff piece didn’t have enough substance and so couldn’t withstand informed scrutiny. Ex Resource Planning and Development Commission (RPDC) mill expert, Dr. Raverty, reminds us that Gunns couldn’t meet the RPDC requirements, hence the ‘withdrawal’ and later subversion of the planning process.

Ex Premier Lennon’s bibulous fantasies that Parliament could somehow paper over the gaps in the business case for the mill, foundered on the rock of ANZ’s own internal assessment processes and on subsequent market realities.

With the progressive unwinding of the global credit system, the serious holes in the business case, the lack of analysis of critical variables (e.g. uncertain fuel prices, water availability for plantations, capacity of Tasmania’s soil & rainfall to support plantation rotations) and the growing public furore, Gunns hyped up puff piece began deflating big time.

Goodbye to friends

At the end of the day, mill apologists have led their political friends into positions of severe electoral risk and embarrassment. Several have already been sacrificed for Gunns ambitions, and there are probably more to go.

With their mill plans losing credibility, Gunns has offered no alternative means to create profits. Any business that can only degrade resources is doomed when resources become more valued and scarce.

There’re at least 2 big problems that Gunns has to deal with – a further loss of market confidence with more share price collapses, and whether they can turn their company into a serious market performer in the future in a way that captures share market interest.

Our ‘sustainable’ forestry industry has been heavily subsidised for decades, and now that Gunns has exposed themselves to market forces, it’s starting to look as though they won’t be able to cope without the walking frame.

That suggests that they’re not a real business at all, they’re just a consumer of subsidies, which means that without the subsidies, Tasmania’s forests would be saved and our health system could be properly funded.

Next weeks announcements by Gunns will be most revealing.

Watch this space

Mike Bolan

is a complex systems consultant, change facilitator and executive/management coach.

1. http://northerntasmania.yourguide.com.au/news/local/news/economy-business-it-finance/gunns-unable-to-give-pulp-mill-assurance/1257104.aspx
2. http://oldtt.pixelkey.biz/index.php?/weblog/comments/the-importance-of-critical-thinking-in-environmental-management/
3. http://oldtt.pixelkey.biz/index.php?/weblog/article/mill-doing-the-sums/
4. http://www.theaustralian.news.com.au/story/0,25197,24226199-643,00.html
5. http://business.theage.com.au/business/credit-crisis-to-hit-business-debt-20080822-40fu.html
N.B. This is a rewritten copy from A Better Australia’s newsletter and is intended only for information purposes and is not for making investment decisions.